George Osborne ate my pension – a blog by Hilary Salt

Osborne

This is a blog written on Hilary Salt’s Facebook page which everyone should read. They aren’t my views and I don’t agree with a lot of what Hilary is saying, but this is the first coherently argued position I have read from the left.

It finishes with a paragraph that sums up why Hilary is a personal hero of mine and why her voice should be heard in any serious debate about pensions.

The headlines are mine- the picture of George is Hilary’s.

These are my top ten reasons for not liking the Chancellor’s proposals to remove the need to provide a long term income from pensions savings:

inefficient
1. DIY annuitisation is massively inefficient. Annuities are a collective way to provide an income for life which allow the pooling of mortality (and survival) risks. It very clear that not building up pensions collectively is inefficient. If for every 100 people, we expect 97 to be alive at retirement, saving collectively means we need to save 3% less – saving individually costs 3% more. Pooling to avoid this inefficiency is one reason why collective schemes are better. Annuitising individually is inefficiency squared. Everyone needs to spin out their savings to cover a long life expectancy instead of everyone buying an income based on average life expectancy. (This is an economic point rather than the behavioural point covered in 4 below). So at a macro level, private, individual, DIY annuities are massively inefficient.

Short-termism

2. Individual drawdown is likely to mean a reduction in the amounts invested in companies building long term growth in society. It’s already clear that individuals investing on their own account can be “recklessly prudent” and even setting aside wrong decision making, those investing individually rather than collectively are less able to withstand the volatility of high levels of equity investment. (Of course, this was equally a problem with annuities and lifestyling in individual accounts – another good reason to support CDC or collective db schemes).

Tax-payer support

3. Not requiring annuitisation undermines auto-enrolment (perhaps fatally?). I can support (just – I struggle with auto enrolment) employers being made to contribute to a pension arrangement for staff – but should they be required to contribute to a savings scheme? And should immediate tax relief be given to contributions to a savings scheme?

Cashflow management

4. Some people will of course cash in and spend their retirement savings although the Australian experience doesn’t show this as being widespread. And at least some of those who spend their savings and fall back on the State would otherwise have only been able to buy an inadequate annuity so would have been claiming additional benefits from day one. Equally worrying though will be the large numbers who choose the underspend, worrying that they will run out of cash over the course of their retired lives. And there is a real danger that people will draw down cash, look around for somewhere to put it, end up putting it in a bank account earning zero (negative real) interest. Again this is a massively inefficient way to provide retirement income.

Not much wrong with annuities

5. I am unconvinced there is too much wrong with annuities. The FCA review indicated that people lose on average 7% from not shopping around – given that many had very small pots, I’m unconvinced I would be bothered. I do think we as an industry need to take some responsibility – when we throw around terms like annuity rip off, it’s unsurprising people don’t like annuities. In fact annuities can be a good product. I think people should definitely be buying them later and perhaps in tranches. I do think new and better products were starting to be designed – the real push would come when we got to a stage where many more people were reaching retirement with substantial dc pots which made innovation worth while.

The legislation of “pension liberation”

6. Removing the need for annuitisation will have a massive effect on closed db schemes. Those consultancies who have aggressively marketed derisking services to employers are already working on new services. So you offer all the deferred members in your closed db scheme s transfer value (or just cash if under the new trivial commutation limit of £10,000). Of course this is a time limited offer as the Chancellor may change his mind so roll up, roll up for the new flexible personal pension. Employers won’t even need to think about enhancing transfer values. This is the legalisation of pensions liberation.

DB schemes won’t  invest in UK industry

7. So closed db schemes will end up being largely pensioner only. This will of course decrease the length of their liabilities and is likely to result in their decreasing the level of equity investment – again unlikely to help in long term investment in UK industry.

People will give up good DB promises

8. And open db schemes may well be saying goodbye to deferred pensions. Again the lure of a shiny flexible individual plan may mean people abandon good db promises.

