Providers have told New Model Adviser® the next few years will be a ‘golden period’ for retirement income products, and we have Brexit to thank for it.
But it has been over three years since the pension freedoms were announced promising exactly that. And with little innovation so far, advisers feel let down.
Many point to a lack of products that suit the needs of clients in drawdown, both those with big and small pots. For those ‘hybrid’ drawdown products that do exist, high charges are proving a major downside.
Lack of imagination
This absence of creativity was belatedly acknowledged by the Financial Conduct Authority (FCA) in its retirement outcomes review report earlier this year. It said: ‘Innovation for mass market consumers has been limited to date.
‘There has been some progress, such as tools to aid consumer decision-making, simpler drawdown for the mass market and a few “hybrid” products (mainly aimed at advised consumers). However, we have not seen development of new products combining flexibility and guarantees for the mass market consumers who do not take advice,’ the FCA report said.
More recently, in evidence submitted to the influential Work and Pensions Committee of MPs for its pension freedoms inquiry, the FCA repeated its complaint. ‘Product innovation for mass market consumers has been limited and providers have focused on meeting the basic requirements of the pension freedoms,’ it said.
The FCA said it had seen ‘little evidence’ of new mass market retirement income products. It said firms had concentrated instead on tools and calculators and improving their online interfaces.
In its retirement report, the regulator focused on the products people with small pots could use. But advisers also complain about the products available for clients. Where, for example, are variable annuities with rates that can fall as well as rise during the term, an innovation allowed for the first time under the freedoms?
As former chancellor George Osborne’s biggest bombshell Budget in 2014 slides further into the past, will providers now deliver the retirement income tools advisers want? And what will they look like?
Slow on the uptake
Aviva’s head of policy John Lawson (pictured below) admitted providers had not been imaginative in their product creation since the freedoms came into force.
‘One or two have tinkered around the edges of innovation from the provider and asset management sector. But we have had nothing groundbreaking or something that is a real game-changer,’ he said.
He said the reason for this was the host of regulatory and legislative changes these firms have had to contend with.
‘When you look at the market, there have been a lot of strains on businesses,’ he said. ‘Although the freedoms came into force in April 2015, most people were still working through IT changes probably to the end of 2015. Since then we have had a range of other stuff, including an enormous project at the moment with [the] Mifid II [regulatory reforms].’
With the ongoing Brexit negotiations causing a hiatus on new legislation, Lawson said there was now a real opportunity for manufacturers to bring new products to market.
‘I think now is going to be a golden period,’ he said. ‘Brexit is incredibly useful in that regard. We are not going to have much legislation coming out of Westminster on pensions, although we will have to comply with European directives even beyond Brexit. But over the next couple of years, it looks like a golden period for providers to push their own agenda.’
Lawson said solutions should involve more partnerships and collaboration between asset managers and providers. He said there was potential to create small panels that would be available in drawdown for advisers to choose the investment manager.
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‘The potential is out there for solutions that are real game-changers, which can be something genuinely brand new,’ Lawson said. ‘Something not only innovative but also that can become mainstream. The equivalent of an iPod for retirement income.’
What advisers want
An iPod version of drawdown may seem a far-off reality and some IFAs are unsurprisingly dubious about what changes are around the corner.
Darren Cooke (pictured below), director of Derbyshire-based Red Circle Financial Planning, said: ‘In terms of investment management, if you were going to do it, why haven’t you done it already? If [the product] was that wonderful, why do you have to put it in a pension?’
Ben Cordiner, director of Leeds-based The Financial Advice Company, said he wanted charges to come down, particularly for hybrid products that combine annuities and drawdown.
‘We have looked at some hybrid products,’ he said. ‘But, of the ones we have come across, the total costs seem prohibitive. That is a concern because these costs eat into returns for clients.’
When it comes to the world of the pension freedoms, whether it is for drawdown fees or investment management, cost is a recurring theme. A New Model Adviser® report in August found some providers were charging beyond 2% all-in for non-advised drawdown products.
