Speech by Christopher Woolard, Executive Director of Strategy and Competition at the FCA, delivered at the Pensions Policy Institute, London.
Speaker: Christopher Woolard, Executive Director of Strategy and Competition
Location: Pensions Policy Institute, London
Delivered on: 16 July 2018
Highlights:
- Demographic shifts and economic trends over the last 30 or so years have remade the social contract across the generations – from the difficulties younger people face getting on the housing ladder, to the need for older people to pay for care for longer.
- The question of how to deal with such challenges is not for the regulator to lead, but rather for democratically elected governments. But we do have a role to play.
- With a broad, complicated remit and finite resources, we have to be targeted in our interventions to yield the best results. So we focus on areas where we can have the biggest impact.
- The aim that unifies our pensions work, whether it’s the Asset Management Market Study, Retirement Outcomes Review or Platforms Market Study, is to ensure consumers have the best outcomes possible in retirement.
Note: this is the speech as drafted and may differ from the delivered version.
I’d like to start with a song. Not, you’ll be pleased to hear, one I’m going to sing myself. But, rather, a lyric.
“Every generation blames the one before. And all of their frustrations, come beating on your door.”
I’m pretty sure Mike and the Mechanics aren’t often called upon to help explain pensions policy. But I quote the 80s supergroup because they happen to have landed on a defining issue of our time, perhaps the defining issue.
When Paul Carrack sings those lines, he could be referring to the way young people feel about getting on the housing ladder, or how people in their 50s feel about their prospects of a comfortable retirement, or even the way people in their 80s worry about ill health or leaving a legacy for their children.
Because demographic shifts and economic trends over the last thirty or so years have fundamentally reconstructed expectations about our circumstances at the beginning, middle and end of our lives.
Today I want to talk about those intergenerational issues that touch on the boundary of our remit as the FCA. And how we, as a regulator whose powers and objectives are granted to us by Parliament, go about fulfilling our duty within this wider context.
The challenges we see today
It’s the primordial right of older generations to tell the ones that come after them, “it wasn’t like that in my day”.
But, grating though it may be to the young people on the receiving end, in 2018 it’s a difficult assertion to dispute. Because the way life looks in your 20s and 30s has changed dramatically.
According to the Office for National Statistics, house prices have increased 7% per year since 1980 and the percentage of 25 to 34 years olds who own their own home has withered from 67% in 1991 to 36% in 2014. Accordingly, the Resolution Foundation estimates that while it would have taken a typical household in their late 20s about 3 years to save for an average-sized deposit in the 1980s, it would now take 19.
At the same time, ‘the bank of mum and dad’ is increasingly the lender of choice, or rather necessity, for young people. Government research published last year showed that over a third of first-time buyers in England now turn to family for help[2], compared to 1 in 5 in 2010.
And, of course, that support is only available to those who have mums and dads with the necessary reserves. With homeownership seemingly out of reach for many, we might expect to see profligacy on the part of young people, splurges on single-origin coffee and avocado toast perhaps.
But rather than a ‘last days of Rome’ nihilism, the evidence suggests many millennials are preoccupied with growing their savings. According to research by the Pensions and Lifetime Savings Association, half of millennials are saving into a workplace or private pension, a number we’d expect to rise as auto-enrolment grows, and half of them are also putting additional money aside. At the same time there is a nuanced picture here, with higher levels of debt than previous generations, much of it accounted for by student loans.
As a regulator, we can do two things for this younger cohort. We can make sure that when they save that money does the most it can for them, which I’ll talk about later. And for those that do use credit, we can tackle the worst harms we see in the market as we are doing with credit cards and high cost credit.
What about Generation X? By some measures their outlook is pretty rosy. According to our Financial Lives survey[3], 45 to 54 year olds have some of the highest levels of product ownership, of knowledge about financial matters and of satisfaction with their financial circumstances. Eyeing retirement, 79% have a private pension while 75% hold some form of cash savings product.
So far so good. But this age group is not without its challenges either. 20% of 45 to 54 year olds have no form of private pension arrangement.
