Much has been written about.the new UK pension freedoms; to treat pension pots like bank accounts. What has not been talked about is the vast burden these so called freedoms impose on both organisations and pension trustees. These burdens can be split into three categories.
What the freedoms do is to pass more of the burdens of an ageing workforce to employers and pension trustees and away from the state. Further, if employers and trustees pause for thought, let alone refuse to implement these measures, they are demonised by
Government ministers. In a stroke of genius, they even co-opted one of the most articulate and high profile commentators on pensions and ageing population issues, Roz Altman, by making her part of the Government.
The pension freedoms are a Government smoke and mirrors exercise that would make Darren Brown blush.
We are aware of the issues and costs of an ageing population. Successive governments have not only taken a “head in the sand” approach by ignoring the spiralling costs, but, have cynically protected state pensions and other age related benefits to attract the grey vote.
In an environment of out of control public spending, the Government has cynically and arguably with stealth, sought to transfer the burden of old age to pension schemes, employers and individuals, of future pension risks and costs.
There are many risks implicit in the pension freedoms. Some examples:
Bad or no advice
Under estimation of longevity
Administration issues, from complexity through legacy IT systems to poor administrative practices.
Loss of guaranteed benefits
Bad or no advice
Good advice is hard to find and expensive. You get what you pay for in life. There is a perception encouraged by the Government, that advice is either not necessary or should be free. Yet those exercising pension freedoms are taking risks and facing uncertainty, sometimes without even realising it. When the money runs out or the unexpected tax bill arrives,they will look for someone to blame, to claim compensation from or to sue. For DC and DB Occupational schemes that is likely to be the employer or the Trustees (which give trustee indemnity amounts to much the same thing). This also applies to the partners and families of those who exercise the freedoms. There will be much wailing and nashing of teeth when survivors find no death benefit and no cash left after the death of a loved one.
There has already beehn commentary about the unsuitable nature of ‘lifestyle” investment options under the new freedoms. If experience is anything to go by, this new pension class will be looking for the holy grail of rising returns and no risk. Good luck with that…
Then there are the sharks in the water, circling the unsophisticated. Coming up with expensive schemes that are doomed to failure in a few years: particularly when the economic black swan appears all too soon. Again, who will be to blame, the former employer or pension trustees.
The same “advisors” urging taking a lump sum to take a holiday or buy a new car. Pensioners cannot pay exorbitant utility bills with a holiday or eat their ageing, devalued car. Who will be to blame, who will meet the costs?
Under estimation of longevity
The killer (pardon the pun). The already puny pension pot (current average £120,000 at retirement) will have to last twenty years, with inflation, care and medical costs rapidly eating in to the capital. A rough calculation, without any lump sum, looks like the average amount will not last ten years.
It is unlikely, short of an unbelievable economic miracle, that the Government can maintain the so called triple lock on pension increases. We have already seen stealth reductions in the state old age pensions for those who followed advice and opted out of SERPS and its successors. The generational unfairness, as pointed out by David Willets in “The Pinch” Is getting worse. The costs of increasing longevity are falling on the young as more and more Government expenditure goes to the elderly, paid for by a shrinking workforce often still burdened with student debt before the rapidly rising cost of housing bites.
Few in the pension industry would argue, with a straight face, that pensions administration is agile or even efficient. To ask pensions IT systems to be upgraded quickly to administer the pension freedoms is to live in a fool’s paradise. To identify crystallised and uncrystallised funds over long periods, managing the tax issues (and reports of major HMRC errors and poorly thought out assumptions are already circulating) are major hurdles. The required IT changes will take many months, if not years.
In addition, recent history shows that changes to pension regulation occurs almost monthly. Attempts to correct both poorly thought out implementation as well as unintended consequences will result, quickly, in a perfect storm of regulatory, tax and structural changes: all to be absorbed by employers, trustees and providers at their own cost of course.
