FCA's plan to shake up non-workplace pensions market
It’s often said that pensions never stand still, that they are always changing. Even in today’s climate, when the political focus is firmly turned on only one subject, there are still multiple changes going through the pension legislative and regulation mill. Given that, it can be easy to miss some areas of development, especially if they haven’t yet resulted in a firm policy change.
Effective competition in non-workplace pensions is one such example. The FCA’s latest paper – a feedback statement (FS19/5) – was published in late July at the same time as its latest consultation on defined benefit transfers, and the final rules for the Retirement Outcomes Review (discussed further later in this article).
The non-workplace pension work has slipped somewhat under the radar. However, it has the capability to be a very important piece of FCA regulation for financial advisers and planners, and it’s worth being aware of the emerging debate.
What is the non-workplace pension market?
Over the last two years, the FCA has been gathering information about the non-workplace pension market, with a view to establishing whether it is operating effectively and competitively. The non-workplace pension market is really all individual pensions – ranging from older-style contracts such as S226 Retirement Annuities and Section 32 buyout bonds, through stakeholder pensions and older-style individual pensions, right to SIPPs (both ‘streamlined’ and ‘complex’).
This is a massive market. There are 12.7 million individual pension accounts administered by more than 100 providers. The FCA estimates it’s worth around £470 billion assets under administration – more than double the size of the market for contract-based defined contribution workplace pensions.
Individual personal pensions dominate the market; they account for over 70% of all accounts and over 50% of assets. However, 89% of individual personal pensions – and 44% of stakeholder pension plans – are in schemes that are closed to new business.
What did the FCA discover about non-workplace pensions?
The FCA expressed concern with several themes emerging from its research.
1. Most consumers are not engaged with their pension. The FCA’s research found most participants were not engaged with their individual pension, both when buying it and afterwards. This seemed to apply whether the person was working with an adviser or not. Most participants had low knowledge, interest and confidence in their pension but, even worse, they had limited appetite to acquire any more knowledge. They couldn’t see any point in doing so. The FCA believes the lack of consumer engagement reduces providers’ incentive to compete.
2. Charges are complex. Both advised and non-advised consumers were unaware of charges or misunderstood them. The research found consumers can be faced with several layers of charges – product charges, fund charges and potentially also advice charges. Some providers bundle these together and others don’t, making it hard for consumers to compare. Tiered charging structures also add to this complexity, as do the different naming conventions used for charges by different companies.
3. Level of charges vary widely. Perhaps unsurprisingly, the FCA research found average charges were higher for older-style contracts. Undoubtedly that could be because of adviser commission paid before the Retail Distribution Review (RDR) was introduced, but it could also be down to older charging structures being more expensive. The other key find was that consumers with smaller pots pay on average higher total charges. Charges also vary widely. The FCA acknowledges this isn’t in itself proof of weak competition, and that other factors must be taken into account, such as costs of providing the product and its quality. But it was still concerned that when it removed outliers, the range of charges remains relatively large.
4. Switching levels are low. Consumers don’t tend to switch their provider or even consider it. The research pointed to consumer barriers caused by lack of awareness, understanding and confidence.
The FCA’s sources of inspiration
Before we go on to discuss the FCA’s proposed remedies for non-workplace pensions, it’s advisable to recap on other recent regulatory developments to address high charges and value for money within pensions.
Broadly, in the workplace market, all employers have to offer automatic enrolment of relevant employees into a qualifying workplace pension scheme. These schemes have to meet a set of criteria including, for defined contribution schemes, a charge cap of 0.75% a year and a default investment option. The FCA also demands firms operating workplace personal pension schemes establish and maintain Independent Governance Committees (IGCs) to scrutinise the value for money offered by the scheme.
Another big piece of recent regulation policy is the FCA’s Retirement Outcomes Review. This concentrates on helping non-advised consumers accessing their pensions, but has consequences for all consumers. Over the next year, it will introduce changes so:
The FCA’s proposed remedies for non-workplace pensions
When considering the non-workplace pensions market, the FCA has not strayed too far (if at all) from this rulebook. In fact, the solutions it is advocating look remarkably similar to those already adopted for other areas. It proposes:
1. providers will have to offer ready-made investment solutions (with lifestyling) to non-advised consumers to align with their broad objectives: this could be a single pathway or multiple pathways tailored to different objectives;
2. providers will have to warn all consumers about the long-term impact of investing predominantly in cash;
3. providers will have to show charges incurred in pounds and pence; in addition an independent body, which will most likely be the FCA, will publish charges league table to help people compare charges;
4. considering further the role of IGCs in assessing value for money and whether they would be appropriate and proportionate for the individual pension market: IGCs can be complicated and expensive beasts to run.
What does this mean for financial advisers and planners?
Likely none of the FCA’s research and findings will come as a surprise to financial advisers and planners.
The research throws into sharp focus the state of the individual pension market. It highlights the vast number of people who are members of closed individual and stakeholder personal pensions. These are likely to be older contracts, and many people could be paying much higher charges than they need to. These people will greatly benefit from moving to a newer-style individual pension, offering lower charges and additional features, such as pensions freedom flexibility. The FCA is advocating for this cohort to consider their current position and is encouraging switches within this market.
Sometimes this can be complicated – especially if the person holds scheme-specific protection for higher tax-free cash or an earlier pension age – and these people will need help from financial advisers and planners to negotiate this route.
Many of the proposed solutions have already been (or are in the throes of being) adopted for different pension markets – in particular those accessing their pensions through the Retirement Outcomes Review work. However, they are not yet tried and tested. Investment pathways and changes to charges disclosure will be introduced from August next year and it’s unclear at the moment how they will affect consumer behaviour. There is also an important question about whether the solutions the FCA has introduced for, say, workplace pensions, can work just as well for the individual market. Consumers in this market are a varied bunch, as the FCA research proves. Some will be unengaged with their pensions but others, such as SIPP holders, will be very much alive to their investments and may resent the FCA trying to force an investment solution upon them.
There is a temptation to dismiss the FCA’s proposed remedies as something that will apply only to non-advised clients and have no implications for those who work with an adviser. But the FCA will apply a broad brush and all types of clients will get caught.
For example, the FCA believes investment pathways will also deliver benefits for advised consumers, and propose requiring advisers to explain why the recommended personal pension investment is at least as suitable as the pathway when making recommendations about personal pensions. This is exactly the same approach advisers will have to adopt when advising clients on choosing their drawdown investment strategies from August next year. This isn’t a complicated requirement: the adviser will have to identify the consumer objective and corresponding pathway, and put together their reasoning why their recommendation is superior. But it is one that advisers have to be aware of and build into their processes for drawdown recommendations from next August, and probably for SIPP recommendations in future years.
The publication of a charges league table may be another example. Once investment pathways are launched next year, there will be occasions when providers have to highlight the Money and Pensions Service’s drawdown comparator to consumers. Likewise, all individual pension holders, whether advised or not, will be pushed towards a charges league table.
The FCA’s proposed changes to the non-workplace pensions market appear to be a fixed approach, and at the moment it seems doubtful whether the FCA will stray too far from the script it has adopted.
Financial advisers and planners need to be aware of the possible changes and what they mean for their clients and processes. They also should be aware of the make-up of the individual pension market and which clients could benefit from switching to more modern contracts.