Beyond Risk Profiling: Achieving better investment outcomes for consumers and industry

In the wake of the Retail Distribution Review, there remain fundamental questions about how best to support consumers to make sound investment decisions, particularly those with modest amounts of money to invest, for whom a poor investment decision may have a disproportionate adverse impact. The advent of new pension freedoms from April 2015, which give people more choice and flexibility about how they use their retirement savings, adds further impetus to the issue. To help inform policy and practice on this important subject, in June 2015 we brought together consumer and industry experts to explore possible new approaches to improve risk profiling and investment decision-making

Whither UK annuities? Why lifetime annuities should still be part of good financial advice in the post-pension-liberalisation world

The UK government’s 2014 Budget proposed major pension liberalisation for retirees from 2015, which will allow them to draw their pension savings in any form they choose at any time they choose from age 55 onwards. Until now, the majority of retirees have turned their pension pots into income by buying a lifetime annuity. However, annuity rates have fallen steeply over the last 25 years and ‘annuity bashing’ has becomes something of a national sport in the UK. Thus the proposed liberalisation looks politically astute by playing to popular sentiment, and some commentators have predicted that a huge permanent decline in the sale of lifetime annuities will result. Contrary to the dominant view, this paper argues that many lifetime annuities do in fact offer fair value for money and the protection against longevity risk is probably poorly understood by consumers. The fall in annuity rates has been due primarily to rising longevity, which does not reduce value for money, and post-crisis monetary policies, which although prolonged are not a permanent feature of the economy. While the types and features of annuities on offer may need to adapt, this much maligned financial product should ideally still play a key role in most people’s retirement planning and in the free, impartial guidance for every retiree promised as part of the government’s pension liberalisation package

How Might We Create a Secondary Annuity Market that Works for Pensioners?

In April 2015 the government’s pension freedoms came into effect, removing the requirement for pensioners to turn their pension pot into an annuity in order to retain the tax benefits. Later last year they announced plans to extend these freedoms to pensioners who had already bought annuities from April 2017, by creating a secondary market and allowing pensioners to sell their annuities on it. The government’s expressed aims were to “achieve parity between those who are able to access their pension savings flexibly… and those with existing annuities” by developing a secondary annuity market that “best suits the interests of pensioners” (HM Treasury, 2015b). Creating a secondary annuities market that works well will be a difficult task. It is an unusual and complex market, with ‘consumers’ as the sellers, firms as the buyers, prices that are individual to each pensioner, legal complexities with the original annuity provider having to agree to any sale, and the product being one of the most important we ever purchase – an income for life. There is huge potential for it to go very wrong, with the details of government policy and regulatory action likely to play a big role in whether or not the market works for pensioners. To inform the debate, and help the government and regulator decide how best to intervene, we have conducted a study of the secondary annuity market: how one might function, what problems are likely to require addressing, and which policies appear most promising in doing so. A secondary annuity market must function on two axes if it is to deliver good outcomes for pensioners: Competition must be effective in driving value-for-money Pensioners must be adequately protected from harm. Neither of these axes is as simple as they may seem. The role and potential advantages of the original annuity provider in the secondary market may present a barrier to the emergence of competition, and the behaviour of pensioners and information difficulties may render it ineffective. Preventing harm to pensioners involves not just regulation to protect the most vulnerable, but also stopping ordinary people from making significant mistakes. Our analysis suggests there are fundamental problems that need addressing, which the government and regulators have underestimated when designing their proposals, including a real risk that there will be no functioning market at all when the laws come into force next year. Normally a study such as this would analyse how the market is currently working and look for evidence of market failure, however this market does not yet exist. Instead we have focused on how the market might develop and the potential impacts policies may have on our two axes – effective competition and consumer protection – both of which there is considerable uncertainty about. We therefore caution against overconfidence in any particular option, and strongly recommend that the government and regulator review the market carefully once it has launched and reconsider what intervention is necessary and beneficial in light of that evidence

Pensions and Gender Equality: Policy paper for the Commission on a Gender-Equal Economy