Lost benefits, seen and unseen
Many pension schemes, both private and company cover a mixture of risk benefits. These include life cover and, most critically, a small number have guaranteed annuity rates. These are often far in excess of market rates. Yet, some in the Government are saying no advice is needed (because good advice is expensive). Well, as the song said, you what, you what, you what! People may be giving up expensive non- replicable benefits for immediate cash.
Then there is the issue of long-term care costs. Pension freedoms will result in tomorrow’s care costs being spent today. Pensions from annuities at least provided some income stream against future care costs. The ever rising costs will have to be met by asset disposal (spending their children’s inheritance) or by the hard pressed tax payer. The benefits of a steady cash flow in elder years is washed away by immediate cash.
Pension freedoms have been sold by the Government as a panache to the perceived evils of annuities. So the masses are swapping a guaranteed lifetime income, albeit small; for volatility, uncertainties and risk – and that is only the taxation regimes.
An expectation has been built up that these freedoms will magically change a lifetime of under provision of pension saving in to a happy retirement. Even before the freedoms: research showed a yawning (sic) chasm between pension expectations and the actual amount saved by the vast majority of the UK workforce.
Who will be blamed when these great expectations run into the buffers of economic reality? Could it be the pension trustees, the sponsoring organisations and the pensions industry by any chance? PPI anyone?
Here we have the nub of the issue. The cost subject can be split into four main issues:
Professional and legal costs
Pension funds are often the biggest asset pool an older individual has.. (If not then insufficient has been saved), These savings have to provide cash flows for an unknown period. This at a time of unprecedented economic uncertainty. Yet there is a wilful refusal by Government and individuals to see the necessity to pay for expert, tailored advice. Yes, advice is expensive, but better than an old age of poverty. The issues that require expert advice include longevity risk (living longer or shorter than expected); investment risk (risk vs return and volatility) and taxation risk. (The frequent changes in tax regimes impacting savings).
Trying to develop investment strategies, hedging overlays and appropriate risk and reward approaches will tax the most learned financial advisors. We are already seeing some advisors turning away business, either because they fear being overwhelmed by demand or they are worried about giving best advice in the minefield of shifting regulation and tax treatment.
Getting any of these issues wrong will result in financial embarrassment at best and abject poverty at worse. When it goes wrong in the absence of advice who will be asked to “bail out” the individuals? The former employers, the trustees and the insurers. The state will, of course, wash their hands, not that they will have and funds anyway.
Even in the short period since the “freedoms” started: we have seen billions of pounds of assets and cash moving around; all of which attract transaction costs, another deduction from the asset pot. For small funds transaction costs eat rapidly in to already inadequate savings. Again, employers and trustees will be expected to meet some if not all this cost.
Professional and legal costs
Trustees will pass large expenses for lawyers, actuaries and other advisors on to employers. Where there is no sponsoring employer the pension scheme will take the hit. Yet Trustees and their sponsoring organisations will have to take more and more advice as the regulations and practical exercise of the freedoms create greater complexity, risk and uncertainty.
The advisors will be very conservative in their advice and rightly so. The results will be frustrated pension scheme members, fearful trustees and exploded balance sheets of sponsoring organisation both expenses and provisions.
And there’s more. The announcement of consultation on major changes to tax treatment on pension saving and payments are both radical and involve a great and unlikely leap of faith in politicians keeping to their word over a lifetime of pension savings and income. Who, in their right mind, would base advice to trustees, sponsors and individuals on the fatal quicksands of government tax and pension policy?
Much has been made of the potential of the new pension freedoms. But, even putting aside the fact that these freedoms will only really help a small constituency of middle class, middling affluent, middle aged people (definition of the Conservative Party?). Who will carry the enormous costs and risks? These include, but are not limited to, financial, reputational and legal risks. They are also very long tailed risks. With life expectancy for those retiring today being somewhere around twenty years; who will to be blamed when the pension well becomes dry in ten years?
An adult discussion is needed between the Government, the insurance industry, the actuarial profession, sponsoring organisations and trustees on the allocation and mitigation of costs, risks and responsibilities before the pension freedoms turn in to a swamp of expense, recriminations and legal action stretching far in to the future. And, should I see any other flying pigs I will let you know.