A strain on the PPF

9. And how will a massive shifting of db liabilities out of schemes affect the funding of the PPF?

Removing the safety net

10. A major safety net for people who now have inadequate dc schemes is the legacy db benefits they also have. If these are also sacrificed on the altar of choosing to transfer to a flexible individual pot, this will leave them with no protection. 

The real problem of course is that these proposals are hugely attractive to employers and to individuals. So standing up and saying they are wrong will be very difficult. That is why the Labour Party are struggling to sound coherent in their response. But anyone who wants efficient and sensible pension arrangements needs to really question these proposals. The proposals transform pensions savings into individual tax planning arrangements. We need to argue for sensible ways to provide dignity in retirement to the vast majority of working people.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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13 Responses to George Osborne ate my pension – a blog by Hilary Salt

  1. Thanks Henry for sharing Hilary’s blog. I too disagree but share the desire to create better collectives than individual annuities.

    I think Hilary misses the vital point that removing the caps on income drawdown has created the flexibility in the tax system to offer collective invested alternatives to annuities.

    Ask yourself, why did these alternatives not exist before now and why were they unlikely to ever to? Why did annuities plummet from 6.15% to 5.2% from summer 2012 to December 2012 with no noticeable changes in bond yields? The answer was the annuity product monopoly.

    Hilary has 1 valid point and 1 valid point only. There are some wider consequences of that.

    Some, possibly many, people will make even poorer retirement savings decisions than buying a badly priced annuity. However, they won’t mind because they have the chance to splash some cash on reaching retirement.

    Of course that is true. Whether such ‘waste’ (see George Best quotes) – which will modestly increase means tested benefit payout over time – is worse than the current system is far from clear.

    Another valid point – not made – is that some crooks will pop up to try and steal people’s pension or offer them toxic products.The FCA will need extra vigilance to police this area too which I am concerned about their resource to do.

    I’d like to see the bright people with good intentions at heart, like Hilary, focus on what collective to offer alongside individual annuities and how to ensure people have access to expert advice to allow them to make the best decision at retirement. In my opinion, these changes make it easier to solve these two problems which beset the current system.

    Alan Higham

    PS

    My detailed comments on her 10 points are below.

    1. Annuities were being bought individually. There has been decreasing pooling of risks with increased underwriting. We had though reached the ceiling of shopping around for annuities with £500m being wasted on price rate alone each year.

    2. The amounts of money ‘wasted’ will be relatively small. But who am I to say what is ‘waste’ and what is enjoyable consumption? The Calvinists are out in force on this topic. They should see how much equity release has increased in recent years under the “Wonga Pension” model. It goes like this. You lend £30,000 to an annuity company at 2% interest and when inflation has ravaged your standard of living 5 years later you borrow it back at 6% interest for life.

    3. Hilary seems to say that (soft) compulsion on pension savings needs (soft) compulsion on buying an annuity or perhaps she just means spending the money reasonably evenly over the remainder of life. I won’t nit pick on her words but she is just wrong. Soft compulsion to save was needed to get a large proportion of 10m+ people saving nothing to save something.

    People have other assets they can use to provide income in retirement. Requiring them to spend private retirement savings on annuities is inefficient as many people can and should spend their pension savings up front, deferring State pension and certainly putting off equity release for as long as possible.

    Where Hilary would be on strong ground is to say why do we default people into retirement saving in all aspects and then think it is a good idea for them to make choices at the end without any effective support? But she doesn’t say that even if she agrees with it.

    The lack of reliable expert advice to tell people what the right decision for their needs is at retirement remains a big problem and features nowhere in her article. We must not give up on providing people with easy access to good outcomes.

    4. If people behave as Hilary predicts – and unaided, I suspect she will be proved right – then there will be an increase in housing benefit etc as a result. I think it will be modest and it will assume that people have saved privately too. Who knows, the savings ratio might go up.

