Speaker: Edwin Schooling Latter, Director of Markets and Wholesale Policy
Event: Pensions and Benefits UK 2019, London
Delivered: 25 June 2019
Note: this is the speech as drafted and may differ from the delivered version
- There has been significant growth in the pensions market subject to FCA regulation.
- Current priorities for FCA work on pensions include supervision and policy in relation to transfers out of defined benefit pensions, improving options and outcomes for customers entering “drawdown”, and countering pension scams.
- Strategic priorities for the years ahead are value for money and making consumer engagement easier.
I would like to start by thanking Professional Pensions and Workplace Savings & Benefits for organizing this event and giving me the opportunity to speak on behalf of the FCA.
I would also like to thank Charles Counsell for his thoughtful speech. You will hear many common themes in his and my own remarks. That is no accident.
A decade ago it might have seemed odd for the FCA to be speaking at an event described as ’specifically researched and developed for in-house pension and benefit scheme representatives’. Most of the pension schemes in question would have fallen within the regulatory scope of the Pensions Regulator (TPR).
By 2018 the total contract-based pension market subject to FCA regulation had over 25 million members with £667 billion of assets in accumulation.
However, the pension landscape today is already quite different. The FCA’s role is becoming increasingly significant. By 2018 the total contract-based pension market subject to FCA regulation (this includes workplace and non-workplace) had over 25 million members with £667 billion of assets in accumulation. Additionally, there were 7.2 million annuities in payment, backed by nearly £300 billion of annuity reserves and almost 1 million drawdown plan holders with around £116 billion of assets in drawdown.
Auto-enrolment has fuelled the growth in the workplace contract-based market. While annuity market stock figures have been largely flat for the past few years, the drawdown market has grown rapidly. Non-workplace pensions have also seen significant growth, notably as consumers have used the market to consolidate pots before accessing pension freedoms.
But let me pause for a moment before I delve further into the substance.
While I have spent enough years in financial regulation to tell me that I must be quite a bit older than I’d like to think, I should note that I am relatively new to the field of pensions. I assumed this role in October last year. So, my remarks today will include my own impressions and observations after those first 8 months. I will conclude by linking these observations to the areas that are strategic priorities for FCA.
The changing UK pensions and retirement income sector
Two of the most immediately striking aspects of the pensions sector are its scale – over 34 million consumers and over £2 trillion of assets – and the profound change it has experienced, and continues to experience, as a result of changes, in turn, in demographics, macro-economic conditions and government policy. Those 2 aspects – the scale of the industry and the pace of change – are of course interrelated.
The pensions industry has a venerable history. It has been around for some 350 years in the UK. The Royal Navy introduced a pension scheme for officers in 1670, a time when life expectancy at birth was 48.
Lloyd George’s 1908 Old Age Pension Act provided for a non-contributory old age pension for people over the age of 70, with the cost being borne by younger generations. It is only from this date that you begin to see significant numbers of citizens with pensions. But still, when the State Pension was enacted in January 1909 just half a million people were eligible.
The weekly pension was 5s a week (7s 6d for married couples). I understand that is said to be about £30 and £45 in today’s money. The level of benefit was deliberately set low to encourage workers also to make their own provision for retirement. We clearly have far greater expectations of the sort of income our pensions will provide today.
The number of people past retirement age or in receipt of pensions has also of course increased massively, and this continues. In 1997, around 1 in every 6 people were aged 65 years and over. This was 1 in every 5 people by 2017. It is projected to reach around 1 in every 4 people by 2037.
The length of retirement which pensions savings are expected to fund has similarly been increasing. When the State Pension was first introduced, men and women who did reach 70 were expected to live on average for a further 9 years. Nowadays, with the State Pension age currently at 65, men and women reaching this age are expected to live for approximately 20 more years.
The needs the pension sector is expected to meet have expanded enormously in terms of the level, the length and the breadth of provision.
The needs the pension sector is expected to meet have therefore expanded enormously in terms of the level, the length and the breadth of provision. In other words, this industry has become massively more important over time.
The other striking change in recent years has been the prevailing level of interest rates. Across the century up to 2008 the average level of central bank policy interest rates in the UK was a little over 5%. From August 2008 until today it has averaged 0.6%. Real interest rates – measured by taking away Consumer Price Inflation from these nominal policy rates – have averaged minus 1.7% over that decade.
