For most schemes, now is not the right time to offer in-house drawdown
Defined contribution pension schemes have been slow to introduce in-house drawdown. In fact, according to research from law firm Sackers, while 67% of schemes are already offering new options, only 14% are planning to offer flexible drawdown in-plan.
Nevertheless, the freedom and choice regulations have created an expectation among consumers that they will have access to all the new options, such as cash and drawdown, as well as more traditional annuity products.
And many retirees are baffled that they have to move their savings into retail products such as SIPPs to be able to take advantage of the new freedoms. This frustration is only exacerbated by high exit penalties and slow transfer times.
With the government launching an inquiry into why providers have been slow to create new products and assessing whether members have been granted adequate access to freedom and choice, some questions have been raised as to whether schemes should be doing more.
They’ve got no commercial imperative to do this”
But Richard Butcher, independent trustee and managing director of PTL, believes that schemes have good reasons for delaying on freedom and choice and are meeting with the necessary regulatory requirements.
“They’ve got no commercial imperative to do this… so they were quite happy to wait and see what happened. In any event, [schemes not offering drawdown] hasn’t frustrated freedom and choice because people have always had the right to statutory transfer.”
Gregg McClymont, head of retirement savings at Aberdeen Asset Management, agrees that trustees are being unfairly criticised. “It’s such a big change, isn’t it? There are so many questions around the ongoing potential role of trustees that I don’t think it’s a surprise that there’s not been a rapid move towards a post-retirement framework for scheme members.
My own view is that it would be unfair to point the finger at trustees”
“When you have lots of smaller pension schemes the demand on resources is always significant – so it’s not a surprise that trustees are wanting to approach this in a calm and cool-headed manner.
“My own view is that it would be unfair to point the finger at trustees, because they are trying to manage a situation which has changed overnight without consultation, and something that potentially fundamentally changes the nature of a pension.”
Some commentators have remarked on the relative slowness of trust-based schemes in adopting the freedoms, when compared with their contract-based counterparts.
Are trust-based schemes slower than contract schemes? Possibly”
However, this is an unfair competition, as contract-based schemes have a commercial imperative to offer freedoms quickly. With annuity sales as low as 10%, the insurance landscape is scrambling to keep hold of people’s assets in other ways.
Paul Faulkner, director of administration at RPMI, a pension scheme administrator, thinks that a steady approach may be best. He says: “Are trust-based schemes slower than contract schemes? Possibly, but the trust-based schemes are ensuring that they maximise the availability of these freedoms for their members. They’re not necessarily altering what their particular scheme is able to provide, but making sure that members have access.
The main thing is that trustees are not rushing into things”
“That may give the impression of being slow to react but it’s because ultimately as long as a member has the ability to make those choices, then they’re satisfying the regulations.”
Helen Ball, head of defined contribution at Sackers, says: “The main thing is that trustees are not rushing into things. That’s probably what’s causing a lot of frustration on the occupational side, but there are good reasons why.”
So why might trust-based schemes elect not to offer drawdown to their members?
1) Sponsor reluctance – enterprise risk
A big issue is that providing drawdown means trustees and employers will be taking on more enterprise risk (organisational risk). Butcher believes this means that in-house drawdown won’t be appropriate for most schemes.
“Their concern is for the welfare and wellbeing of their staff – not people who retired 30 years ago. I think most trustees of single-employer schemes said: ‘We don’t need to do this, we don’t particularly want to do it, there’s a risk to doing it, so why should we bear that risk and cost? Let’s just leave it to the commercial market’.
“It’s going to be the large schemes that do it if anybody does it. J.P. Morgan got quite well advanced with their plans on it but then the Americans decided against it because of enterprise risk.”
Steve Budge, principal DC and savings at Mercer UK, points out that even when trustees are keen to look at in-house drawdown, sponsors are ruling it out because of this risk.
“Clearly there’s a nervousness in the market in terms of clients and schemes wanting to offer some flexibility but, because of the nature of drawdown, it exposes members to a lot more risk in terms of running out of money.”
2) Governance challenges
As well as creating enterprise risk, bringing drawdown in-house creates an ongoing governance challenge for trustees.
McClymont explains: “Generally speaking, trustees’ jobs stopped at retirement and so that’s a big shift towards the trustees having a significant role in governing options for retirement income.”