    5. The FCA quantification of loss at retirement of 7% was flawed. It compared the rates people took with the average of the best 3 rates on offer rather than the best. It ignored the impact of those who were ill not taking enhanced annuities when they stayed with their current provider. It ignored the impact of buying annuities too early – age 55 being the 3rd most common age to buy after age 65 and age 60. It used made up annuity data provided by insurers rather than real time like for like annuity comparisons.

    Using real time, like for like, annuity comparisons from people who shopped around via Annuity Direct, the average loss of not shopping around during June 2012 to June 2013 was 23% not 7%. Accepting that those who didn’t shop around would get less increase than 23%, I would pitch the loss at c15%, on price rate alone.

    There were no new products being designed other than one asset manager who is – after years of publicly launching the idea – yet to have it on the blocks to be bought (despite it being a good idea).

    6. The Government proposes to ban transfers out of DB pensions. It might not succeed but that is where it plans to go.

    DB transfers to DC will in any case require advised recommendations to proceed. I hope the EBCs do not repeat their complicity in the ETV scandal by helping their employer clients appoint IFA firms willing to mis-sell transfer values in the hope that the FCA won’t object. When I put the ETV point to an actuary in 2012 that this transfer advice wasn’t fit for purpose, he just shrugged and said “I advise the employer, it is up to the FSA to regulate the IFA. If they allow it, who am I to object?” I think the FSA eventually woke up and caught up with these IFAs.

    7. DB schemes having no new joiners must eventually reach this stage. The acceleration only occurs if point 6 falls away.

    8. see point 6

    9. See point 6. But assume TVs aren’t banned and DB schemes do de-risk. The long term losses of DB pension will be felt by those who TV out. If DB schemes then have smaller liabilities and can buy out then the PPF is less likely to have further deficits as well as fewer future levy payments. Is it so clear cut that this is bad for the PPF? If it is bad for the PPF, is it right that society as a whole should be funding greater security for generations of people with much more valuable pension rights than tomorrow’s generation?

    10. Yes, if it happens – but see point 6 – people may well lose long term economic value. Hilary ignores the fact that people have greater need for cashflow earlier in retirement and their only way of accessing it is to borrow at say 6% pa. It is very Calvinistic to tell people to live within their means and spread their income over their uncertain life. If Hilary is to be consistent then she must also campaign for equity release to be banned. It can be far worse than taking a TV from a DB scheme.

  2. The other point about annuity pricing is that even the best priced annuities are worth (in actuarial risk neutral values, calculated using forward projection of GAD mortality and risk free rates) about 70% of what they actually cost, so if the typical provider takes another 15% off then you are getting an average of 0.7 * (0.85) = 59.5% of your money back (if insurance companies are investing in corporate bonds and picking up a liquidity spread then its even worse than this). The value is appalling and nobody arguing generic waffle about pooling risk and sharing and community and all that lefty nonsense is facing up to the fact that whenever the financial services industry start talking in this sort of rhetoric they are just taking your money and masses of it.
    Pensions have always been used to buy Lamborghinis just for the hedge funds, bankers and insurance companies that take all the fees – why shouldn’t they buy something for the people who have saved in them for a change.
    You can get 3.4% net just buying a pot of equities and it’s a real asset so why would you take a gross annuity rate of less than 3%. Dividends aren’t that risky its equity price / annuity price de-coupling that is where the risk is and that is now gone so no need for life-styling or any of that stuff – just buy shares re-invest the dividends and when you’ve got enough dividends to live off you can stop working – pensions are easy

  3. henry tapper says:

    Collective decumulaiton is the obvious default; why people are writing DA off post Wednesday defeats me! The two impediments to DA were the inertia in a system that was working very nicely (for everyone but the annuitants) and the obligation to provide insurance against extreme longevity. Both impediments are gone – so let’s get on with delivering a collective alternative to individual drawdown- Hilary- Derek- Kevin- Alan- Your Round!

  4. andyjags says:

    A few quick random thoughts

    Many congratulations to Hilary and Alan on their stimulating comments.

    When I saw the headline of Hilary’s blog, I thought she was arguing that George had taken away HER pension by abolishing the need for actuaries.

