generation dc issue 3: how to educate and ...generation dc issue 3: how to educate and guide...

GENERATION DC ISSUE 3: HOW TO EDUCATE AND GUIDE GENERATION DC TO A POSITIVE PENSION OUTCOME

How to educate and guide Generation DC to a positive pension outcome

Generation DC

ISSUE 3

GENERATION DC ISSUE 3: HOW TO EDUCATE AND GUIDE GENERATION DC TO A POSITIVE PENSION OUTCOME 2

FOREWORD

In the case of planning for retirement, we now have a golden opportunity to address those concerns. Freedom and choice will only fulfil its potential to deliver better outcomes for millions of people if we can teach a whole generation of savers how to make informed decisions about their future.

That will require a concerted effort by policymakers and pensions professionals alike to rethink the way in which they engage with savers from the moment they begin thinking about planning for retirement. New tools and technologies will have a crucial role to play – but so too will the language with which we communicate.

There is every reason to be ambitious. Armed with the right education and information, the vast majority of savers will make good decisions about their futures.

Concerns over standards of financial literacy and acumen among Britons today cannot just be laid at the door of the individuals themselves. It is also a responsibility of a range of stakeholders - including educators, government and financial service providers - to engage and communicate effectively with their audience.

Emma Douglas Head of DC Distribution, LGIM


INTRODUCTION Ensuring Generation DC is not the lost generation

Generation DC are embarking on the pension freedom journey

balance the desire for financial comfort in retirement against the risk of running out of money.

The early signs are that Freedom and choice reforms have captured people’s imagination. In the first 100 days after the reforms, savers took lump sums worth more than £1bn from their pension pots according to the Association of British Insurers.2 Amongst people buying regular income products, just 50% opted for annuities, down from 90% prior to the change in the rules.

The stakes are high for these people. The complexities of the pension choices now available to those heading into retirement are challenging for even the

most financially astute savers. They require people with little experience of managing their own investments to make difficult decisions. And the consequences of getting it wrong are potentially severe, with little opportunity for those in retirement to recover from mistakes.

The decision-making process does not only begin at the point of retirement. The ability of people to execute their chosen strategies may depend on the investment decisions they have made over the previous decade, or even longer.

The typical British man celebrating his 55th birthday today can expect to live for another 31 years according to the Office for National Statistics.1 For women aged 55, life expectancy rises to 34 years. How well-equipped is the next generation of pensioners to plan their retirement finances over such lengthy periods?

The challenge has never been more formidable. The increasing ubiquity of DC pension schemes means that most pensioners will have to make informed choices about how to generate, secure and manage income for retirement. And with Freedom and choice comes greater responsibility. Retirees will need to make informed and educated decisions that

1 http://visual.ons.gov.uk/how-long-will-my-pension-need-to-last/

2 https://www.abi.org.uk/News/News-releases/2015/07/100-days-of-pension-reforms

3 “Industry figures reveal more than £1.8 billion withdrawn in first two months as consumers exercise new pension freedoms”, Association of British Insurers, 15 July 2015.

£1.8BILLION £630

MILLION

£720MILLION

TAKING OUT PUTTING IN

withdrawn from pension pots in first two months following Freedom and choice, made up of £1 billion in cash withdrawals and £800 million in payments from income drawdown3

put in annuities vs. £1.2 billion a month in annuity sales in 2012 3

Annuities down in first two months after April 2015

Drawdown up in first two months

put in to buy income drawdown policies vs. £100 million a month in to drawdown in 2012 3


Against this backdrop, this report considers how best to ensure people are able to grasp the opportunities afforded by the reforms while managing their exposure to risk. It considers the crucial role that education, communication, information and advice will play in ensuring that Generation DC does not become a lost generation. In particular, it will ask:

• What are the foundations of good later life investment?

• What roles should individuals, financial advisers, government, trustees and pension providers play in building these foundations?

• How can the pensions and investment industry innovate in order to help schemes interact and communicate with their members more effectively?

• What action on advice and education is required now?

Retirees will need to make informed and educated decisions that balance the desire for financial comfort in retirement against the risk of running out of money.


Pensions intelligence?Are pension savers ready to engage with the increased complexity of the retirement planning environment? The evidence is not encouraging. In the weeks after the new rules came into force in April 2015, pension providers experienced a surge of enquiries from savers anxious to discuss cashing in their funds.4 Large numbers of callers displayed a lack of basic knowledge about the negative tax implications of what they proposed to do; some had not even realised the reforms did not apply to people under the age of 55.

This lack of knowledge is symptomatic of a global problem with standards of financial acumen (see “Financial IQ: A global challenge”). But in the context of greater freedom and flexibility in the UK, it is especially dangerous. The need to plan for and then execute a diverse range of investment strategies will require a degree of expertise many people do not currently possess.

