December 3, 2012, by CRBFS Professor James Devlin
Pensions: Time to Reconsider a Kite Mark?
Here at the Forum, we have been reflecting recent research concerned with attitudes, expectations and behaviour in pensions. A report by the National Association of Pension Funds, in conjunction with the Institute of Fiscal Studies, provides an excellent indication of how attitudes have to change and become more realistic if people are to enjoy a comfortable retirement. The research focussed on the over-50s and Defined Contribution (DC) pensions. The first notable finding is the highly unrealistic expectations held about likely retirement age compared to probable income in retirement.. Over a third of women either have, or still expect to retire at 60 and over 20% hope to retire before 60. For men, over 40% either have, or expect to retire by 65 and only 9% expect to retire after 65. Both women and men underestimate how long they are likely to live in retirement, meaning that they will tend to under-provide and also that annuity incomes will appear relatively unattractive. Although in many cases somewhat confused about likely future pension incomes from DC schemes, expectations as to likely future income tend to be over optimistic, with an average increase in DC fund value of 77% required to meet expectations. Overall, the message is clear; to enjoy the expected relatively comfortable retirement people will have to save more, work longer or a combination of the two. People are also harbouring unrealistic hopes about how comfortable their retirement will be, and although not a popular message, the Government and policy makers should arguably be doing more to disabuse people of such expectations before to is too late to act. The NAFP/IFS report focussed on the over-50s, the segment generally considered to be in the most favourable position in terms of pensions. Another recent report by the Pensions Institute looks at a broader age group and considers the impact of auto-enrolment. Auto-enrolment began in October and will be phased in fully over the next 6 years. The aim is to ensure that all private sector employees (except the very lowest paid) have a private pension scheme into which they and their employer contribute. The National Employment Savings Trust (NEST) scheme has been championed by regulators and designed in accordance with DWP guidance on default fund investment strategies and is available to employers who seek to meet their obligations under the 2008 Pensions Act. It is also a low cost scheme, with an Annual Management Charge of 0.3%. NEST undoubtedly represents an excellent, low cost option for most potential savers. However, companies do not have to use NEST if they have an existing scheme and existing schemes are not tightly regulated in terms of charges and default fund investment strategies. The Pensions Institute encountered charges of up to 4% for existing small funds and noted that only 10,000 of the 205,000 existing DC schemes have more than 100 members. Therefore many existing funds are not sufficiently large to be efficient, meaning that many investors will be paying high fees and may well not even be aware of this fact. The Pensions Institute estimates that such charges could result in pension incomes being halved for some savers. Such outcomes are obviously not in savers’ interests and although pension companies have a duty to ensure that default schemes are competitively priced and the ABI is working on disclosure of charges to employees, arguably policymakers need to do far more to protect savers from the corrosive impact of high charges. Otherwise auto-enrolment will have far less of a positive impact on retirement situations than hoped and we may be witnessing another mis-selling scandal in the making. The Pensions Institute suggest a target total charge of 0.5% for any scheme deemed appropriate and recommend a “Kite-Mark” approach for schemes that meet this target and have good investment governance. Kite-Marks have a chequered history in financial services, with CAT standards for mortgages, ISAs etc having been widely regarded as an abject failure. A report written by the Forum for HM Treasury on why CAT standards (and Stakeholder Products) failed argued that a combination of supply and demand side factors accounted for such failures, but that a “Kite-Mark” based approach, along with an obligation to justify recommendation of/use of products that do not meet such standards may provide the most suitable approach. This finding echoes the arguments of the Pensions Institute and a Kite Mark approach is arguably the most effective way to ensure that those saving in an auto-enrolment scheme enjoy a retirement income that has not been eaten away by unreasonably high fees.
Great to see that HMT have asked you for research on ‘lessons learnt’ from previous initiatives in this area. I know when I went to speak to Carol Sargeant at the start of her review, officials were very interested in understanding more about this.
The FSCP has been very interested in this topic and, indeed, you reference the work for them by David Severn on Safer Products. They argue that an approach that focuses on outcomes rather than simplicity of constrcution may be a better apporach. I’d refer you to their research on this theme at http://www.fs-cp.org.uk/publications/pdf/straightforward_outcome.pdf which also discusses some of the practical issues to be addressed in implementing a kite mark approach.
It seems the debate in the UK has at its heart two different approaches being proposed. One is the provide consumers with products that are better points of comparison to enable them to then shop around for the best deal – this is effectively a demand-side approach. The other is to drive suppliers to provide better value (ususally, but not always, equated to lower-charged) products – this is effectively a supply-side approach.
The conflation of these two approaches can produce some very unpreditable environments for policy makers, regulators and suppliers. I suspect the approach of combining a ‘kite mark’ with a obligation to explain ‘why not’ risks just this situation. As an aside, the relevance of regulated advice, given the withdrawal of nearly all high street banks from such advice, probably makes this device largely irrelevant to a broad swath of consumers. But I guess this obligation could be extended to financial promotions in some way along the lines of cigarette packet health warnings.
The challenge for kite marking pensions is further complicated by the patchwork regulatory regime. The FSA regulates contract-based schemes but only TPR regulates trust-based. Creating a consistent kite mark that can span the wide range of offers that will be made to those being autoenroled is indeed a big ask. I know that DWP have kept a keen interest in monitoring the cost and charges in workplace schemes in the run up to autoenrolment, so it may also be helpful for you to review their literature on this topic, such as http://research.dwp.gov.uk/asd/asd5/WP91.pdf .