Changes in the UK retirement fund industry over the last decade

Comparing retirement reform developments in the UK and South Africa over the last decade

A South African perspective

The Turner Report, published in April 2006, brought about significant changes in the UK retirement fund industry. At that time, the UK system could no longer rely on generous private pension funds to compensate for a meagre state system. Defined benefit schemes were closing down or found themselves in deficit as a result of longer life expectancy and lower investment returns. The shift to defined contribution schemes was nowhere near comprehensive enough and, on the whole, the population did not set aside enough for retirement.

The report identified 3 key concerns: The percentage of workers who relied entirely on the state pension increased from 46% in 1995 to 54% in 2004. Only a small percentage of people made pension decisions on a rational basis and as a result compulsion was considered a more effective tool. The cost of running a pension fund for smaller enterprises became prohibitively expensive.

A number of key policy interventions were introduced:

• Revised State Pension: A more generous and simple state pension was introduced starting at a later age (the retirement age was increased to 66 from 2020, will be further increased to 67 by 2028 and possibly to 68 by 2044); the means test was scrapped and the annual pension increases linked to average earnings rather than inflation.
• Cost thresholds: A fee threshold was introduced. If invested in the default investment portfolio the total charges to a member may not exceed .75% of the assets under management. In addition, the UK Government introduced a ban on both initial and ongoing commission payments from providers to advisers. As a result, any services required by the employer must be paid on a fee basis. An adviser is able to agree with an employee for any services that they require personally to be deducted from their pension fund through what is known as adviser charging, although this is not facilitated by all providers.
• Auto-enrolment: An occupational pension plan that is “strongly encouraged” but not mandatory was put in place. People’s inertia was harnessed by auto enrolment.  Workers are automatically enrolled in a DC or DB scheme but can opt out. If they do, they would however automatically be enrolled again at least once every three years in line with the three-year anniversary of the employer’s original staging date, which is known as triennial re-enrolment.

A big challenge was how to include the ‘unpensioned’ at the lower end, especially those employed by small employers. Pension providers did not have much traction in this end of the market for obvious reasons and it was therefore necessary for the state to establish a fund that could provide a pension offering at an affordable fee. Because of Eurozone laws, the state could only be allowed to establish and operate this kind of fund after they had gone through a legal process in terms of which they established a “market failure” in this sector.

The establishment of NEST

The National Employment Savings Trust (NEST) was established specifically to serve the low income market. It is funded by a £600 million loan facility by the state (currently standing at £400 million). Analysts are divided as to when this loan will ever be repaid but management is positive that they will be able to repay the loan in the not too distant future. The fund has however been very successful. The National Audit Office has recently given them a clean bill of health on all their procedures. With the latest tranche, employer participation grew from 40 000 in January 2016 to 100 000 at the end of April.

What are the retirement fund options for employers?

Employers that do not have their own DC fund have a choice of two types of funds: master trusts (the South African equivalent is an Umbrella fund) and a GPP (a contract-based retirement solution offered by a large financial services company. It is effectively a retirement annuity policy, with no need to establish a fund and appoint a board of trustees). NEST is constructed as a master trust. It has both an executive board (responsible for the business of the operation) and a board of trustees who have a fiduciary duty to the members of the fund. The regulator (PMI news, April 2016) indicated that master trusts are now used by 76% (3.9 mil) of savers in schemes being used for auto enrolment. This is a significant shift, primarily fueled by smaller employers who had to enroll.  In the 2015 Aon survey, 56% of employers surveyed had their own DC funds, 38% a GPP and 4% a master trust.

NEST currently enjoys a market share of around 50% of new business, The Peoples Pension approximately 30% and the balance of 20% is serviced by some 110 providers (estimates vary) with most of these being master trusts.

Progress with auto-enrolment

Auto-enrolment was implemented in October 2012. The first employers that had to comply were those with 120,000 employees or more. The legislation set out dates that the larger employers had to comply based upon the number of employees that they had as of 1 April 2012. These larger employers had a staging date (the time that they had to comply with the auto-enrolment legislation) ranging from October 2012 for the largest through to mid-2015 for medium sized businesses. As from June 2015, the legislation started to affect smaller and micro employers and their staging dates were dictated by their PAYE reference (this is their HMRC reference for paying employees).

To put it into perspective, around 100,000 employers had complied by early 2016 but in the next two years more than 1.8 million small and micro employers (less than 30 staff) will embark on this journey. An estimated 90% of the UK employers have therefore still to be involved. Of those 66% are micro employers with 4 members of staff. Just less than half of those have only one employee.

Opt-out rates to date have been low and upwards of 5 million workers are now saving towards retirement.

Pension freedom and freedom of choice reforms

In 2014, the government announced pension freedom and choice reforms. They allowed members to withdraw their entire pension fund in cash at any point in time from age 55 onwards. This has been a game changer.

Many studies were done to determine the needs of members and how best to accommodate them. In the main, the energy is focused on the format of targeted benefit and how to fund it. Most firms are now working in the direction of a combination of a pension, a drawdown and a cash benefit and most of them have calculators to plot and project progress.

Intelligent Pensions, for example, developed a calculator into which they could layer the family income – state old age pension, any DB benefits, and DC benefits and model ways in which a “secure” income could be planned using the latest technology and funding methods. They charge £150 per advice session (telephone and web based) where both the FAIS-accredited advisor and the client can see the same numbers and projections. A record of advice is provided. If the member requests them to implement, the cost could be in the order of 50 to more than 100  basis points, all inclusive. NEST is working on a similar offering incorporated a deferred annuity, which they hope to offer at between 50 to 75 basis points, all inclusive.

Aon’s 2015 survey finds that 70% of members want an annuity style income – “just do not call it an annuity”.

Retail Distribution Review

The UK Government undertook a Retail Distribution Review (RDR) to address how much consumers pay for financial advice, what they pay for and to introduce a minimum level of qualification for all investment advisers. The RDR took effect from 1 January 2013.

The higher level of qualifications required by the RDR resulted in advisers having to sit a number of exams. As a result, adviser numbers dropped as those close to retirement decided to not to achieve the qualifications and others exited the industry.

One of the outcomes of the Retail Distribution Review was that advisers could no longer be remunerated by way of a commission from individual and corporate pensions and investments. Any fees for adviser services have to be agreed with the client, although the costs could still be deducted from the product rather than the customer have to pay these from their savings or income.

Lord Turner’s top five ideas for the next 10 years

In an interview with State Street Global Advisors, Lord Turner suggested the following:

• Continuing improvements in life expectancy mean that the age of retirement needs to be increased to ensure that the state pension becomes too onerous. “Anyone aged 30 today should be planning their life around their age of retirement being 70 or higher”.
• Increased tax incentives should be used to encourage workers and employers to contribute more than the combined 8% minimum that is mandated under auto-enrolment from April 2019.
• Auto-escalation could play an important role to increase contributions. “Employers could tell new hires their contributions would be automatically increased to around 15% unless they decided to opt out.”
• The goal must be for all employees to have their pension pots in one place to take advantage of economies of scale. The current average number of jobs a working person will have in one lifetime is 11 and it is predicted to increase to 20. The current system of individual company schemes established with each employer results in a messy system of multiple pots. “It is crucial for employees to auto-enroll into one system, otherwise there will be a proliferation of costs to a member.”

The outlook for the UK’s 4.5 million self-employed that currently fall outside the auto-enrolment provisions, is bleak. Pension provision for this segment is now much lower than salaried workers, with only 30% of the self-employed saving for a pension, compared to 51% of employees.