Our Changing Future – Current Issues in Retail Pensions

1. Our Changing Future – Current Issues in Retail Pensions Ian Naismith

2. Agenda • Legislative landscape • The impact of A-Day & NPSS • Regulatory landscape • The challenges of TCF & RDR • Economic landscape • The search for secure growth • Demographic landscape • The opportunities at retirement

3. A-Day basics • A-day was 6 April 2006 • Legislation in Finance Acts 2004, 2005, 2006, 2007... • Plus regulations and guidance manuals • Simplicity8 pension tax regimes into one • FlexibilityFewer rules, more options (especially at retirement) Source: Finance Act 2004, Chapter 4

4. Post A-Day contributions • Alternatives to pension? • May add flexibility but with risks (redundancy, death) • Large contributions close to retirement • No 40% tax in final year – utilise value of business? Source: Finance Act 2004, Chapter 4

5.  X X  Post A-Day Investments • Essentially no change to investment options • SIPP momentum proved unstoppable Source: Finance Act 2004, Chapter 4

6. } } Minimum age for drawing benefits (55 from 2010) Maximum age for drawing benefits Unsecured pension (drawdown) Secured pension (annuity) Secured pension Alternatively secured pension 60 65 90 55 85 80 70 75 95 50 45 Post A-Day Benefits • Additional tax charge if benefits > lifetime allowance (£1.6m) • 25% tax-free lump sum up to Lifetime Allowance • Transitional protections Source: Finance Act 2004, Chapter 4

7. A-Day effects • The rise and rise of SIPP • Driven by consolidation, not new money • New business opportunity but persistency hit • Potential change to adviser remuneration model • Market regulated - FSA concerns over sales • Flexibility in contributions and retirement timing • Still unclear if saving & retirement patterns changing • Post-retirement innovation • Largely in unsecured pension – variable annuities etc

8. State pension reform • Increase basic state pension with earnings • Probably from 2012, subject to affordability • Raise state pension age starting in 2024 • Eventually to 68 by 2046 (more later?) • Move towards flat-rate State Second Pension • Stop defined contribution contracting-out in 2012. • Better provision for women and carers • e.g. Full basic State pension available with 30 years of NI contributions paid or credited Source: Pensions Act 2007 Part 1

9. National Pension Savings Scheme • Automatic enrolment into Personal Accounts • Employees aged 22 or over earning > £5,000pa • Opt-out available. Self-employed can opt in. • 8% basic contribution • 4% employee contribution, 3% employer, 1% tax relief • Centralised scheme, managed in private sector • Limited involvement from employers & employees • Employer helps enrol staff & passes on contributions • Defaults for employee, but limited choices available Source: Personal Accounts: A New Way to Save – DWP December 2006

10. NPSS issues • Focussing on those with no current pension • No transfers in before 2017 • Modest contribution limit - £3,600pa in 2005 terms • Preserving good existing provision • Straightforward exemption criteria for employers • Level playing field – no subsidy, consistent regulation • Ensuring members make good choices • Possible loss of means-tested benefits • Generic advice – Thoresen review

11. Individual Pensions Corporate Pensions Pre-NPSS Pre-stakeholder Demonstrably different product & advice proposition Group SIPP SIPP/SSAS GPP / group stakeholder Personal Pension Traditional PP squeezed due to regulation and lack of differentiation Possible impact of NPSS Post-stakeholder Post-NPSS? SIPP/SSAS Group SIPP GPP/ stakeholder Personal Pension Personal Accounts Stakeholder

12. Principles-based regulation • Movement towards principles, not prescription • FSA, TPR, ICA, SMPI etc • FSA ‘NewCOB’ in force since 1 November • Flagship initiative - Treating Customers Fairly • 6 key outcomes for consumers • MI to measure TCF to be in place by March 2008 • Firms able to demonstrate TCF by December 2008 Source: http://www.fsa.gov.uk/Pages/Doing/Regulated/tcf/index.shtml

13. Key TCF areas for actuaries • Outcome 2 • “Products…are designed to meet the needs of identified consumer groups….” • Outcome 3 • “Consumers are provided with clear information and kept appropriately informed….” • Outcome 5 • “Consumers are provided with products that perform as firms have led them to expect…” Source: http://www.fsa.gov.uk/Pages/Doing/Regulated/tcf/index.shtml

14. Current TCF pensions hot-spots • Quality and clarity of Key Features • Only 15% of those sampled met FSA standard • Communications & advice on with-profits • Explaining guarantees, managing expectations, clarity • Annuity rates and retirement processes • Flagging of Open Market Option • Sales of SIPPs • Quality of advice, justification for higher charges Sources: Good and bad practice in Key Features documents – FSA – September 2007 Insurance sector briefing – FSA – May 2007 Outcome of review of operation of the open market option – HM Treasury, October 2007

15. Retail Distribution Review proposals Based on Thoresen Review Simple advice on straightforward products Likely to be commission-based Remuneration agreed with client Source: ‘A Review of Retail Distribution’ (DP07/1) – FSA – June 2007

16. The search for secure growth • Highlighted by falling markets & interest rates 2000-2003 • Traditional options

17. Reduced-risk investments Protected equity funds, absolute return funds, constant portfolio protection insurance… • What’s the growth potential? • What protection is offered? • How does it respond to different markets? Source: Personal Accounts: A New Way to Save – DWP December 2006

18. Variable annuities • Reduced-risk investment around retirement • Guaranteed income for life or fund at a point • May offer wide fund choice • Risk hedged via options etc. • Guarantee funded by increased annual charge • How strong is the guarantee? • What does it cost in different scenarios? • Can it ratchet up – how often & by how much?

19. Variable annuity simulation Average growth 7.5% minus 2.5% annual charge. Income 5% of guaranteed ‘fund’

20. Variable annuity pension from age 75 as a % of drawdown Pension is from level annuity purchased at age 75, or guaranteed income if higher. Based on 60 year old male at entry taking income of 5% a year of initial fund until age 75. Variable annuity guarantees the 5% for life, with a 1%pa additional charge. Based on 250 stochastic simulations of possible future financial conditions. Results are dependent on parameters used, and should not be taken as an indication of the outcome of any particular product.

21. The retirement market Estimated population over 90 Estimated population over 65 Sources: GAD 2006-based population projections Mid 2002-Mid 2005 population estimates reflecting the revisions due to improved international migration (ONS 2007)

22. Current issues in annuities • Longevity • ongoing mortality reassessment – rates & reserves • reinsurance – based on annuity book or index? • longevity bonds – arbitrage of investments • effect of enhanced annuities and drawdown • Protected Rights • Removal of requirement for spouse’s/partner’s pension? • Annuity value • Open Market Option review • Differing views on overall value for money

23. Annuity payback periods GAD estimates. Female cohort life expectancy (UK) 22.3 years Male cohort life expectancy (UK) 19.7 years Based on 65 year old, monthly in advance guaranteed 5 years Market annuity rates @ 5/11/2007 from FSA comparative tables.

24. Flexible retirement options • Great flexibility up to age 75, but then reduces • Phase retirement, vary income, maintain investment control • Government not planning to loosen rules for annuities Source: Finance Act 2004, Chapter 4

25. Conclusion • Lots of changes • Legislation, regulation, markets • Lots of challenges • Can actuaries adapt to the changing environment? • Lots of opportunities • Actuaries have a vital role to play in innovation and communication

26. Questions & discussion