Our obsession with the financial consequences of “dying old” shows a strange behavioural bias.
I used to tell my kids I was worth a lot more to them dead than alive! Luckily I am still here to tell the tale!!
— Paul Lewis (@paullewismoney) April 13, 2022
Paul’s comment laughingly suggests that his financial value is measurable in terms of capital, but of course Paul’s capacity to earn in his 74th year and is a veritable moneybox for his family so long as he preserves his mental and physical faculties. Were Paul to die he might leave some capital from his pension savings (tax-free till he turns 75) but unless he invests in a joint life annuity or buys a family income life insurance plan, his wife will be left with little replacement income. Paul is of course valued most for being a good bloke but his utility is more than in the pleasure he brings.
One of the most quoted reasons, steelworkers gave for choosing a cash transfer of their BSPS pension, was the bequest of the pot. The residual pension paid to the partner was not considered as valuable. Perversely, tax was often mentioned as a determining factor in this decision, the cash sum – tax free to 75 was weighed against income at the recipient’s highest rate, taxable in payment.
What drives this bias? I suspect three things;
- We find it hard to understand the present value of a string of payments paid to a person’s death
- We underestimate how long people live (especially men of women)
- We have a fear of taxation and of its corrosive power on living standards.
Which leads us to value a “pot in hand” over a “pension in the bush”.
Playing on behavioral bias
I haven’t heard it explained this way, but I suspect that much of the FCA’s aversion to pension transfers is based on the exploitation of behavioral bias against income in favor of “cash in hand/pot”.
The phrase “no-brainer”, which is often used , to explain why someone took a transfer, is heavily loaded. Had more brain been employed, many people who transferred to improve death benefits would have considered
- We (especially men) underestimate how long we live by on average seven years.
- People in retirement pay less income tax and no national insurance on pension income (relative to time in work)
- Contrary to popular belief, cash is taken into account in the calculation of means tested benefits such as pension credit, it is not just an income based means test.
These considerations apply to all transfer considerations, including the swapping of pension increases for cash through the process of Pension Income Exchange(PIE) . Here a slightly different bias is exploited, our inability to understand the power of compounding interest both as a positive for index linked pensions and as a negative in terms of inflation.
Clever people are particularly good at exploiting the weakness of less clever or less well-educated people. This is because the less brain we employ, the more we go with gut instinct. Financial decisions taken as “no-brainers” are taken intuitively, intuition is easy to exploit. Clever people exploit intuitive decisions, that’s how risk-transfer works.
Steve Webb knew this when he railed (as a Minister) against “sexy-cash”. Sex is of course the creator of super-bias and Steve knew just what he was saying when he likened the allure of cash in hand to the advantages of a string of index-linked payments that last as long as you do.
There are still a number of pension consultancies urging employers to offer cash incentives for pension scheme members to give up future income for present day cash. It seems to be “ok” with the regulator , so long as the regulator is the Pensions Regulator and the FCA doesn’t get involved. Consequently PIE “exercises” are favored over enhanced transfer value. Consultants know about regulatory bias. Financial vulnerability for tPR is considered at scheme level , for the FCA – it’s considered by its impact on individuals (see my complaints about blame apportionment at BSPS)
To correct the impact of these behavioral bias , which allow clever well-educated people to exploit not so clever, not so well-educated people, rules have to be put in place to stop “no brainer” decision making.
Part of this is the imposition of checks and balances. Banning conditional charging, which made it very easy for no-brainer decisions to be taken, has been a check to the avalanche of transfers that happened between 2016 and 2020. The Professional Indemnity insurers have put up barriers to some advisers transferring defined benefits to SIPPs. The FCA has closed many advisers down who have not been able to meet the adjudications of the Financial Ombudsman Service.
Many people think that the sanctions on transfers have gone too far and that they are impacting on the freedoms put in place for people to make choices with their money. But like positive discrimination in other areas where vulnerability has been exploited, there is necessarily a need to “re-bias” to create equilibrium.
Proceeds of “de-risking”.
So we find that the tap has been turned off for most “de-risking”. This week we saw the FCA/TPR and FOS issue a joint warning to members of the P&O DB scheme, that there should be no “no-brainer” rush to transfer benefits from the scheme. This was also a message upstream to advisers and insurers.
This comes as a nasty shock to many of the financial institutions – insurers, fund managers and platform managers who were “upstream” of the financial advisers and the decisions they recommended, (but not party to those decisions). There are some, me among them, that feel that these institutions are the beneficiaries of a financial crime but have got off with impunity.
If the FCA, FOS and FSCS are looking to change their future funding, they should be asking more questions of those receiving the proceeds of “de-risking” and consider the provenance of the huge profits declared over the period by the financial institutions that were fed by the advice given.
So what of Paul Lewis and David Hearne who inspired this blog?
Follow the thread and you see a number of comments about “widows”. They stem from a call for input from Scottish Widows on how the ABI and PLSA should be promoting pensions to the general public as part of a “pensions statement season” in the autumn.
My hope is that the ABI and PLSA will focus on pensions as pensions and not as sexy-cash, as a tax-efficient way of passing wealth on or even as a way of shifting risk from employers to their staff. In this, people like Paul and David have a part to play as they are influential in different ways on those upstream.
I’m not a killjoy, I enjoyed the banter. But behind the banter are some serious issues, which I hope I have treated seriously in this blog. It is no laughing matter being a widow or a widower, bereavement is made worse if the financials play out wrong for the survivor. Similarly, it is no easy thing , losing mental faculties in later age and discovering a principal source of income (your pension) has run out before you have.
Responsible behaviour includes addressing natural bias’ we have to have cash in the hand rather than a pension in the bush. But pension income is typically undervalued. I hope we can put a greater value on primary and residual pensions going forward and that we address the bias in the system towards “sexy-cash”.