One possible remedy to these charges put forward by the FCA was a charge cap (similar to the 0.75% cap imposed on auto-enrolment workplace pension policies) for default decumulation, where savers keep the same provider.
Darren Philp (pictured below), head of policy at master trust The People’s Pension, said a charge cap would be a good intervention for the regulator to make.
‘If it is good for the goose, it is good for the gander,’ he said. ‘Would I be averse to a charge cap? No. Do I think a charge cap should apply for default accumulation? Yes.’
Philp said many providers were still in the process of responding to the pension freedoms but he hoped better products would arrive in the near future.
‘Introducing the pension freedoms was the right thing to do, as the old system was not working, but the implementation was rushed. To rip up the rule book, and when all the new rules and regulations were being finalised at the last minute, it was a tough ask for providers,’ he said.
‘Once you create the right regulatory environment for providers and trustees to offer drawdown in a safe and well-regulated way, there will be a steadier platform for innovation.
‘At the moment it is a bit of a sales game,’ he said.
For advisers, the drawdown provider is only half of the picture. Finding the right investment manager is arguably a tougher challenge.
One product that has flown off the shelves since the introduction of the pension freedoms is Prudential’s PruFunds range, which achieved £30 billion assets this year. Many advisers use its smoothing mechanism to cope with the dangers of sequencing risk.
As the flood of defined benefit (DB) transfers continues, advisers want products that manage market volatility. A particular concern is sequencing risk in decumulation; whereby poor returns early on in the investment term have an adverse and lasting effect on overall performance.
Many advisers are turning to PruFunds to tackle this problem. Now other providers want to get in on the act.
As New Model Adviser® revealed in June, Aviva is also plotting to launch its own version of PruFunds to the extent that it too will aim to ‘offer protection from stock market volatility’.
PruFunds uses a multi-asset investment strategy combined with a with-profits smoothing mechanism. Analysts have suggested Aviva could adopt a similar approach to its launch, which is expected later this year. This is essentially an update on the traditional with-profits model.
The with-profits name took a hit after mis-selling in the 1980s and 1990s. Many plans were sold to homeowners with the notion that they would repay people’s mortgages and generate a tax-free lump sum on top.
But as inflation and investment returns fell, providers, like Aviva, had to tell customers the with-profits policies would not generate the returns expected, and the provider froze bonuses in 2010. However, bonuses are also paid on maturity, so as a long-term savings vehicle they worked much better.
For income investors, the resilience against market crashes also appeals, as regular bonuses hold back growth in good years to try to smooth out market volatility.
Steve Buttercase (pictured above), principal at Cambridge-based Verve Investment Planning, welcomed the return of with-profits products.
‘Although [PruFunds] has been successful and loads of DB transfers are going into it, I would like to see more with-profits type products,’ he said. ‘With the old model there was a comfort factor. In terms of income planning, it offered something a little different in that there was a semblance of guarantee.’
The elephant in the room for many advisers at the moment is what happens in the case of a market correction, particularly with the amount of DB transfers going through into drawdown plans.
PruFunds would provide advisers with a delay to a market drop because it does hold back returns. However, Prudential’s investment business development manager, Paul Fidell (pictured above), conceded the fund would not be immune from a market crash.
‘It would be naïve of me to suggest PruFunds could defy gravity and, if everything started to fall, it would magically go in the opposite direction. It wouldn’t,’ he said.
‘It has at its heart asset classes like equities. The smoothing mechanism would provide a lagging effect, so it would put the brakes on if the market went into extreme free fall.’
No time like the present
Advisers are crying out for more products that can offer protection from stock market volatility, particularly in the post-pension freedoms world.
While equity markets remain so buoyant, providers need to bring to market keenly priced products that can offer some protection against falling markets.
The ‘golden period’ of innovation from providers and asset managers needs to happen soon as a wave of money finds its way into a non-guaranteed environment.
Providers should be offering more to advisers now to ensure they are prepared when things go south.