Last line of defence

If you are a fan of such jokes, read no further – the Social Market Foundation’s  (SMF) study “Golden Years? What freedom and choice will mean for UK pensioners“, contains all three characters (unsexed), but there the joking ends. This is a serious study into the likely consequences of changing the tax rules around the purchase of annuities in the UK.

If I was studying it for English A level, I would have to give it low marks for characterisation. It assumes that we all behave the same and that left to our own devices, we are likely to become like the Cautious Australians , Quick Spending Australians of Typical Americans. Racial stereotypes feature throughout and for good reason; the study finds that

Cautious Australians reduce their pots by 1% per year, Quick- Spending Australians run out of cash by the time they’re 75 and that the typical American burns their pension pot at 8% a year and like the feckless Aussies, are likely to find themselves broke before they die.

But what of the English person?

Were we to copy our (ex) colonial friends we too would be potless in our seventies and with a life expectancy of 87, staring out of our attic window in penury .

State pensions and benefits may put a crust of bread in our hand but for many late retirement will see us sink below the poverty line.

The scrooges who scrimp on savings may be alright later on at the expense of having a party in their sixties and seventies.

For those choosing DIY or even advised drawdown, there’s little certainty of success and relative to buying an annuity, someone drawing down from a £200,000 pot  is likely (on average) to need an extra £10,000 in state benefits.

An Economic discussion (verging on philosophy).

It was when  I read this final finding that I smelt a little editorial bias , so I turned to the front page of the report to find that it had been sponsored by Just Retirement – an annuity provider.

When considering how UK retirees are likely to act, the SMF talk of something “often called the annuity puzzle”, the paradox is that

‘consumers will not act as rational economic actors. Standard economic theory predicts that an “economically rational” individual would choose to guarantee income in retirement by buying an annuity, as doing so  allows for higher consumption in retirement and eliminates investment and longevity risk’,

I’m not sure I’d agree here!

The economically rational human being is going to work out for him or himself the correct balance between certainty and return for him or herself and will choose the level of risk specific to them. They might be prepared to have a 1% chance of not getting a pension increase in one year in return for the 98% chance of having a 2% better income for the rest of their life (for instance).

The assumption that economically rational people are the ones who want their future financial welfare guaranteed, assumes a very one dimensional view of human nature. I suspect it is a world-view very prevalent in the offices of Just Retirement, but were they to decamp themselves to the offices of William Hill or Joe Coral for the afternoon, they would find a quite different world view who consider the aim of life to be happy, this being achieved by taking substantial risk on the outcome of the fifth race at Perry Barr,

“Money is something we use to alleviate poverty and purchase pleasure” – Pension Plowman.

The political popularity of Freedom and Choice is that it recognises that the balance between these two extremes should be in the control of those living their lives and not the Chancellor of the Exchequer. In my book, it is economically rational to maximise the utility of the retirement pot in a balanced way – I think economists would call me Benthamite, I don’t consider calculated risk-taking irrational, not when it optimises pleasure!

Assumptions.. assumptions

The bulk of the report (and I have read all 96 pages and noted all 106 sources), is an attempt to

1. Draw on international patterns of behaviour
2. To use financial models to analyse the long-term impact of changes resulting from freedom and choice
3. To look at how impacts change for different groups

To do this there are a lot of assumptions. Assumptions can be bad but they can also be good. Assumptions are statistical short-cuts that allow conclusions to be reached without the report running to 1000 pages and costing more than the problem it is trying to solve!

As soon as an assumption is made, it is open to challenge – which is why you will find so many earnest conversations in the offices of First Actuarial! The key thing for actuaries is to understand where bias’ are creeping in and to eliminate those bias’.

My worry about “Golden Years” is the bias identified in the previous section of this blog. namely that an “economically rational human” being would always favour a guaranteed solution’.

That said, the modelling methodology adopted by SCF seems a good one and the data sourced from ELSA is generally considered reliable. The modelling was done by the PPI, an organisation I am a fan of (and would join if I could afford it). NB – Andrew Young.

