Pensions: The Biggest Social Challenge and The Biggest FinTech Opportunity

We continue with our FinTech series and today’s topic is pensions and the demographic time bomb.

It is widely acknowledged that the UK population is not saving enough and might have problems continuing to live comfortably in older age.  Increasing life expectancy means that people are spending more and more years in retirement and as birth rates decline, the overall ratio of non-workers to workers increases, putting an unmanageable strain on the government welfare system.  To rebalance the pension pot the government can 1) pay less to pensioners, 2) transfer a larger proportion of workers income to pensioners, 3) make people retire later.  But will it solve the problem in the long term?  The current state of affairs is that many of us will have a very poor life in retirement - unless something revolutionary occurs in the pension industry.

According to Chris Sier, Fintech Envoy for the Northern Powerhouse and pensions expert, Asset Management industry has not engaged with the consumer in a way the consumer wants to be engaged with, apart from offering some new asset classes such as equity crowdfunding.

I have seen people getting excited about 10 small investments on peer-to-peer platform, and yet would avoid the issue of doing their allocation to their pension fund. It is the biggest single asset you’ve got apart from your house. Why wouldn’t you care about your pension fund. But people don’t.

Millennials don’t buy any asset management products which have long-term time horizon.

Pensions and other annuity products are not cheap, and overall pension funds performance is hugely inhibited by the hidden costs of infrastructure, intermediation and administration.  According to Chris, “The costs of pension funds are not well understood, neither by consumers/beneficial owners of a pension fund, nor by many intermediaries in the pension fund industry chain. Shockingly, the providers of pension funds also have little idea of the total cost of ownership of a pension fund” (Source link).

There is a globally acknowledged cost of owning a pension fund: it should not exceed 30-50 basis points, but the actual costs go to up 500 basis points.  A huge proportion of these costs can be sorted out with technology.

According to Chris (see interview below), this is one of the biggest social challenges that needs solving, as well as being one of the best opportunities for FinTech companies, due to the unprecedented size of the pension market.  “Reducing cost of holding long-term assets by 2-5% will save consumers £300 billion a year”.   Watch full interview with Chris Sier:

So why are there not many FinTech companies fighting for this potentially huge reward? 

While we see a lot of innovation and investment in short-term financial products such as payments, crowdfunding, peer-to-peer lending, there are fewer developments in long-term finance such as pensions and mortgages. According to Rob Moffat from Balderton Capital, startups have tended to steer clear of long-term FinTech initiatives because pensions, mortgages, and investment are:

  1. highly regulated, require deep industry knowledge and the regulatory expertise to navigate protracted legal processes and to pass strenuous due diligence,

  2. capital intensive, often requiring long-term capital early on, to provide for the higher cost of customer acquisition and regulatory capital,

  3. offer returns over longer periods of time.

The current trend in long-term finance is that most FinTechs aim to take the place of brokers and advisors. Many work on creating a marketplace for financial products, while the actual products are still provided by traditional players. 

The recent government pension reforms gave a rise to a new wave of FinTechs providing pension auto-enrolment service.

Government Reforms - Pension Auto-Enrolment

To encourage workers to accumulate retirement savings the Government introduced the Pensions Act of 2008, which requires employers to enrol all eligible workers to workplace pension schemes.  In this way, eligible employees do not have to spend time searching for suitable pension schemes, but employers must enrol them automatically and administer paying contributions into the schemes.

Automatic enrolment began in 2012 and is rolled out in stages, starting from requiring the largest employers who employ over 250 workers to become compliant and is to be completed in October 2018, when even small and micro employers (between 1 and 49 workers) would have to comply. By February 2017 over 7 million workers had been automatically enrolled into pensions and over 340,000 employers had became compliant (Source link).

As the majority of incumbent pension providers were not ready to provide a low-cost service for vast volumes of SME auto-enrolments, the government has set up their own auto-enrolment company, NEST (National Employment Savings Trust), which is run as a non-profit organisation and is funded by the taxpayer.  NEST is currently the largest pension scheme for auto-enrolment, holding about 65% of the market. 

At the same time, the private sector has also come up with auto-enrolment solutions:  Smart Pension, Now: Pensions, Creative Auto Enrolment and the People Pension, to name a few.  As they have to compete with both the government and incumbents, the private sector companies are a lot more focussed on efficiencies and cost: ease of the set up process, low or no cost of set up, running the scheme for the employers, competitive pricing for the employees, no lock-ins, as well as reliable, safe and easy to use automated technology platforms.  We had an opportunity to talk to Will Wynne, the managing director and co-founder of Smart Pension, the leading private sector pension auto-enrolment business.  Watch this video to learn about the company’s operating model, their partnerships, competition, and plans for the future.

Smart Pension is a great example of how FinTech companies are transforming the financial services industry. This is done by introducing technology that dramatically reduces the cost of pension enrolment, set-up and maintenance, nonetheless this seems to touch only the tip of the iceberg.  Smart Pension is an enrolment business -  the actual pension products are provider by their strategic partner Legal & General.

This is already a good start as it makes some costs more transparent, and provides better financial inclusion and superior, cost-effective service to customers.  However, there is a lot more that can be done in FinTech space to reduce the costs of pension funds, including fund administration costs, asset management costs and custodian costs. 

Who knows what further efficiencies could have been achieved if the likes of the Smart Pensions looked further into optimising the pensions funds business.  Let’s keep a look out for who will the next big innovator in pensions.