Edition: July / September 2016


Having recently returned from a study trip to the UK, Kobus Hanekom of Simeka Consultants & Actuaries reports on their progress with retirement reform.

THE Turner Report, published in April 2006, brought about significant changes in the UK retirementfund 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 (DB) 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 (DC) schemes was nowhere near comprehensive enough and on the whole the population did not set aside sufficiently for retirement.

The report identified three key concerns. First, the percentage of employees who relied entirely on the state pension increased from 46% in 1995 to 54% in 2004. Second, only a small percentage of people made pension decisions rationally; as a result, compulsion was considered a more effective tool. Third, the cost of running a pension fund for smaller enterprises became prohibitively expensive.

There were several critical policy interventions:

  • A more generous and simpler state pension was introduced. Starting at a later age (the retirement age was increased to 66 from 2020, 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;
  • A fees threshold was also introduced. For savings in the default investment portfolio, the total charges to a member may not exceed 0,75% of assets under management. In addition, both initial and ongoing commission payments from providers to advisers were banned. Any services required by the employer have to be paid on a fee basis. An adviser is able to agree with an employee for any services required personally to be deducted from the pension fund through what is known as ‘adviser charging’, although this is not facilitated by all providers;
  • An occupational pension plan that is “strongly encouraged” but not mandatory was put in place. People’s inertia was harnessed by auto enrolment. Employees are automatically enrolled in a DC or DB scheme but can opt out. If they do, however, they would automatically be enrolled again at least once every three years in line with the three-year anniversary of the employer’s original staging date. The process 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 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 such a fund after it had gone through a legal process to establish a “market failure” in this sector.

The National Employment Savings Trust (NEST) was established to serve especially the
low- income market. It is funded by a £600m loan facility (currently standing at £400m) by the state. Opinion is divided on when this loan will ever be repaid, but management is positive that repayment will be in the not-too-distant future.

The fund has been highly successful. The National Audit Office has recently given it a clean bill of health. With the latest tranche, participation grew from 40 000 employers in January 2016
to 100 000 at end-April this year.

Employers that do not have their own DC fund can choose between master trusts (the SA equivalent is an umbrella fund) and a GPP (a contract-based retirement solution offered by a large financial services company). The latter 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 which has a fiduciary duty to the fund’s members. The regulator has indicated that master trusts are now used by 76% (3,9m) of savers in schemes for auto enrolment. This is a significant shift primarily fuelled by smaller employers who had to enroll. In the 2015 Aon survey, 56% of employers 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.

Auto enrolment was implemented in October 2012. The first employers that had to comply were those with more than 120 000 employees. As from June 2015, the legislation started to affect smaller and micro employers.

By early this year around 100 000 employers had complied. It’s expected that, within the next two years, more than 1,8m small and micro employers (fewer than 30 staff) will have to enrol. An estimated 90% of UK employers must become involved. Of these, 66% are micro employers with four employees; just less than half have only one employee.

To date, opt-out rates have been low. Upwards of 5m employees are now saving towards retirement. In 2014 the government announced pension freedom and choice reforms. They allow members to withdraw their entire pension fund in cash at any time from age 55. This has been a game changer.

Many studies were done to determine the needs of members and how best to accommodate them. Focus is mainly 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. Many of them have calculators for plotting and projecting. Intelligent Pensions, for example, has developed a calculator into which it can layer the family income – state old age pension, any DB benefits and/or DC benefits – and model ways in which a “secure” income can be planned using the latest technology and funding methods. It charges £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 IP to implement, the cost could be in the order of 50bps to more than 100bps all-inclusive. NEST is working on a similar product which incorporates a deferred annuity and which it hopes to offer at an allinclusive cost of 50bps to 75 bps.

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 January 2013.

Hanekom . . . valuable insights

The higher level of qualifications resulted in advisers having to sit a number of exams. As a result, adviser numbers dropped. Those close to retirement decided not to achieve the qualifications and others exited the industry. A RDR outcome is that advisers can no longer be remunerated by commission from individual and corporate pensions and investments. Any fees for adviser services have to be agreed with the client, although costs can still be deducted from the product.

For the next 10 years, Lord Turner has suggested amongst other things:

  • Continuing improvements in life expectancy mean that anyone aged 30 today should plan to retire at age 70 or older for the state pension not to become too onerous, the retirement age should be increased;
  • Improved tax incentives should encourage employees and employers to contribute more than the combined 8% minimum mandated from April 2019;
  • To take advantages of economies of scale, all employees should have their pension pots in one place.

The outlook for the UK’s 4,5m self-employed, who currently fall outside the auto-enrolment provisions, is bleak. Pension provision for this segment is now much lower than for salaried employees, with only 30% of the self-employed saving for a pension compared to 51% of employees.