4 Pension freedom drives surge of interest, Financial Times / ft.com, 7 April 2015.

5 A Three-Question Test of Financial Literacy, Wall Street Journal, 25 March 2015.

6 http://www.sfo.gov.uk/protect-against-fraud/current-scams/pension-scams/press-releases-from-project-bloom/a-lifetime’s-savings-lost-in-a-moment.aspx

Financial IQ: A global challengeLack of financial literacy is a widespread problem around the world. In a survey of Americans over the age of 50, only half could answer the two questions below correctly: 5

Q1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money to grow? A. More than $102; B. Exactly $102; C. Less than $102

Q2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, how much would you be able to buy with the money in this account? A. More than today; B. Exactly the same; C. Less than today

Financial Literacy: Implications for Retirement Security and the Financial Marketplace, Olivia S. Mitchell and Annamaria Lusardi, Pensions Research Council, 27 Oct 2011.

Drawdown strategies, in particular, are a delicate balancing act. Without the security and certainty of an annuity, some people may draw down too much income during the early years of their retirement, leaving themselves in financial difficulties later in life. And while an annuity-based default investment approach often moves into less volatile assets in the final years of saving, this may not be the right strategy

for drawdown. While such savers will certainly be focused on wealth preservation, they will also have other priorities – income generation, for example.

It is in the years following savers’ 55th birthdays, however, that the risks posed by lack of financial acumen are highest. At this stage, people have the freedom to take action. This

group is also becoming a target for unregulated firms and fraudsters, who see April’s reforms as an opportunity to prey on unsuspecting savers with large capital sums. Even before the reforms, the Serious Fraud Office, one of the stakeholders in Project Bloom, an initiative aimed at warding off pension fraud, said £495 million had been paid into pension-related scams.6


Giving directionsThe Government hopes its Pension Wise service will counter some of the problems of financial literacy and enable people to make more informed decisions. Initially available to people approaching 55, this free service has recently been made available to everyone over the age of 50. It offers personalised help, via face-to-face or telephone-based appointments, managed by The Pensions Advisory Service and Citizens’ Advice. Pension Wise no doubt has an important role to play in ensuring people make better decisions as they approach retirement. However, Pension Wise offers guidance rather than full-scale advice – its counsellors will not recommend particular products, or even suggest a particular course of action.

“Advice and guidance are two very different beasts - guidance gives you much less to go on than advice,” warns Louise Farrand, Editor of Pensions Insight magazine. “Pension Wise will give quite generic guidance, rather than pointing people in a particular direction, which is what most people are going to want.”

Nico Aspinall, Head of UK DC Investment Consulting at Towers Watson, agrees. “It’s really an education tool,” he says. “It’s saying what options exist, what a pension is, what compound interest is, and things like that. There is a huge problem with people lacking financial literacy, certainly in the complexities of the pension space. It’s very much intended to pick up those people and give them a basic understanding of the choices they’re going to face.”

“Advice and guidance are two very different beasts - guidance gives you much less to go on than advice,”

Louise FarrandEditor of Pensions Insight magazine

7 “A lifetime’s savings lost in a moment”, Serious Fraud Office, 24 July 2014.

8 “Advisers increasing minimum portfolio sizes since RDR”, FT Adviser, November 2014.

9 “DC Trust 2014 published”, The Pensions Regulator, 29 January 2014.

In which case, will full-scale independent financial advice fill the gap? For those with access to a high-quality independent financial adviser, it may well do, but the number of such people has been falling rather than rising since the Retail Distribution Review (RDR) reforms introduced by regulators in January 2013.

£495MILLION

£50,000 VS. £25,000

that has been paid over the years into pension-related scams in the UK according to the SFO7

A typical minimum savings portfolio required to secure advice is £50,0008 but the average pot size at retirement in an occupational trust-based DC pension scheme is £25,0009

But, as pot sizes grow, we could see advice for all


“The only time the UK will ever become genuinely financially literate is when they totally revise the way maths is taught in schools.”

John RoeHead of Multi-Asset Funds at LGIM

10 “Advisers increasing minimum portfolio sizes since RDR”, FT Adviser, November 2014.

11 “Chart that tells a story . . . financial literacy”, Financial Times / ft.com, July 11, 2014.

12 http://www.financialreporter.co.uk/retirement/mps-launch-pension-advice-inquiry.html

A three-year global study by the OECD compared levels of financial literacy in 15-year-old children with the amount of financial education they have received.11 The study, released in 2014 and taking in 30,000 15-year-olds, found the highest standards in Shanghai, China – 43% of Shanghai students were capable of performing at the highest level of financial literacy, against 4% of Spaniards and 2% of Italians. But the report also found the optimum route for developing financial literacy is not necessarily classroom instruction: mathematical skills and personal experience with financial products were much more important.

