Innovative thinking must be urgently embraced by the DC market if members are to receive the income they’ll need in retirement, warns Hymans Robertson, as it launches a new report – Risk sharing: an age old solution to an age old problem. It says that greater innovation in the options offered by Providers and financial advisors to pension savers could increase their retirement income by 20%¹. This would be a lifeline for the majority reaching retirement with less savings than required for a decent standard of living. The leading pensions and financial services consultancy’s report explores a range of existing and new risk sharing options, which it claims the industry must comprehensively adopt.

Commenting on the problem facing millions of DC members, Jon Hatchett, Senior Partner, Hymans Robertson says:

“Millions of people in the UK are heading towards retirement outcomes that are worse than their parent’s generation. The PLSA’s Retirement Living Standards maintain that a moderate standard of living in retirement will cost about £23k per annum, a target that is currently out of reach for most². This is far from ideal. Members will be simply losing out on the chance of increased income in retirement by the industry’s inertia and resistance to change the ways in which DC pension are accessed.

“It’s been eight years since the introduction of Freedom and Choice which completely altered the DC pensions landscape. Drawdown remains by far the most popular choice for retirement³, yet it does not give a typical retiree any way to efficiently manage their pension pot. Any individual, whatever their life expectancy, might spend a year in retirement or 40 years. And they cannot know in advance. This longevity uncertainty trumps investment volatility for most DC savers.

“Each year, UK retirees are ever more reliant on DC pensions. For most this income will be insufficient as they haven’t saved enough, and are unlikely to be able to, even if they increase their contributions now. It might be too late for those in their 50s and 60s to save enough, but not too late for the industry to help.  Risk sharing can allow these people much better ways to manage the uncertainty of how long they will live, and for those that choose to prioritise spending while they are alive, increase their income in retirement by around 20%¹.”

Commenting on what Providers, regulators and the industry need to do, Paul Waters, Head of DC Markets, Hymans Robertson, adds:

“There should be a real onus on the Providers, regulators and the wider pensions industry to focus more resources to develop ways to help DC members with this problem and to help them extract more value from their DC savings. But the clock is ticking. To help members who are really going to need the increased income, the work now must be done now. Many members in this position will have moderate incomes and not be able to access advice. So, the industry must provide defaults that don’t require active engagement in the decision making by the member.

“Providers and the pensions industry need to quickly develop some of the ideas that are emerging into tangible solutions. This will deliver retiring DC savers increased incomes when they’ll need it.  Risk sharing presents an opportunity for the industry to do this. The various flavours of risk sharing must be supported with innovative thought and investment. With just a little more work by Providers and schemes to design and implement new ways for DC pensions to be accessed, this problem could be solved. While CDC is one approach, it is not the only answer. Other options are available that have the potential to deliver more value to savers, at arguably lower long-term risk, and can be implemented today. The government and regulators’ single-minded focus on CDC risks missing the bigger picture.

“As an industry, we cannot afford to get this wrong for savers.”

The report outlines a number of options and risk sharing ideas that could increase the sustainable income people can draw from their pension pot, allowing them to plan their spending with confidence and reduce the risk of running out of money. Some of these ideas are tried and tested (e.g. annuities and drawdown), while others are emerging (e.g. CDC), and more are yet to be developed (longevity pooling and deferred annuitisation). The report also recognises that, in search of the optimal outcome for members, we could see the blending a number of these different approaches as they are developed.

Annuities: A guaranteed regular income payment until death, or an earlier pre-defined term. Members can choose between various product features such as inflation protection or not, dependant’s pension and lump sum on death. Provided through life insurers, annuity pricing is largely linked to gilt and bond yields.

Income Drawdown: A method of accessing your DC pot for ad hoc lump sum or regular withdrawals, while leaving it invested. Members can choose to take tax free cash first and also select the investment strategy for their pot.

Longevity Pool: A way of pooling longevity risk and boosting income while alive. Members draw income from a flexi-access drawdown fund, within limits. Upon death of a member the remaining pot is spread fairly amongst surviving members of the pool, rather than going to the member’s estate.

CDC (Collective DC): A way of pooling investment and longevity risk. Members join a collective scheme with their pots invested together and benefits determined by performance of the scheme (investment returns and member deaths) and calculated by actuarial assessment to offer a fair return to different cohorts over time.

Later Life Longevity Protection: A decumulation design that has built protection against longevity risk at a pre-determined age e.g. 85. Designed to combine flexibility in the early years of retirement with the security of a later life protected income, which could be delivered through annuitisation or a longevity risk pool, without requiring too much active planning and decision making from the member.

Investment Pathways: An FCA mandated option for customers in non-advised income drawdown, where customers are given a choice of four options based on how they plan to take their income over the next five years. A single investment default is created for each of the four Pathways.

¹  Hymans Robertson’s modelling analysis

² Analysis by Hymans Robertson shows: An average earner contributing at AE minimum level of 8% has only a 1 in 3 chance of achieving a moderate standard of living and contributions would need to be as high as 16% of pay to have a 2 in 3 chance.

³ https://www.fca.org.uk/data/retirement-income-market-data-2021-22

Hymans Robertson thanks the organisations that contributed to the report: Nest, Standard Life, Hargreaves Lansdown, Retirement Line and Club Vita.