The answers to the three questions is of course “it depends” and the dependencies are all about the likely real return on investments (eg the extent to which investments beat inflation) and the risks of being in the market (in particular sequencey risk- known on this blog as “pounds cost ravaging”).

The conclusions reached is that we carry on like the Australians and Americans , we are risking poverty in old age or a rotten lifestyle in late middle age. What’s more, the State is likely to be on the hook for bailing many of us out if we blow our savings and fall into destitution. This is what the Aussies call “double dipping” – you dip into your savings, then you dip into somebody else’s.

Throughout the report, we hear the same editorial bias as identified earlier e.g.

3.3 “The likelihood of someone going below the “low income thresholds” is much reduced for someone buying an annuity than any other path”.

The message for the Treasury is clear, as Adam Smith pointed out, the only argument for compulsion is to keep one group of tax-payers from being a burden on another.

Bring back those days before the war!

The bulk of the back end of the report is directly pointing to “policymakers” – e.g. the Treasury (and to some extent the DWP).

It argues that there is too little financial literacy to make drawdown the default option, that people are their own worst enemy and will behave irrationally given half a chance. That Freedom and choice is giving them more than half a chance and that were we to “shop around” annuities would look a lot more attractive,

To return us to a pre 2014 world of sensible behaviours (that would return annuity providers like Just Retirement to pre 2014 levels of profitability), SMF suggests a remedy.

The remedy’s an early warning system that (like radar pointing to France in 1940) detects the impending arrival to our nation’s health -eg bad behaviour (see Rational Economic Behaviour stuff above).

That big room below Dover Castle

This comes in the form of a “Retirement Risk Dashboard” and a Personal Pension Alert”. The former is what fighter command would get in that big room below Dover Castle, the latter the financial equivalent of squadrons of spitfires sent up to beat off the beastly Hun.

Spitfires beating off the beastly hun

There is a lot of good stuff about how this might be done which I thoroughly agree with. If only I agreed that this was the battle for Britain I wanted to fight.

For my analogy breaks down at this point;   the enemy is not some foreign power, but “the enemy within”, a kind of fifth columnist infiltration of our  formerly green and pleasant land by the freedom and choice brigade.

I don’t see freedom and choice as the enemy, I see it as a liberator. What I want to see is a way to use freedom and choice to repatriate the millions of refugees displace by policy failure over the last 30 years and looking for a new-start.

What the report doesn’t say

What the report doesn’t do is speculate on whether there may be any other solutions out there which might be used as an alternative to income drawdown or annuity.

My new-start solution is nothing more than a return to the collective system of paying pensions that worked very well in Britain from the end of the war until the end of the millenium.

What happened then was that the savings of the workers were supplemented by those of the bosses and tipped into one big fund which paid out a regular amount to the workers until they died (and sometimes till the spouse died). This simple idea might be called collective decumulation or if it might be called the default way to spend your money.

We can worry about where and how the money might be invested, how to avoid the impact of pound cost ravaging, how to give people rights to take a transfer value and how people might use the fund to insure against long-term care but first we’d need to agree that the majority of the problems identified in “Golden Years” could be solved or mostly solved by agreeing…

1. That there must be a balance between risk and reward (guarantees aren’t everything)
2. That doing things together is more efficient than doing everything on your own
3. That if you don’t want to take decisions about your retirement income, you’ve got to trust someone to do that for you
4. That the cost of guarantees under our current regulations makes guarantees too expensive
5. That to bring costs and charges to reasonable levels – we must cut out most intermediaries.

So we need to move the debate on

I’ve taken a lot of time in the past twelve hours reading Golden Years and it was great, Thanks SMF and thanks Just Retirement and the PPI.

I don’t agree with the conclusions because I don’t believe we are fighting the Battle of Britain II (but I know there are those (Steve Lowe) who think we are!)

Without this monumental work, we couldn’t move the debate on, and this work allows us to have a proper discussion. I hope the likes of Paul Lewis pick up the report and debate it on social media and the radio. If they do, I’ll be listening!