That calculation of real interest rates starts from a risk-free rate of return. It is reasonable to hope for a higher return on long-term pension investments where sensible levels of risk can be taken to increase returns on a diversified portfolio and daily liquidity is not required on the bulk of investments. In 2007, FCA rules on investment return assumptions allowed projections up to a maximum intermediate rate of 7%. The equivalent FCA rule now mandates a maximum of 5%. Taking Consumer Price Inflation at the Bank of England’s target rate of 2%, that is still just 3 percentage points of real return. If total costs are 1.5%, for example, that would strip out 50% of that return. The low interest rate environment makes necessary a continuous focus on the central challenge for the industry, providing attractive returns on investment at low cost.
In our recent Discussion Paper – DP19/2: Intergenerational Differences – we said more on the impact of increasing life expectancy and other forces re-shaping the pensions landscape.
It focused on 3 different generations:
- Baby Boomers born between 1946 and 1965
- Generation X born between 1966 and 1980
- Millennials born between 1981 and 2000
For some Baby Boomers retirement and maintaining living standards through their retirement are already real, or near-term prospects. People around retirement age have significantly more pension wealth compared with their peers 10 years ago. This increase is particularly significant for those in the top 25% of the wealth distribution, with their pension wealth being around £175,000 higher.
As retirement is changing with increasing life expectancy, many in this generation will have important and complex decisions to make about their drawdown options. Many will have valuable defined benefit pension entitlements, and might be tempted to transfer from defined benefit (DB) to defined contribution (DC). Usually, it will not be in their interests to make such a transfer, and the FCA is concerned that too many are being advised to do so. I will come back to this area when I discuss the FCA’s near-term work priorities.
Consumers in Generation X are often more financially stretched. While they tend to have higher than average incomes, many find themselves unable to set aside enough money for their pension. They have lower than average cash savings and the highest amount of unsecured debt (excluding student loans). But they have often benefitted from rises in house prices and low borrowing costs.
Millennials face a series of difficulties in building wealth, due to the combined impact of rising house prices, insecure employment, and higher debt (including student debt). These factors constrain their ability to save for retirement during core earning years.
Perhaps the core dilemma for each of these generations was well expressed by baby boomer George Foreman, when he said:
‘The question isn’t at what age I want to retire, it’s at what income.’
I treat his views with respect as he regained the world heavyweight championship at age 45.
More seriously, though, we need to be acutely conscious that savings rates shown in national statistics are at a historic low of 4.5%. That compares with an average savings rate of 11% between 1980 and 2000 – when our baby boomers were in their 30s. In May, we published a Research Note, looking at the distribution of wealth holdings in Britain using the latest wave of the Office of National Statistics’ (ONS) Wealth and Asset survey, and considered what this can tell us about individual preparedness for retirement. One of our headline conclusions was that almost 40% of individuals of working age (over 14 million people) have no private pension wealth at all. The issues facing millennials and Generation X are therefore central to our strategic priorities in the years to come.
The other major factor in change has of course been Government policy, notably:
- the introduction of auto-enrolment from 2012
- the implementation of the Pension Freedoms from 2015
Over 9 million employees have been enrolled into a pension as a result of auto-enrolment, and over 1 million employers are complying with their AE duties. 98% of employers are now automatically enrolling their employees into DC schemes. It is estimated that, by 2030, workplace DC schemes will have grown 5-fold since 2015.
Retirees have started using the greater flexibility provided by the Pension Freedoms. Far fewer retirees are using their pension savings to buy a guaranteed income in retirement. Annuity sales declined by over 80% between 2014 and 2017.
The FCA’s role
All of which begs the question: what does this all mean for the FCA’s role and focus?
Our core role is to make markets work well and protect consumers. For the pensions sector that means focusing on the 2 phases in the pensions life cycle:
- accumulation – when and how people save for retirement
- decumulation – what they do with those savings when they retire
In both areas, we want to make markets work well. In my view, the key to that is consumers having confidence that the returns made on investment in pension savings for the future will justify the sacrifices made in terms of reduced consumption today.