Does financial literacy begin in the classroom?

The RDR reforms set out to improve the quality of advice by raising qualification standards and preventing advisers from earning sales commissions when recommending particular products. Instead, advisers have had to move to more transparent fee-based charging structures. But while many people have welcomed this move, it does appear to have made it more difficult for less wealthy savers to access independent advice. Reports suggest many advisers have left the industry, while those that remain are increasingly only prepared to deal with savers who have sums to invest upwards of £50,000.10 Some advisers, however, set the bar even higher – seeking a minimum portfolio for new clients of £250,000.

Can we at least attempt to improve financial literacy standards so that people are better equipped to make decisions for themselves? That work has now begun, with the introduction last year of financial education to the National Curriculum for secondary school children. But while better financial education at school is likely to improve literacy in the long term (see ‘Does financial literacy begin in the classroom?’), it won’t help those who have already left full-time education.

In any case, many people are unconvinced about the way financial education has been implemented. “The only time the UK will ever become genuinely financially literate is when they totally revise the way maths is taught in schools,” argues John Roe, Head of Multi-Asset Funds at LGIM. “Maths shouldn’t be taught as a synthetic subject which is abstract: most people don’t need to know geometry, they need to understand compound interest, the impact of a charge over a long period

of time, and how they should think about retirement.”

Towers Watson’s Nico Aspinall also feels that the problems with financial acumen run deep. “There’s a social problem here that is quite deep, and pensions are a feature of it,” he says. “In schools, there’s too much emphasis now on teaching what are perceived as facts and not so much on life skills. There’s a huge piece around how to exist in a society such as ours that children are not equipped to address. There needs to be a certain level of understanding and the big risk is that people disengage from the financial system. It’s important to sit with children and say ‘This is how interest rates work; this is how debt works, and this is how to have an attitude towards debt.’ I think those life lessons are important.”

The immediate outlook for pension savers therefore looks worrying – so much so that MPs sitting in the all-party Department for Work & Pensions Select Committee have just launched an inquiry into the guidance and advice available.12 But while its conclusions will make interesting reading, today’s generation of savers need help straight away.


• Face-to-face communication Pension scheme managers and trustees should be prepared to go on the road, hosting workshops and seminars that give members an opportunity to find out more about their options. One scheme chairman, who has now been hosting roadshows for members for more than a decade, says: “This isn’t about trying to turn people into active investors, but getting them to understand the challenges of saving in a DC environment and to think about what they’re going to want in the end. Members are much more responsive to seeing their trustees present these workshops than, say, someone from HR.”

• Digital channels Too few pension providers are yet making full use of digital communication tools, either because they haven’t harnessed certain technologies, or because they’ve become too fixated on the tool and neglected the message. “As well as a good website, you need to cater for mobile communications via people’s tablets or smartphones,” says Emma Douglas, “But whatever the medium, if it’s a really boring message, people are going to ignore it - it’s the content, as well as how it’s delivered, that is important.”

• Interactive tools Technologies that enable people to explore their options by, say, road-testing particular scenarios, can be powerful engagement levers. For example, tools that help people understand how drawdown would work for them in practice. A member can explore the options by entering the size of their pot and how much they intend to take out each month. The model will then tell them when their money will run out.

Communication and guidance is key to engagementGiven the challenges facing Generation DC and the lack of help available to many savers, it is inevitable that pension scheme sponsors and trustees will come under increasing pressure to fill the void. While they may not be able to offer independent financial advice either, trustees who are able to engage scheme members throughout their retirement planning journeys will be able to help them make better decisions.

While the traditional role of the trustee was to secure and safeguard the members’ benefits and to make sure they were delivered in accordance with the trust rules, that role originated in an era when pension schemes were final salary and the benefits were fixed.

Today, members will need much more help and assistance to get the pension they need out of the scheme.

This is clearly a difficult area for trustees, who will be concerned about the danger of straying into the territory of regulated financial advice. “Trustees are very worried about the changes and they want to make sure that members are protected,” adds Louise Farrand. “There’s also a fear among trustees that this might all come back to bite them. Perhaps a member who takes a wrong decision with their retirement pot might come back and say to the trustees, ‘you should have given me more guidance’.”

Still, at the least, trustees need to do more to communicate effectively with members – to ensure members are engaged and informed about their options. In many cases, this may require a root-and-branch review of existing methods of communication, with many schemes still relying on lengthy paper reports that are full of jargon and offer no possibility of interaction. More rewarding methods of communication include:

“Trustees want to make sure that members are protected. There’s also a fear among trustees that this might all come back to bite them.”

Louise Farrand Editor of Pensions Insight Magazine


13 “Half of DC defaulters haven’t ‘defaulted’ at all”, Pensions World, July 2013. State Street Global Advisers research.

