Trustees are being given more responsibility for retirement income solutions. Here’s how they can work out what good looks like for members.
The Department for Work and Pensions has published a consultation outcome relating to the support and products available to members of occupational pension schemes when they access their pension assets.
Trustees are expected to play a pivotal role. They will be responsible for making retirement income solutions available to members and must act in the member's best interests when developing products and services.
The DWP says that trustees are best placed to understand their members and to determine the suites of products to be offered to their members. We believe the additional responsibilities to provide solutions should apply to all trustees.
The additional responsibilities being given to trustees are exciting and demanding. Millions of people in the UK will rely on trustees to provide a range of default retirement income strategies and a route to the best solution.
However, the DWP is silent about how trustees should evaluate different retirement income strategies or recommend/guide members to the best default solution.
Trustees will need expert advice and a quantitative/qualitative framework to help them determine the default solutions they should offer.
The framework should help trustees estimate what a member may receive. Then, based on each member's profile, it must estimate and rank the value or utility each member gets from different strategies and direct them to their best strategy.
Trustees will want to show that they have evaluated different strategies and provide their members with a clear pathway to select the best default.
Retirement income strategies can include some combination of flexible drawdown, annuities, and CDC. The income received may be fixed or variable. The investment fund may be standard or bespoke funds designed to be used in DC retirement income. Members may be offered personalised products or be ushered into a cohort of people with a similar profile.
In the section on defaults, the DWP holds up the Australian Income Covenant as a clear example of using trustees' understanding of members' needs to decide on products to be offered and in designing the appropriate default, consistent with member profile and needs being critical to the way forward.
The Australian example is interesting because the covenant gives providers conflicting aims. Maximising income and minimising risks to the member's income in retirement is at odds with providing flexible access to funds. What’s best for one member will not suit another. Trustees are being asked to create default solutions to meet the needs of different groups.
The DWP expects trustees to assess the needs of their members. This is a vital part of the policy because the decumulation policies are designed to shift the industry’s focus towards supporting individuals to make informed decisions at decumulation…. The DWP wants user insight and user-centric design to be much more at the forefront of all trustees' thinking.
The implication of this is that a scheme must use some process to help identify each member's retirement income needs and wants and then use this to propose a suitable and appropriate default solution.
Defining what good looks like
What we need is a common analytical framework to help trustees evaluate and develop retirement income solutions.
We need to agree and define what good looks like when we talk about better outcomes and use an analytical framework that combines a client’s retirement income profile with a rigorous quantitative assessment of the benefits they may receive to score and rank different solutions. This helps trustees and schemes work out what is really in the best interests of members.
Creating a profile for each customer is the basis of all regulated financial planning. But for the retirement income market, the questions must be different. What trustees should be doing is building a profile based on what they can ascertain about each member's income needs and wants.
- What are they receiving?
- What do they want?
- What do they need?
Behavioural investing experts can develop simple questions that can allow trustees to build an accurate profile of each member. For most people, a flat, single-life annuity is a helpful benchmark.
- How would they feel if they received more income than the annuity?
- How would they feel if they received less income than the annuity?
- How would they feel receiving much less income than an annuity? (Most people will have a strong preference to avoid a significant reduction in the income they receive)
- How much do they value the ability to manage their assets?
- How much do they value leaving a legacy?
- How do they feel if their income changes from month to month?
- Would they prefer more income today or in the future?
We need to use the member's profile to estimate the utility they receive from any given strategy and then rank different strategies to help determine what’s best. Without such an approach, we (i.e. those running pensions on behalf of members) can only be guessing.
David Macdonald is CEO of Socius Technologies
