The importance of innovation in defined contribution pensions

How can we help members achieve good outcomes in retirement? This was the question posed to our panel during the second session of last week’s “Assessing the future of DC” breakfast seminar. The panel of industry professionals raised a number of interesting points, but the major unifying theme that came out of the session was around innovation, or a lack of it.

Developing new options for DC members

The consensus of the morning was that the slow pace of innovation post pension freedoms is leaving defined contribution (DC) members woefully unprepared. The solution is for the industry to prioritise developing effective drawdown options alongside suitable, low-cost, guidance to help individuals towards sustainable incomes in retirement.

You only need to look at the recent Financial Conduct Authority figures that show a third of non-advised drawdown sales are being invested in cash funds, to see that members are being let down. The truth is that the vast majority of people are underserved and unsupported with the decisions they now have to make at retirement. A huge swathe of the market simply cannot afford to access advice.

While there is a desperate need for innovation, the industry is fearful of innovating in a way that provides much needed personalised guidance for fear of straying into advice. We’re currently in a situation where a fear of providing meaningful support in an affordable way means that many people have none.

It’s three years since pension freedoms were introduced and what is offered for drawdown investment remains in the stone-age. In the absence of any creative thinking from the asset manager community, the regulator (yes, the regulator!) is proposing default pathways as a potential solution, directing folk into a strategy that suits based on likely duration. Hopefully, we’ll now see some managers taking the regulators lead and start designing solutions in this way.

Supporting retirees

Drawdown needs to be seen as a service, not a product, and investments should be personalised, and aligned to individual’s goals. We need to support individuals to manage their pensions in an appropriate way through the development of low cost tools and guidance that aren’t hampered by heavy regulation.

Additionally, let’s accept the inevitability of the need for a charge cap in drawdown and move on. This industry has proven incapable of regulating itself when it comes to cost and therefore intervention is necessary. There is a cap of 0.75 per cent in workplace accumulation. Arguably there is a greater need for this in decumulation as this is when pots are at their largest.

When it comes to helping members to consider sustainable drawdown rates, one of the most important elements of this is how long people are likely to live, something they tend to underestimate. Add this to variations in pot size and financial situations, and a ‘sustainable’ withdrawal can look very different for different consumers. It is vital for people to have a fully informed view of how long the pot needs to last. If they decide to take a higher initial income, at least ensure they understand that their pot is likely to run out before they do. The need for tools that help people better understand and frame their income in the context of their life expectancy could not be greater.

Interestingly, when we asked our seminar audience what they saw as the main issue the industry must tackle for members to achieve good outcomes throughout retirement, the most popular choice (41 per cent) was ‘improving member education and communications’. Although there is undoubtedly a clear need for better education and communication, there is also an equal if not greater need to provide better directive support and guidance, particularly at retirement where we see irrational behaviour and decision making. It’s in this area where we cannot ignore the importance of innovation.

The author is Lee Hollingworth, head of DC at Hymans Robertson.

This article was provided by Hymans Robertson.