    I agree with most of what both Hilary and Alan say, in places working out my compromise position. Probably the eternal civil servant in me.

    I do think it is an interesting experiment in government to look at an institution, deem it ineffective or whatever, and then abolish it and see what happens. Thee must be lots of other opportunities for that.

    It now seems odd to have a pensions savings regime, with various tax rules and auto enrolment, and an ISA structure as well with different rules. What price the tax free 25% in future?

    Although the change seems designed for the immediate future for those people who saved voluntarily in DC pensions (perhaps over encouraged by tax relief and now understandably annoyed that they did not realise about annuitisation at that time), it is more important that we focus on the auto enrolment generation. Someone earning median earnings and contributing for about 40 years (say) might have a pot of some £150,000 (say). After a lifetime of defaulting on choices, what is the default around retirement going to be? (And of course adapt that for the immediate future as well.)

    And is “guidance” or “advice” just a one off event or ongoing and thus a lot more expensive?

    Whilst the immediate discussion will be fun and basically political, I am already looking forward to how it will all be redesigned in 2025.

    • henry tapper says:

      I think we are on the same wavelength Andy! There are a number of grounds for optimism.

      Firstly we are better at getting guidance and advice- witness how people use MSE and other websites, people are also getting better at using modellers (tax, longevity, investment returns and inflation are key variables that we individuals can think about).

      Then there is a general acceptance of increasing lonevity , of the limits of welfare and the need to plan for LTC and other events.

      What is missing is a responsible set of products from the financial services industry to meet this new demand.But that will come, provided we don’t allow ourselves to be seduced by shake-oil.

      I am optimistic about 2015 and resigned to a transitional 2014, I think the majority of problems will come from the annuitants of the last fifteen years who will be looking at these freedoms with a degree of envy.

  5. Hilary Salt says:

    Good to have some sensible debate. On Alan’s rebuttals – with numbers now his not mine:

    1. Individual purchase and risk pooling are not mutually exclusive although pooling is probably more efficient without underwriting. 100 equally impaired lives still benefit from sharing risks as they will die at different times.

    2. I don’t think we disagree that there will be some splurging of cash and I make no moral judgement (Calvinist or otherwise) on this. The more problematic waste will be people stopping investing productively or people worrying and under spending.

    3. There is nothing soft about the compulsion on employers to pay contributions or the compulsion on tax payers to subsidise this saving. If this saving is not for retirement, it undermines the basis of both tax relief and auto enrolment. I don’t think either of these concepts are sacrosanct but if we are ripping up the consensus, we need to recognise what we are doing.

    6 and 9. I’ve seen no evidence that Government intends to ban transfers from (non public service) db schemes. Guess we need to wait and see. Quicker de-risking just means a quicker importing of the inefficiencies of dc into db. (Buy out means withdrawing money from productive assets and paying insurers’ profits – can’t see how that helps members).

    I don;t really get the point that this means more collective annuity products will be possible. They are possible now. DC build up with annuity purchase in the legacy db scheme is entirely possible and seems a good option to me – could well be part of the CDC landscape. But I suspect employers will remain unwilling to countenance this while tPR are behaving as they are.

    On PensionSchool points, I don’t think anyone would argue that annuity prices don’t include a profit margin (and why shouldn’t they?). I’m less convinced about the additional pricing point – some of the work I have been doing with the IFoA doesn’t suggest that so maybe we need to explore more.

    Absolutely agree with the dividends for cash flow point but a lot of people will retire on assets which aren’t sufficient to allow this cash flow to be enough so will need to draw down on capital. That does probably mean some less volatile investments. And rebalancing your portfolio in your 60s and 70s might be fun, trying to do it in your 80s and 90s is likely to be challenging. So we do need products that will work for people.

  6. Pingback: Pensions – where next? | ToUChstone blog: A public policy blog from the TUC

    • henry tapper says:

      Thanks for linking this – Hilary has touched a chord with many people! Alan’s comments are a blog in themselves and the thread one of the most interesting we’ve ever had!

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