Whose risk is it anyway?

The Government wants us to think about pension risk sharing…

To consider how much responsibility we can take for our own financial welfare when we’re really old.

To consider what our employers can do to help

And consider (which they talk of quietly)  what the State should be doing (other than providing the current safety net).

The Government is suggesting the employer  will take on more of this risk – and they are hoping that employers will step up to the plate and bail it out.

It’s not hard to see why it needs a bail-out. A failure in personal financial  planning and it’s the Government that’s faced with a later lifetime paying the bills. The true cost of financial failure is not just a pension bill- it is a pension and welfare bill which is underpinned by the misery of those in poverty.

Pension experts often consider some of these costs, welfare experts others, – but the total cost of the problem is bigger than the sum of the parts.

To understand the social cost of failure , read this testimony. It is drawn from a comment by Onwabia , a student who read a recent post of mine. You can read more about Onwabia here.

People keep thinking ‘a rainy day’ won’t happen to them. I think we all need to accept that at some point we are going to need help. Every country is beginning to struggle to look after it’s population. The UK has a high tax rate compared to many other countries and people work tirelessly for years on end and then have very little to show for it. My parents are a sadly a prime example of people who were benefiting from the boom a few years ago, with their own successful business of over 20 years. Several loans and stages of re-investment later, my father needs pension credits. Our family used to spend £250 on an average weekly shop. We now spends less than 20% of that per week on food. Where did all that money go? I, their first child, a graduate has to go on benefits as they can’t provide for me in the present. These are people who brought me up to think going on the dole was a failure of some sort. This current situation was never planned.

Weaning is definitely necessary. Irresponsibility seems to be a bit of a drug when it comes to some of my parent’s generation. Choice and change are part and parcel of a free society, but choice without being informed is like a baby looking at a knife and thinking ‘shiny’.

The phrase “intergenerational transfer” sounds pretty hollow reading that.

Onwabia’s situation is particularly painful as her parents risked their financial futures on a business venture which would have been their pension. There was no PPF to bail them or their family out. Her conclusion “choice without being informed is like a baby looking at a knife and thinking ‘shiny’ “, resonates with me as someone involved in financial education. It may resonate with you, even if you’re not!

At the other extreme of UK companies , we have the early staging mega-employers which  have been enrolling hundreds of thousands into workplace savings schemes designed to make means-tested benefits like pension credits , some thing of the past.

The question this blog asks is whether it is the employer’s job to act like a surrogate social insurer.

Most employers now see the pensions they offer staff as part of “reward” and the nature of the pension reward is linked to lifetime earnings, itself a reflection of the individual’s financial contribution to the company’s prosperity. Pension is a reward strategy not an insurance strategy.

The employer may want to offer a reward, but they end up either providing social insurance (DB) or offloading the risks back on the individual (DC). The problem facing employers is this, to offer social insurance by paying a pension for life, the employer needs take on a risk it cannot control.

The life expectancy of the employee is extendable through the behaviour of the retiring employee and through medical science. The employer has no control and no insurable interest in paying the price for the resulting extreme old age .

Frankly it’s a risk that we should not be expecting an employer to take on. Many employers saw the knife and thought “shiny” and throughout the last fifty years of the 20th century agreed to act as social insurer but this proved as foolhardy for many of them  as the business planning of Onwabia’s parents.

Nowadays , employers ususally “duck” setting aside money for ex-employee’s extreme old-age. They chose instead  to pay cash to an insurer and hope that they’ll be seen to have discharged their obligation.

Collectively,  this system is not working and it will get worse. Insurers providing annuities have no obligation to insure away long-term poverty and most of  the annuities being set up today will prove hopelessly ineffective in avoiding the poverty that Onwabia’s family finds itself in.

The incomes being provided from DC and even cash balance DB plans, are so poor that employees are deferring retirement and working on, often in an unproductive fashion, doing work they are no longer suitable for or new work they are unskilled in. Meanwhile their children struggle to find the jobs their parent’s retirement would have created.

Here is my conclusion and the basis of a solution which I think can be adopted over time.

If we as a society are collectively responsible for poverty in old age , we need to find collective “social” solutions. Employers can and will reward staff but do not have bottomless pockets. They should not be expected to act as social insurers and take on the long-tail risk of the very old.