Ball argues that these ongoing risks and concerns demonstrate why most trustee boards would rather leave the at-retirement provision to third parties such as insurers.
“It’s far easier if you’re a trustee to say to members: ‘There is a developing market of service providers who have lots of business need to develop drawdown, to develop different kinds of annuities and so on. Go there, we’re not in the business of providing complicated pension things. We’re just the accumulation phase of your pension.’
“I don’t see the need for in-scheme arrangements. Why build the infrastructure when it’s freely available elsewhere?”
3) Lack of appetite
One of the reasons trustees have been delaying providing access to drawdown is that many of their members don’t want it. Most retirees have been taking their benefits as cash, probably because most have very small DC pots – often underpinned by a DB scheme.
Faulkner says: “All we need to do to satisfy the requirements is make sure members have the ability to transfer out to a specialist provider. We are considering whether we’d wish to offer our own income drawdown solution, especially now our DC scheme is an auto-enrolment vehicle. We want it to be credible and flexible.
“So we’re considering that, but we’re considering it in a measured fashion because at the moment our stats, such as they are, show that members haven’t shown a great deal of appetite for it.”
4) Lack of product innovation
Another challenge, according to McClymont, is that all the surveys suggest that pension scheme members would like both flexibility and security of income.
He says: “That’s not straightforward to achieve, so I’m sympathetic to the challenges trustees are facing. In terms of the product side of things, asset managers are developing income products and multi-asset products, but that product innovation is at a relatively early stage, not least because those at retirement at the moment are, according to all the evidence, tending to take cash in larger quantities than investing in markets.”
Budge agrees. “There’s definitely a lack of product innovation. I don’t think anyone’s at fault here, there just hasn’t been much time to put things together.”
5) Lack of scale
Another key issue is how schemes can get enough scale to provide true value for money with in-house drawdown.
RMPI’s Faulkner uses the Railways Pension Scheme that it administers as an example. “In principle, the trustee is in favour of providing that facility, but clearly they want to make sure they are totally focused on members’ value for money.”
“So even if technologically we are able to provide it – if we can’t provide at as low a cost as is available in the market we wouldn’t touch it, because why should a member pay more to stay if they can pay less and go?”
Ball believes that only the big mastertrusts or perhaps some of the very largest single-employer schemes will ever be able to achieve true flexibility. “Over time it is more likely that they’ll think about some of the new flexibilities because they’ve the scale to provide the funding to do it.”
Even though most schemes probably won’t and perhaps shouldn’t provide access to drawdown, there are still things trustees can do to make switching out less disruptive for members.
One solution is to work with a preferred provider of drawdown solutions.
Butcher explains: “The trust could buddy up with a commercial provider or perhaps a commercial mastertrust, so the individual can move across from the single-employer trust to a commercial mastertrust and gain access to drawdown.”
Three questions when choosing a preferred drawdown provider
1) Are they an organisation of sufficient standing that you can trust them?
2) Have you spoken to your investment advisers about this?
3) What do you say and how far do you go in pointing people to these things? Trustees must ensure that they make consumers aware of the other options out there
If you look at how schemes were operating before April – when most people defaulted into an annuity arrangement – many plans tended to have agreements with brokers, and the brokers would choose the annuity for the scheme member.
It’s possible that similar ‘drawdown brokers’ could spring up that give members either a set of options or look at what’s available and make a recommendation.
For RPMI, the issue is less about providing members with access to specific providers and solutions and more about providing them with guidance or advice to enable them to pick the best product for them.
This is the approach the scheme itself has been adopting. Faulkner says: “All our outputs have been devised to ensure that in these circumstances we’re flagging the need for independent financial advice.”
One possible way to deliver part of this retirement puzzle is through digitally guided outcomes”
“We’re not in the business of providing advice – as an administrator we can’t – but we do try to bang the drum about the importance of getting that independent financial advice and determining what the best course of action for an individual is.”
McClymont thinks digital solutions could help here. “One possible way to deliver part of this retirement puzzle is through digitally guided outcomes. So maybe not a provider literally just saying ‘here are our products’, but also ‘here are our tools that help your scheme members make the choices they need to make’.”
Scheme communications are crucial”
Budge agrees that scheme communications are crucial. “From our point of view, where we are getting most interest is in how you support people and engage them into making sure they make the right decision rather than worrying too much at this stage about where it’s best supported.
“Raising awareness is probably the first target from the trustee’s point of view.”