As you know, FCA is not the only regulator in the sector.
Broadly, we are responsible for regulating the parts of the pension savings and retirement income sector where individuals access pensions directly. TPR is responsible for regulating the areas where individuals access pensions via their employers.
FCA also has significant regulatory responsibilities for firms that provide products and services for pension schemes that are regulated by TPR, eg financial advice and asset management.
I suspect most consumers are not particularly interested in which authority regulates their pension, and probably would not know if asked if their contract was trust-based or contract-based. But they do want to know their money is well-managed, wherever the regulatory responsibility lies.
Accordingly, in 2018, FCA and TPR published a joint strategy for regulating the pensions and retirement income sector.
We have, of course, worked together for many years, but this was an opportunity for us to demonstrate that co-operation, and to embed it more deeply, further enhancing our collaboration to identify and resolve the issues that concern us.
Our strategy identified that the overarching potential harm in this sector is that people may not have adequate income, or at least not the income they reasonably expected, in retirement. That strategy set out a range of workstreams to address that potential harm and its underlying causes, while noting that some factors – such as real interest rates – are outside of our control.
But I want to focus on 3 immediate priority areas in ongoing FCA work, and then look ahead to two of those wider strategic priorities.
The first immediate priority is around pension transfers. There has been an increase in people transferring their DB to DC investments in recent years. This is related to the Pension Freedoms, the record high levels of transfer values being offered on DB pensions, and under-funded DB pension schemes looking to reduce their risks.
DB pensions, and other safeguarded benefits providing guaranteed pension income, give valuable benefits. Most consumers will be best advised to keep them. Advisers should start from the position that a transfer is not suitable. It is deeply concerning and disappointing to see that transfers are still being recommended at the levels we have seen.
Defined Benefit pensions [are] valuable. Most consumers will be best advised to keep them.
Pension transfer advice for transfers out of DB schemes therefore continues to be an area of intense focus for us. This is both on the supervisory side – on which we gave an update on 19 June 2019 – and on the policy side.
We continue to be particularly concerned that too much unsuitable advice is being given. Our supervisors are already visiting firms where these concerns are highest.
Through our policy consultations we have sought to set out a clear advice framework to enable advisers to give suitable advice. In CP18/7 we also sought views on whether to intervene in relation to charging structures. This could include banning contingent charging, which is when a fee for advice is only paid when a transfer goes ahead. We have said previously that contingent charging is a higher-risk approach than non-contingent models, due to the need to sell products to generate revenue.
A second key piece of work on the immediate horizon also relates to decumulation, and in particular to drawdown. We published the final report of our Retirement Outcomes Review in June last year, alongside a Consultation Paper setting out some proposed remedies.
Our review was launched to investigate how consumers and firms were responding to the pension freedoms, and has focused in particular on consumers who don’t take advice.
We found that while many consumers have welcomed the freedom to access their savings in ways they previously couldn’t, they need further support to make the most of that flexibility.
Perhaps this isn’t surprising. The pensions market is complex and questions like which provider to use, where to invest your remaining pot and how quickly to drawdown require careful thought and consideration. We found that many consumers who don’t take advice are ending up in investments that may not be right for them, including in cash. The remedies we proposed seek to protect drawdown customers who do not seek advice and may inadvertently make inappropriate choices. To address this, we proposed new rules on ‘investment pathways’ that firms offering drawdown must offer to unadvised consumers. The 4 pathways, each linked to a particular objective, are designed to enable non‑advised consumers to achieve better outcomes by helping them to choose the best way to invest their money in drawdown. Consumers entering drawdown, or transferring in assets already in drawdown, would be presented with 4 options on how they might want to use their drawdown pot. These range from ‘I plan to take out all my money within the next 5 years’ through ‘I plan to start taking a long-term income within the next 5 years’, to ’I have no plans to touch my money in the next 5 years’.
We also proposed that consumers’ pension investments are not defaulted into cash savings unless the customer actively choses this option. And that consumers should receive information annually on the actual charges they have paid in decumulation.
We will shortly be announcing our final rules in this area.