Meanwhile, generous DB pension schemes are disappearing. From a high of 8 million enrolled in 1967, the Office for National Statistics[4] (ONS) estimates active membership of private sector DB pensions has fallen to 1.3 million in 2016.
For almost half of all those who reach retirement age, their principal source of income will be their state pension even if they have some private savings. Moreover, debt is a looming presence in the lives of many, with 1.5 million over-indebted 45 to 54 year olds in the UK.
In fact, the Centre for Economics and Business Research estimates that, on average, households aren’t totally debt free until age 69, 12 years later than they expect.
And this trend of taking debt into later life looks set to continue. Research by the Building Societies Association suggests it is becoming increasingly common for consumers to buy for the first time in their late 30s or 40s.
The result is that borrowing into older age will move from niche to mainstream within the next decade, with an estimated 1.42 million 35 to 64 years olds not paying off their mortgage before entering retirement given the current term of their loan.
Again as, policy makers we can respond to this. Earlier this year we concluded our work on the ageing population[5]. We recently amended regulation around retirement interest only mortgages. Meaning we now treat them as standard mortgages, not as equity release.
Shifts in spending into retirement
The main upshot of all these shifting facts and figures is a cultural change in how we view life in our old age.
On the one hand, many people in their 70s are likely to be sitting on significant amounts of accumulated wealth. FCA analysis of ONS data shows 50% of 70 year olds have wealth of approximately £220,000, while 25% have wealth of around £450,000. According to our Financial Lives survey[6], 71% of people aged 65 and over own their own home outright.
So you might think that this cohort are sitting pretty. But there is still cause to pause.
The reality is that significant numbers of these people are cash poor, with the bulk of their wealth tied up in their home but far less to spend day-to-day.
Our analysis shows that the median net income for individuals aged 70 to 89 is about £13,000 a year, with around a quarter of these people, 1.8 million or so, receiving a net income below £8,300, the new state pension level.
That’s a situation that can quickly turn precarious. Should they fall ill, consumers in this group may find themselves burning through cash to pay for long-term health care, particularly if you live in certain parts of the UK. BBC analysis of NHS data shows residential care could cost £22,000 for those living in south London. And if you have assets and income of over £23,000, you have to pay all of that yourself. Those with assets of less that £14,250 can apply for help from their local authority, though are likely to still have to make contributions from their income.
The issue of care is set to become increasingly acute as many more older people live for longer, often with one or more chronic long-term health conditions. The House of Lords’ report[7] on ageing projected a 90% increase in the number of people in need of care from 2010 to 2030, with an 80% increase in the number of people with dementia alone.
And while headlines are often devoted to some groups not saving enough for retirement, a surprising frugality is permeating some quarters. A recent Institute for Fiscal Studies (IFS) report shows that some retirees hold “unrealistic expectations about [their] chances of survival”, which is leading to an “over-reluctance to spend”.
In other words, far from blowing their pension savings on Lamborghinis and lavish holidays, we’re seeing people penny-pinching because they’re trying to make their pot last for longer than is probably necessary.
The same trend can also be seen in Australia, where economists have noted that most retirees in their 60s and 70s draw at modest rates, close to the minimum amounts each year, meaning many are likely to die with substantial amounts unspent. Indeed, the Government has tried to encourage pensioners to spend more.
While life expectancy today[8] is perhaps not as protracted as some retirees seem to assume, it has been on the rise, although that rate of increase has slowed in recent years.
This, predictably, has a knock-on effect.
The estimated average age at which millennials will inherit is 61. That means that where before young people may have expected to receive an inheritance during the expensive, child-rearing stage of their lives, they’re now more likely to be looking towards retirement by the time they receive that financial boost.
It can’t be a bad thing that our parents and grandparents are likely to be with us for longer. But the ramifications of that shift are challenging traditional policymaking parameters, causing some to ask if they should be redrawn entirely.
In short, the race has changed.
The passing of the baton from one generation to the next is being put on hold as older family members comfortably reach 80 and beyond.