Due to their much greater likelihood of taking on unpaid care responsibilities, women face disadvantages in the labour market compared to men. Not only does this result in a gender pay gap of around 17% in the UK during women’s working lives but an even larger gender pension gap in retirement of 36%. While part of any long-term solution to this gender inequality would address the labour-market disadvantages, there is no inevitable association between a pay gap and a pension gap. The design of pension systems can offset, perpetuate or exacerbate the inequality. The new UK state pension system is more gender equal than the pre-2016 state system and a major strength of both systems is the protection of carers’ pension rights since 1978. However, transitional rules mean that it will be another 20 years before women receive the same state pensions as men. Moreover, while the government considers the new state pension to be enough to live on, it is around 40% lower than the level deemed adequate by independent sources. The UK private pension system is highly unequal with the capacity to save and the associated tax reliefs heavily skewed towards men. As a result, the median pension wealth of women on the brink of retirement is just half that of men. The cost of pension tax reliefs in UK was £35.4 billion in 2017- 18. This compared with public spending on state pensions of about £94 billion (Great Britain). All pensions, however financed or calculated, are claims on future national income and so, to the extent that these claims are met, involve a transfer of national income from the working population to the retired population. The most economically efficient way to ensure equal, adequate and reliable retirement incomes for women and men would be to replace the current patchy recognition of unpaid work and lottery of ability to save inherent in the current state and private pension systems with a state-funded universal basic income (UBI) for all retired people payable at a level of around £277 a week (£14,400 a year)1 . With an adequate retirement UBI, any additional provision for retirement would be a matter of personal choice with no need or justification for subsidies from taxpayers. Assuming the private pension tax relief saved was diverted to help fund UBI, as a percentage of GDP, the cost would be less than the current OECD average of public expenditure on pensions. There is, in any case, a lack of evidence to suggest that pension tax reliefs are effective at incentivising saving for retirement and the UK system of reliefs is highly regressive. In the absence of a retirement UBI, pension tax reliefs should still be scrapped and the amount used to finance state-funded carer credits to private pension schemes

Consumers and competition: delivering more effective consumer power in retail financial markets

Competition reviews of retail financial markets are frequent and commonly include recommendations designed to increase consumer shopping around and switching in order to drive competition. However, many of these markets are characterised by 'monopolistic competition' and firms use a variety of tactics to increase or maintain their market power, including product complexity, price obfuscation and price discrimination. These tactics are effective because they exploit consumers' behavioural traits, such as status quo bias, anchoring, present bias, satisficing, and more. As such, consumers are not equipped to engage actively in these markets as regulators would wish. However, digital innovation may hold the answer, if mass-market consumers delegate the tasks of shopping around and switching to automated services via computers and mobile apps. Innovation is already moving this way, but raises issues around data security, conflicts of interest and trust, which will need to be resolved

Investment choices

Having identified a need to save or invest, private investors have a wide range of assets and products to choose from. There are many different types of savings and investment product, with a variety of different features. Some offer income, some capital gain, others both; some have guarantees, some do not; charges may be explicit or subsumed into the interest rate offered; and tax treatment may vary. But whatever the make-up of the product, the attributes come down to three basic features that can be characterised by the questions: How much will the return be? When will the return be paid? What is the risk that the amount or timing of the return might not turn out as expected

Chapter 10 Financial Crimes

• Trust between customer and provider is implicit in most financial services which contributes towards opportunities for crime. • Financial crime lies on a spectrum of behaviours that may cause consumer detriment. Whether or not some types of behaviour amount to a crime may change over time and can differ depending on whether it is viewed from an industry or consumer perspective. • Financial crimes can result in widespread economic damage. • Scammers exploit innate human behavioural traits and so one form of protection against scams involves identifying and diffusing the emotional response

Policy Choices

Consolidation of how Keynesian fiscal policies and the alternative of monetary policies may be used to manage output and employment; their application to an open economy; advantages and disadvantages of, and winners and losers from, each policy approach

Chapter 9 Financial services and the role of government

• The role of government is important for personal financial planning in three ways: fostering trust in the financial system; through its social policies; and its management of the economy. • The actions of government in these three areas influence individual and household confidence in the financial system, the nature and amount of financial products and services they need privately to arrange, and the cost and outcome of financial decisions