We are also consulting – in a consultation paper published in April this year – on extending the remit of Independent Governance Committees (IGCs) to oversee the value for money of investment pathway solutions for pension drawdown. This means assessing the costs and charges of pathway solutions relative to their quality, and the appropriateness of a pathway solution for consumers invested in it.
As with workplace personal pensions, IGCs will have the power to raise any concerns directly with the Boards of firms. Firms will be obliged to respond to these concerns.
Let me highlight a third ongoing workstream which relates to pensions – and in particular pension scams. Pension scams are devastating. Victims can lose their life savings, and be left facing retirement with limited income, and little or no opportunity to rebuild their pension savings. That’s why preventing pension and investment scams is a priority for the FCA and TPR.
Consumer awareness and education plays one essential part in preventing people falling victim. Last year, we launched a new ScamSmart communications campaign to raise awareness of pension scams and how to avoid them. During the campaign period 173,000 users visited the ScamSmart site, which helps us to warn consumers about unauthorised firms.
From 1 July 2019, we are running the campaign again on TV, radio and online. Many of you will be able to play a part in warning your members about pension scams. The FCA ScamSmart or Pension Regulator websites contain a range of resources that can help you in doing so, and help consumers directly.
Value for money
…the key strategic priority in the years ahead [is] value for money.
Let me turn to what seems to me the key strategic priority in the years ahead: value for money. Reflecting its strategic importance, it is also a priority workstream in our joint strategy with TPR.
We can have little hope of incentivising satisfactory levels of saving without consumers having confidence in the return that can be earnt on those savings.
That value for money will be a function of investment returns – noting the relationship between expected returns and risk – and, in particular, of costs and charges. The low interest rate environment that has prevailed since 2008 makes that focus on costs and charges all the more essential.
As part of our joint strategy with TPR, FCA will use its powers to drive value for money for members of pension schemes, including by the setting and enforcement of clear standards and requirements where relevant.
FCA has already implemented a number of measures in this area, including:
- new governance standards – rules requiring the providers of workplace personal pension schemes to set up and maintain IGCs)
- a charge cap on default funds and the banning of certain charging practices
- measures to improve how asset managers disclose costs and charges to pension scheme governance bodies
We will consider if we need to go further.
We have, for example, also been undertaking a comprehensive review of non-workplace schemes. We will publish our findings in the weeks ahead.
We think there is a debate to be had about whether we should offer firmer views on how value-for-money should be assessed, how it is measured, and how it is reported.
We think there is a debate to be had about whether we should offer firmer views on how value-for-money should be assessed, how it is measured, and how it is reported. Should we establish, or encourage others to establish, more benchmarking mechanisms that enable comparison of value-for-money metrics between schemes and providers?
We will consider where further interventions be focused – on providers, on IGCs, or both? And we will look at how benchmarking information can be used to help individual consumers, IGCs, and intermediaries.
The consumer journey
The second key strand of the strategy must be the demand side – we sometimes refer to this as the consumer journey. In the days of one main employer for life, and one final salary defined benefit pension scheme, the offer to the individual consumer was simple. Difficult choices were not offered. There were risks, but these were managed by others. The pension scheme had responsibility and incentives to manage down costs because these were not passed on directly to the pension saver.
The need for consumer engagement is now much greater. But engagement is not always easy. For example, I have 5 different pensions from my own career to date. For the oldest of those, there has been no proactive communication from the pension scheme to me for nearly 20 years – though I did get quick and helpful responses when I undertook some personal consumer testing on taking my current role. Initiatives such as the pensions Dashboard will prospectively play a part in making it easier, but are not the only part of the answer.
….if we are to maximise consumer engagement in a context where we know most are not engaged, we have to make that engagement as easy as it practicably can be.
Along with TPR, we will undertake a strategic review of the entire consumer pensions journey – taking an in-depth look at what tools are needed to enable people to make good decisions about their pensions. In my view, if we are to maximise consumer engagement in a context where we know most are not engaged, we have to make that engagement as easy as it practicably can be.
That will interrelate of course with value for money work, with clear and timely disclosures related to value for money, and costs and charges. That will help us to create demand-side pressure for good value alongside our regulatory measures on the supply side.
I hope that gives you a sense of what look to me like the key issues 8 months in. As always, we welcome your thoughts on these.