The markers that define key stages of our lives, from owning a house to clearing our debts, are in transition.
And, whether you’re just out the blocks or approaching the finish line, life looks different in 2018 than in did for your contemporaries 30 or so years ago, with new and emerging challenges every step of the way.
Which begs the question, if people in their 50s aren’t in their financial sweet spot, nor are people in their 80s and people in their 20s certainly aren’t, who is?
Intergenerational issues and the FCA’s role
There’s no clear answer to this. Certainly, people in their 40s fare better on average than all other age groups on the measure of net income, which is roughly £18,500 for those in their 40s vs £12,000 for people in their 20s, according to FCA analysis. On total wealth, however, including housing wealth, they are outpaced by people in their 60s, who have on average £290,000 to their £110,000 and hold the most total wealth of all age groups.
But behind the headline data lie huge variations. For example, despite the generous average figure, 10% of 60 years olds hold no wealth at all.
If we’re looking for a ‘golden generation’, it would probably be the 3 million people aged 65 to 75 who both own their home outright and have an occupational DB pension. These have median wealth of £460,000. And 15% of them are significantly wealthier, with wealth over £1m.
There are no easy solutions for these issues. What is clear, however, is that the remaking of the social contract across the generations presents a huge social challenge.
The conversation around how to manage this is not for us, as the regulator, to lead. That is for democratically elected government, with its powers over taxation, wealth distribution, housing and social policy.
We do have a part to play in the discussion, though. It would be impossible to do our job effectively without considering the wider social context in which we work. Frankly, it would be reckless of us to do so.
And that means we have to apply imagination to the way we regulate.
Part of this is avoiding resorting to blunt instruments where a more flexible approach would yield more constructive results. When you only have a hammer to hand, every problem looks like a nail. That’s why we draw on a varied toolkit.
But what does this look like in practice when it comes to pensions and retirement outcomes?
Tackling the problems of tomorrow, today
Let’s strip this back to the role we play. The FCA’s core job is to make markets work well and protect consumers. So where we see harm, or the risk of harm, occurring, we have a duty to intervene.
But with a broad, complicated remit and finite resources, we have to be targeted with our interventions to yield the best results.
This comes down to a clear understanding of our role as it relates to the wider landscape I described earlier, and a clear sense of where we can have the biggest impact.
For pensions that means focusing on the two critical phases in the pensions life cycle: accumulation – when and how people save for retirement – and decumulation – what they do with those savings when they retire.
In both areas, we are driven by one overarching principle; to make markets work well. To achieve a state of affairs where as many people as possible have an income in retirement that is adequate, or at least, in line with their expectations.
To do this, we need a few things:
- to ensure, as far as possible, that consumers are engaged when making decisions
- products that offer good value for money – healthy competition is a core part of this
- savings that are invested appropriately – in line with the particular needs of that consumer.
There are, however, certain factors stand in the way of us achieving this goal
In particular, despite the boost provided by auto-enrolment, not enough people are putting money away or feel they have the money to put away. Our Financial Lives survey[9] showed that just 35% of 45 to 54 year olds have given a significant amount of thought to how they will manage in retirement. Meanwhile, low interest rates make getting good returns harder.
So we have to make sure industry is helping consumers grow and use the savings they do have. Fees and charges matter disproportionately here. We need competitive markets that provide useful services at competitive prices – and we need consumers to trust them so they are willing to invest their money.
Regulating for this requires us to take on broad challenges, and because of our competition powers, almost unique for a financial regulator, we are well placed to do this.
One clear example is our Asset management market study[10]. Published last year, it showed that the way asset managers compete, the role of intermediaries in helping investors choose between providers and investors’ limited awareness of charges all undermine competition in the sector.
Seemingly small percentage differences between charges make a huge difference in asset management, so consumer engagement is especially important here.
For example, paying a fee of 0.25% versus one of 1% on an investment of £20,000 means your pot will grow by an extra £14,000 over the course of 20 years, based on average UK equity market returns.
