Ros Altmann

Yesterday’s blog which included Mark Ormston’s numbers on the cost of securing the retirement living standards with annuities, got better read than I expected. And it attracted some interesting comments. The blog set out to show just how much it costs to provide an inflation linked income stream akin to the state pension and it ended up concluding that as a nation, we may not be able to afford to guarantee our income with insurance policies.

Ironically, we are in the golden age of annuities in the UK. More annuities are being bought than ever before but they are not being b0ught by us, but for us, by the occupational pension schemes that we have been in over the past 80 years.

Look at the accounts of Legal & General , Phoenix, Scottish Widows, Aviva and even smaller players like Just and LV= and you will find that the biggest source of revenue (and profit) is the bulk annuity, buying out or buying into the liabilities of occupational pension schemes.

Back in August of last year, Louis Goss of CityWire reported

They did, and estimates for 2023 are even higher.

Bulk annuity policies let pensions trustees de-risk their pensions schemes by passing responsibility for any payments to an insurer….

“In 2022 we have seen continued high levels of investment by insurers in the bulk annuity market,” EY’s bulk annuity consulting lead Chris Anderson said.

The bulk annuity expert warned that improved solvency ratios across the insurance sector mean “capital is no longer the primary constraint on values”.

“Instead, the main issue now is how many quotes and transactions insurers can operationally support,”

But is this a cause for celebration. Not according to Ros Altmann who commented on yesterday’s blog

And now you can see why funding DB pensions with bonds is not a sensible strategy for corporate UK, as it will be so enormously costly.

Annuity purchase is far more expensive than other ways of securing long-term income and also enables some growth.

DB schemes need to take risk to earn upside and higher returns than ‘safer’ or supposedly top quality bonds. This lies at the heart of the current conundrum and the UK is wasting hundreds of billions of pounds which could be far better used to invest in productive assets earnings better than bond-returns, but taking more risks over the long-term.

UK plc has spent billions on trying to buy annuities instead of trying to build growth for their pension scheme, society and the economy more widely. DC is not taking up any of the slack and I believe part of the reason for our economic underperformance (aside from Brexit) is the lack of domestic institutional investment for risk assets and growth projects.

The past ten years of more have seen our largest pension funds shying away from equities and other growth assets in the name of LDI/downside protection. Annuities are the most expensive and least productive way to deliver pensions.

Annuities the least productive way to deliver pensions…

The alternative to paying pensions as insured annuities are slim. Government pays our state pensions using tax revenues and a payment system which for the most part delivers on a formula that is published and open to scrutiny. It is not perfect, but it is efficient.

Funded occupational pension schemes fund for future liabilities in a variety of ways. Not all are aiming to offload liabilities to insurers, many do invest productively and more would if the Pensions Regulator let them. One scheme in particular, the Pension Superfund has been prevented from offering an alternative to buy-out, for reasons which aren’t clear.

Another consolidator, Clara, appears to be open for business but unable to conduct any. Attempts by the Pensions Regulator to fast-track smaller pension schemes to buy-out are failing to attract much enthusiasm from insurers who are reluctant to spend scarce resource on small schemes. Attempts to herd small schemes into more attractive (to insurers) DB master trusts are proving fruitless. Master trusts point to the DWP’s funding regulations  and TPR’s funding code as making consolidation (with a view to buy-out) unviable.

So – ironically – the funded occupational pension scheme market – ripe as it is for buy-out , is being cherry-picked by insurers who are choosing the schemes that are best governed, best administrated and best funded. The family silver is being exchanged for insurance policies invested in gilts and bonds. Remaining schemes queue at the insurer’s gates ,  unable to provide the nation with productive capital for fear that their schemes will prove unattractive  for buy-out.

It is not just the schemes that are being bought out, who are avoiding patient capital, it is those in the queue. This is the inevitable consequence of a regulatory system that claims not to interfere with investment decisions , but has re-shaped the market as Ros Altmann describes.

A way forward

There are hard facts that need to be addressed here. While employers have the resources to stump up the cost of buying annuities, their employees do not. But employees have long-time horizons, a 66 year old can expect to be retired 25 years and the vast weight of pensioner capital going forward is going to be in defined contribution pension schemes.

The mechanism that funded DB pension schemes have developed to convert capital into income over time, using scheme pensions, works. It is not the mechanism but the funding requirements that stop employers wanting to pay pensions.

Taking the employer out of the pension process and replacing employer funding with DC pots, is not daft. Using pension schemes to  pay pensions based on the returns from productive capital is a feasible alternative to the “annuity”.

But that would require an alternative type of pension scheme, one fit for the purposes of current and future cohorts of savers into DC and one available to members of DB schemes who do not want to be “bought out” by an insurance company.

I’d be interested in continuing this discussion with Ros Altmann and with any other reader who wants to take advantage of the comment boxes to this blog.