Alison Bostock: Hello, I'm Alison Bostock from PTL. I'm a client director and a professional trustee. Today I chaired a seminar about flexibility and freedom and choice for DB members and I'm joined now by Steve Lewis from LV Retirement Solutions and Steve was talking about the practical solutions that are out there in the market now for members.
Now Steve I think you started off by talking about the new world for DB members who are considering transferring in to DC and the risk that they have to get to grips with.
Steve Lewis: Yes, the risks for DB members have always been hidden behind the guarantee structure and the professional governance that exists around any final salary scheme structure, so I confessed today to having a DB benefit myself and having to think about mortality risk, longevity, investment risk, legislation changes and so forth is not in, you know, it's not in my sphere, I don't, I can sleep easy at night knowing that my final salary scheme will care for that.
Going forward with pension freedoms arriving, people are just starting to wake up to the opportunities that are available to them, so as people start to investigate the value of their final salary benefit, they are also having to be educated on the risks that go with that value.
So moving away from the paternal environment of the final salary scheme where the risks are catered for by the trustees and there is a proper governance around moving into a structure where it's under your own governance, and as the individual you have to look after yourself more, that education process is really important.
Alison: Thanks. So you had an example I think that showed both investment and longevity risk and you looked at two or three different members and it was about the shape of the returns I think.
Steve: Yes, so, one of the key risks clearly once you move your fund out of the final salary environment and start to invest it yourself in a personal pension is going to be coming through on the investment side.
If you start to draw money from a fund as well on a regular basis, on a monthly basis, you are exposed to not only investment risk in actually being able to achieve the returns, but volatility risk with the movements of the market. So the returns that you actually receive on a month by month basis, let alone a year by year basis, and the movements of the market is so important.
So we illustrated a very simple example where commonly a financial adviser might suggest a four percent withdrawal rate from a fund, which is a very reasonable expectation to build an income drawdown structure on, but how the different structure of returns from the markets - investment returns - can significantly affect the longevity of that fund.
So we produced an example where two different scenarios of investment returns and simply in the worst case scenario we put into the numbers the assumptions three negative return years in the first five, and then in the second example just two negative return years.
On a four percent flat yield, so averaging out, which is unlikely to happen, we would expect the fund in the example, it was a 65 year old going through taking a four percent withdrawal from their fund. We'd expect the fund to last for someone until about 91 years old.
The impact though of just having two negative years pulls this back to 86 years old, and three negative years in the first five years would pull it back to 81 years old. In reality this is someone's pension fund running out ten years earlier than they might have expected because of the volatilities of the market.
So when people do move into an income drawdown structure it's so important that we do educate them in some of the other practical solutions available. So people don't have to be exposed to the stock market in income drawdown. They can build structures with guaranteed income structures and these come through in the terms of fixed term annuities or smoothed investment funds or different portfolio allocations.
It's thinking in a similar way to final salary scheme trustees do within the investment committees and actually thinking about their asset allocations. So immediately we dive into quite a technical area where perhaps we understand the issues involved, but our real challenge is how we take these complex issues and communicate them through to the scheme member so they do fully understand the risks that they may be taking on and understand some of the ways in which they may mitigate those risks in the future.
The wider issue for us then is how we engage with people and actually get the employee to understand that process and it's so important that even the final salary scheme member does engage probably 18 months or more before their retirement age and actually now even begin an education process perhaps in their early 50s, perhaps in 52, 53, 54 years old as they approach the 55 age point where they will no doubt now be seeing information and marketing material from organisations making them aware of the pension freedom rules and that from 55 they have new options.
So if we can engage both final salary scheme member and money purchase DC contribution members, we can engage with them and start to educate them so they understand risk, understand the issues involved and they can make better informed decisions. Now, clearly, they have to take advice: if you're going to come out of the final salary scheme you do need to go through an advisory process and it's really important that trustees recognise that.
The trustees of the company don't have to pay for that advice, but it's a good process and we talked in the seminar today about some of the things that trustees may want to think about as far as due diligence is concerned, when thinking about selecting or recommending or choosing advisory businesses, advisory services to put in front of scheme members. Recognising and remembering again, scheme members will always have the choice to go wherever they wish to get their advice.
Alison: Steve, you also talked about some of the practical solutions that your company has brought to the market in this area.
Steve: Yes, we've done a lot of work around this and clearly there are other providers in the market who will also be looking at this as a key topic.
Bringing pension freedoms to the market and allowing this flexibility for individuals as a whole has been right at the core of our strategy anyway. One of the key sectors for us are occupational scheme members and we've been bringing to market different solutions for the occupational scheme environment.
In the DC environment we have a fully online advice process which is a regulated advice process that people can use at their desks and go through that process very efficiently. In the final salary, the DB marketplace, it is very different and we need to make sure that a different set of information is presented and we have the appropriate, again, robust advice process behind that.
So one of the things we have been working on here is a service we can support with trustees to allow the presentation of options to members and again to take the member through an education process to balance out how they can make the decisions against the risk that they may be taking on.
So our compass proposition firstly starts to enable the presentation of data to a member in a simple format, allowing them to see how their existing benefits are structured and how a full transfer or, indeed, a partial transfer could be shown. One of the things we do see as being far more popular in scheme structures and the flexible taking of benefits in the future are partial transfers, and this is an area where we have been working with professional advisers and trustees to model out the services.
That service will then go through where a member can use other tools and it's really important that members do look at tools to create their own budgets, understand their own longevity, so health checks and so forth to just some estimate of longevity. As well as then mapping those things together so that they can start to model their own future income requirements going through.
Crucially that's all backed up with advice processes and there is no insistence in the services we offer that people have to do the eventual solution with LV, this is provision of information, provision of advice so people can then decide. I emphasise that my expectation is that the majority of people will stay in the DB environment. It's strong, it gives strong benefits and protection and within our own advice principles we work hard to ensure that people have that security in life that they have, they're covering their minimum expenditure and they're not going to find themselves in late life in a dire situation with all of their money run out.
Alison: OK, so I can see the benefit to members of the compass proposition. What do you see as the benefits for the trustees and employers of engaging with it?
Steve: That's a really good question. The employer now is going to have members of staff who are approaching 55, possibly ten years before normal retirement age, who are starting to ask questions, perhaps who are members of closed final salary pension schemes with mixed DC benefits as well. Asking questions about what they can do with these benefits.
One of my opening statements this morning was really just to simply say that the big difference with pension freedoms is that pension funds and pension value now is real and it is the member's money, it is their own money and that's the realisation people are coming to. So putting in an education process, backed up by an advice process, will support the employer. Clearly it improves that employee relationship.
There are real issues coming up for employers maintaining their employees between the ages of 55 and 65. Retirement age is no longer a fixed point in time. People will perhaps just work a little less as they go into retirement and travel into retirement, so helping that journey and educating staff will help the HR processes of any business.
For the trustees, clearly it supports the duty of care that the trustees have on the scheme members to ensure that they are fully informed and they understand the processes they are going into and the risks involved and that's most important of all, is that people who are members of schemes are not just jumping at the chance of a windfall of cash and seeing it in that way and are understanding all of the issues and making the right decisions with the right advice.
So it's all about producing the right outcomes for the scheme member.
Alison: Thanks very much, Steve.