So we proposed a series of remedies aimed at enhancing protections for investors, providing them with greater clarity over what they’re actually buying and improving their understanding around what they’re paying for it.
As well as tackling broad challenges, we take targeted interventions where there’s a specific risk of consumer harm. Take our Retirement outcomes review[11], published at the end of last month.
Launched just over a year after the pension freedoms were introduced, the review examines how the market is evolving to identify any emerging issues, focusing in particular on consumers who do not take regulated advice.
We found that while many consumers have welcomed the freedom to access their savings in ways they previously couldn’t, they need further support to make the most of that flexibility.
Perhaps this isn’t surprising. The pensions market is complex and questions like which provider to use, where to invest your remaining pot and how quickly to drawdown require careful thought and consideration. For people with busy lives and full plates, such decisions can just seem too difficult.
As a result, many consumers who don’t take advice are ending up in investments that may not be right for them, including in cash – which, while seemingly the most straightforward option, runs the risk of erosion by inflation. A third of non-advised consumers in drawdown are wholly holding cash, over half of whom are at risk of losing out on income in retirement.
This matters. Our evidence suggests that if firms helped consumers navigate these decisions – for example through offering a more structured set of options - investment outcomes could be significantly improved.
For example, consumers in cash could increase the income from their pot by up to 37% over 20 years by moving to a mix of assets. Another worry is that consumers are paying too much in charges because they’re not shopping around, which, in turn, reduces the competitive pressure on firms.
In response, we’re proposing a package of remedies designed to improve consumer engagement, promote competition and protect consumers from poor outcomes. We are also working with the Pensions Regulator on a strategic approach to the pensions and retirement income sector, which we intend to publish later this year.
At the heart of this is the recognition that we have to respond to consumer behaviour as it is, not as traditional economics tells us it should be.
To quote Nobel prize winner Richard Thaler, “We do not play chess as if we were a grandmaster [or] invest as if we were Warren Buffett”.
As Thaler and other behavioural economists have shown, consumers don’t behave like purely rational beings found in traditional economic texts.
So pragmatism is at the heart of our remedies package. For example, we are proposing that the ‘wake-up packs’ consumers receive before deciding on a retirement product include a one-pager with all the essential information they need – because behavioural trials have shown us that this increases engagement.
We are also challenging firms to ensure they offer the products that consumers need. The financial services sector is constantly changing in line with the society it serves. Part of our role is being alive to these changes, and responding to them swiftly. Our Platforms market study[12] is an example of this.
In the last few years, we’ve seen new investors being increasingly drawn to platforms, with Assets under Administration (AUA) almost doubling to £497bn. Given this trajectory, it was crucial we got under the skin of investment platforms and address any emerging issues before they become embedded.
Our interim findings suggest competition is working well for most. However, there are five specific groups for whom this may not be the case. This includes customers who may be losing out on interest or investment returns through holding large cash balances and those who find it difficult or costly to switch. Overall, we found that the barriers to switching are significant – potentially lessening the pressure on firms to offer value for money.
So we’re proposing a package of remedies aimed at protecting customers and improving competition.
Examples include ensuring that platforms alert consumers holding large cash balances and looking into reducing switching costs, potentially through banning exit fees.
Conclusion
All this work – the Asset management market study, the Retirement outcomes review and the Platforms market study – is driven by our aim to ensure consumers have the best outcomes possible in retirement.
But this aim, good outcomes in retirement, will be influenced by an array of factors – from economic trends to demographic shifts – that are not in our power to control.
The intergenerational question will define policymaking for years to come. And the trends we’re seeing today will play out over decades.
Later this year we are going to publish a paper on intergenerational issues, which will:
- examine the challenges I've highlighted today in more detail
- analyse how the financial services market may respond to those issues
- identify any barriers which are preventing the market from innovating and meeting changing consumer demand
The FCA’s role within this complex and ever-changing panorama is a significant but specific one.
But where we can, we’re committed to taking timely, targeted action that makes a real difference in consumers’ lives.
Because, to give the final word to Mike and the Mechanics, we all want our living years to be the best they can be.