• Targeted messaging Digital businesses understand the importance of customer segmentation, but pension schemes have been slow to collect data on their members that would enable them to target highly relevant information to very specific groups. Targeting information in this way, particularly using electronic communications, may also be a more cost-effective way to engage with members.

• Simplified and standardised language Trustees and pension providers must learn to talk to members in language they can understand, says Jackie Wells, Head of Policy and Research at the National Association of Pension Funds. She points out that consultations over legacy regulation have begun with the Financial Conduct Authority, and the Pension Regulator will be consulting on a new DC code later in the year, which should enable trustees to refresh the tone and the content of their

communications. “If we get this right it will have a knock-on effect for the way schemes communicate with people all the way through their pension history,” she says. “We need to go through the debate about whether we can standardise communications so they can be compared easily, or introduce the idea of a pension dashboard like they have in the Netherlands.”

Perception issues: Reimagining the ‘default’ fund There are a number of issues with the use of the term ‘default’ in the pensions context:

• ‘Default’ is defined by inaction, but many people who are in their scheme’s ‘default fund’ are actually there by choice. According to research, nearly half (49%) of savers in DC scheme default options actively chose to be there.13 Many of these people will have made this choice because they felt it was a secure option

• The use of the label ‘default’ can have negative connotations, reinforcing the perception in people’s minds that it is something that you do not have to give much thought to

• As we discussed in Issue 2, there is less likely to be a single ‘default’ in future scheme design

As schemes rethink how the default is redesigned to fit multiple outcomes (cash, drawdown, annuity 2.0), they may also want to consider their use of the ‘default’ label: using another name for ‘default funds’ in communications could help shift attitudes. Members may choose this option as a secure choice for their purposes, but savers will still need to be educated about where they will be investing if they do not make a choice, along with any possible negative outcomes.


Finally, while these innovations would represent a step-change in the way in which savers are informed about their pension options and engaged in their retirement planning, none of it constitutes full-scale, saver-specific financial advice. Given the ongoing reluctance of the Government to go further than guidance with its Pension Wise service, this is an issue with which trustees will have to grapple.

Trustees could, for example, set some boundaries, such as suggesting to members an appropriate level of income drawdown to take. The alternative, suggests Emma Douglas, may be for trustees to consider paying

for members to take advice on their retirement options. As she points out, many schemes have in the past paid for an independent annuity brokerage service. “I’m not sure there is a lot in it for trustees other than their desire to do the right thing for members,” she says. “But we are seriously worried that post retirement, members are just going to Google ‘income funds’ and pick the one that’s performed best over the last three to five years – that isn’t necessarily going to be the right answer.”

“The alternative, may be for trustees to consider paying for members to take advice on their retirement options.”

Emma Douglas Head of DC Distribution at LGIM


In issue one we introduced Generation DC as the army of savers who will be reliant on their DC savings in retirement and the regulatory changes to the pensions landscape, and in Issue two we discussed the implications for how DC schemes operate their default strategies.

The transition to DC provision and the introduction of new freedoms and choices for people at the point of retirement has fundamentally shifted the pension burden. Today’s generation of savers must take responsibility for generating and managing their income in retirement. From a public policy viewpoint, if people make poor decisions there is the unwelcome prospect of a higher burden on the State to bail them out.

CONCLUSION

This shift of liability does not mean pension providers, advisers and trustees can abandon savers to their fate. There is a real risk of fraud or mis-selling when members have control over their money but inadequate knowledge about how to plan and act.

Even without this extreme risk, in an environment where many savers are poorly equipped to cope with the retirement planning challenges they now face, it is crucial to ensure they are better educated and informed – fully capable, in short, of making sensible decisions.

Finding new ways to engage with savers throughout the retirement planning process will help Generation DC make the positive choices they will benefit from for decades to come.

For more information go to www.lgim.com/generationdc

Important NoticeViews and opinions expressed herein are as at September 2015 and may change based on market and other conditions. This document is designed for our corporate clients and for the use of professional advisers and agents of Legal & General. No responsibility can be accepted by Legal & General Investment Management or contributors as a result of articles contained in this publication. Specific advice should be taken when dealing with specific situations; investment decisions should be based on a person’s own goals, time horizon and tolerance for risk. The information contained in this document is not intended to be, nor should be, construed as investment advice, nor deemed suitable to meet the needs of the investor. All investments are subject to risk.© 2015 Legal & General Investment Management Limited. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, including photocopying and recording, without the written permission of the publishers.Legal & General Investment Management Ltd, One Coleman Street, London, EC2R 5AAwww.lgim.comAuthorised and regulated by the Financial Conduct Authority.M0527 www.lgim.com

generation dc issue 3: how to educate and ...generation dc issue 3: how to educate and guide...

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