Nor should they be dumping the problem on the insurance industry. This is no more than playing “pass the parcel”.

The long-tail risk of an ageing population is society’s risk and not a business or a personal risk. Social solutions to longevity can be created and created at a reasonable cost. They will rely on people making informed choices and set aside more money for their old age.They will rely on corporate responsibility and a financial services industry which helps employers provide better more efficient pensions without taking on impossible risk.

I conclude that employers should be considering paying fixed term pensions that have quantifiable risks that they can plan for and offer decent incomes to employees as a reward rather than an insurance.

From the conversations I have with large employers, the prospect of funding a defined liability is not an issue.

Let me repeat this. The long-term social contract to deal with ever increasing life expectancy involves a triple lock.

  1. Individuals will have to defer much more of their income into well run  retirement plans and not be reckless about their and their family’s futures .
  2. Employers will move to providing fixed-term pensions- perhaps for twenty or twenty five years and a continuation of all or part of the income past an employees’ 9oth birthday.
  3. The long-tail risk of providing pensions from (say) our 9oth’s birthday will revert to the state (think PPF). Whether the long-term insurance is funded or unfunded is a matter for detailed policy. The Government has all options at its disposal.

Extreme longevity is not a risk that can adequately sit on the balance sheets of insurers any more than large employers. It is a national balance sheet item which cannot be bought out by the private sector.

Those with an eye to these things , may have spotted a template for risk-sharing that could be adopted as part of the Government’s current consultation on defined ambition. I am sure that there are many in the DWP and in the actuarial community who have thought these thoughts before.

But we haven’t had a proper debate about whose risk is whose.

We need to think and talk seriously about a kind of risk sharing which doesn’t polarize the debate around employer and employee but accepts that we, the taxpayers, have a collective responsibility to take on longevity risk.

The cost to the tax-payer of formally comitting to such a policy is likely to be less than the buggers’ mess of sorting out millions of families like Onwabia’s.

Because Longevity Risk belongs to society, we need to get a bit of Beveridge in the house!

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in actuaries, auto-enrolment, dc pensions, de-risking, defined aspiration, economics, pensions, Personal Accounts, Retirement. Bookmark the permalink.

5 Responses to Whose risk is it anyway?

  1. Margaret Snowdon OBE says:

    Absolutely spot on Henry. I couldn’t agree more. What we (ie government) need to think about is changing behaviours. As an ex behavioural psychologist, the best way to achieve this is by reward. We should reward savings and investment for the future at the time of saving and this will avoid having to pay the social bill later. Get people into the habit. State matching personal contributions of those who save and don’t opt out is an incentive that could be cheaper in the long run. Oh they will do that through the 1% tax contribution on AE I hear you say, but you know what – 1% is measly and is hidden tax relief – people do not understand or see it. You need to feel the reward for it to change behaviour. It also wouldn’t do any harm to let people know what sort of retirement quality they face if they don’t save.

    • henry tapper says:

      Thanks Margaret- hope to catch up with you later in the week when you speak at the Pension Network- hope there may be a chance to expand on this then.

      I agree with you that much more can be done to incentivise savings but more needs to be done to incentivise employers fo provide better pensions too!

  2. Pingback: A defined ambition scheme that would work | The Vision of the Pension Plowman

  3. andy young says:

    This should be attractive to government. Move state pension age to 90, rising in line with longevity changes. It should be possible for it to be set at a decent level. People and employers are responsible for accumulating sufficient savings and work skills to manage their work and income from savings until that point.
    Might take a long time to phase in.
    I was thinking about something like this when DA was first mooted. It is DD, defined death (from the perspective of the “pension savings”).
    A less extreme version is of course possible. Raise the state pension age to say 75, again rising with longevity and at a higher rate. So the state provision is insurance against longevity (as of course it was when first introduced over 100 years ago at age 70), and focus private, including occupational, saving on a more certain period before then, with individuals having more clarity on what they need to provide.
    As with so much on pensions, if only we did not have to start from here with all the legacy issues.

    • henry tapper says:

      Thanks Andy

      What I thought – this is actually Stellas Eastwood’s idea adn forms the basis of a submission so I’m glad you like it and think it might have legs

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