Taking the “e” out of pensions is not “energising” me!
There was a moment in Paul Todd’s excellent talk when I asked myself who owns the rate at which my pot is returned to me. The answer is not clear even to Nest, it depends on what the provider of annuities tells them they need to restrict their monthly pay out to.
In short, the rules are made by the insurance companies. My discussions with annuity providers who are being asked to price deferred annuities for us folk in Nest is that this is really not the kind of business they want. There aren’t many people in Nest who are over state pension age – let alone 85. 85 is the age at which the insurance that Nest will buy to ensure the pension they provide is maintained and if I was an insurer , I would not be fighting to offer a super competitive deal on this right now.
I have had discussions with reinsurers about buying out liabilities and have been quoted 3% of the money coming in from pots to meet the kind of risks that Paul was talking about when describing “DC pensions”.
It is possible to model anything when you have 14m savers and some of the best data in the world. There is no doubt that Nest will get quotes for buying out the risk of us living too long, but is there any guarantee they will get value for money? Insurers and reinsurers offer rates based on prudent assumptions (they try to minimise the risks to their shareholders).
Collective insurance?
I find it odd that the Government’s pension, Nest , does not do what other Government pensions do and rely on the British pool of workers , who Nest cover. Nest has 14m savers, in 2021 (the last date we have data for) the State was paying pensions or aged benefits to 23 m people. The Government knows how long people are living, they pay these 23 million people with the surety of tax raising as their long-term insurance.
I want to ask my Government why it is relying on the insurance industry to set the pension rate that I (a soon to be 64 year old) will get by default from Nest? Does Government not have a Government Actuary’s Department (GAD). Does it not set discount rates for our £400bn funded Local Government Pension Scheme.
Is there not a huge amount of knowledge about the specific group of workers who are saving with Nest available to Nest from the OBR, the PPF and the various actuarial bodies such as the CMI?
In my view Nest should be laying down the terms on which they expect annuity providers to work and not going into consultation with them to establish the pension they pay to those who are younger than 85 (or even 75 when some kind of glidepath towards reliance on insurance will begin at Nest).
Here is where I have my worry and I am very far from sure that Nest are setting a good example to the master trusts. If value for money is based on selling out your rate setting to annuity providers who don’t come into play till 85 (if at all) then Nest is not taking on much collective insurance at all.
Collective investment?
If insurance companies are to dictate the rates of conversion of pots to pension, then why don’t they determine the investment of Nest’s pension plan? If Nest is to have insurance inside then why doesn’t the same influence creep into the investment strategy of Nest’s default decumulation fund?
How long before we see the much vaunted CDC approach to investing for increases in pots being limited to a very small portion of the Nest fund with the majority of the money having its eye on meeting the demands of the insurer, not just for payment but for payment in the kind of assets they can use – in short quoted bonds and private credit.
Now the argument for “value for money” becomes second to security at the price demanded by an insurer.
We thought we had freedom from annuities but are we?
The rate at which Nest decides to offer pensions will be benchmarked against the rate people could buy an annuity. Will there be any attempt to offer more than an annuity would buy when bought at outset of the pension?
Nest are not saying it will, they are saying they will consult with the annuitant about what they pay. I do not find that satisfactory. I want to hear from Nest that they will provide value for money by offering more than the equivalent annuity. That may not please the annuity providers who they are currently negotiating in a procurement exercise and I suspect that Nest do not want this discussion to happen at this “sensitive time”.
But the truth is that if Nest does not set a rate well above the annuity rate at outset, then there should be uproar. Because pension investment in the long term delivers more than an annuity can deliver. If we don’t believe that, we should make LGPS and other Government funded pension plans insured. We should return to the original plan for Nest – a carousel of annuity providers who will pay the “pension” as an “annuity”.
I want energy from Nest, not the weak talk of setting pension rates in consultation with its annuity insurer.
Why use an insurance company?
If the UK Government were to provide an annuity product, as it historically has done through entities like the Commissioners for the Reduction of the National Debt (CRND) and National Savings & Investments (NS&I), it could indeed be used as a mechanism to manage and potentially pay down national borrowing. Here’s how it would work and its implications for the Debt Management Office (DMO):
1. Direct Funding for Government Spending:
Premium Inflow: When individuals purchase these government-backed annuities, the premium they pay flows directly into the Treasury’s coffers. This inflow of funds is essentially a form of borrowing from the public, but structured as an annuity liability rather than a traditional bond.
Reduced Gilt Issuance: If the government is receiving significant amounts of premium income from annuity sales, it would theoretically reduce its need to issue new gilts (government bonds) through the Debt Management Office (DMO). The DMO’s primary role is to manage the government’s financing needs by issuing gilts. If a substantial portion of those needs are met by annuity premiums, the DMO could reduce the volume or frequency of its gilt auctions.
Alternative to Borrowing: In essence, the government is borrowing from annuitants to fund its current expenditures or to repay maturing debt. This means the money received from annuity sales can be used to pay for public services, infrastructure projects, or to redeem existing gilts that are coming due.
2. Impact on the Debt Management Office (DMO):
Changed Funding Mix: The DMO’s objective is to minimise financing costs over the long term, taking into account risk. If government annuities become a significant funding source, the DMO’s remit might expand to consider how these annuity liabilities fit into the overall debt management strategy. It would need to balance the cost and risk of annuity liabilities against those of conventional gilts.
Diversification of Funding: Offering annuities diversifies the government’s funding sources. Instead of relying solely on institutional investors in the bond market, the government would tap into the retirement savings of individuals. This can enhance financial stability by broadening the investor base.
Managing Long-Term Liabilities: While the initial premium provides immediate cash, the annuity creates a long-term liability for the government (payments for life, increasing at 3%). The DMO, or a related government body, would need to manage these long-term obligations, ensuring that there are sufficient funds to meet future annuity payments. This might involve holding a dedicated investment portfolio or incorporating these future cash flows into broader fiscal planning.
Potential for Lower Cost of Funds: Depending on market conditions and the perceived security of a government-backed annuity, the implicit cost of “borrowing” through annuities might be lower than issuing long-term gilts. This is because individuals might value the absolute certainty and simplicity of a government annuity, potentially accepting a slightly lower return than they might demand from a more complex market-linked product.
3. Direct Debt Reduction (Sinking Fund Principle):
Dedicated Fund: The government could, in theory, establish a “sinking fund” specifically for the proceeds of these annuities. The money flowing into this fund could be explicitly earmarked for the redemption of existing national debt.
Surplus Allocation: If the government runs a budget surplus (i.e., tax revenues exceed spending), and the annuity premiums contribute to this surplus, then that surplus can be directly used to buy back existing gilts from the market, thereby reducing the national debt.
Refinancing Expensive Debt: The funds from annuity sales could be strategically used to retire older, higher-interest-rate gilts, replacing them with the implicit lower “cost” of the annuity liability, thus reducing overall interest expenditure on the national debt.
4. Fiscal Discipline and Perception:
Signal of Stability: A government offering its own annuity product could be seen as a signal of long-term financial stability and a commitment to meeting its obligations, which could positively influence investor confidence in other government debt instruments.
Public Engagement with Debt: It could also provide a tangible way for citizens to contribute to national financing, potentially increasing public understanding and engagement with the concept of national debt.
Challenges and Considerations:
Actuarial Risk: The government would assume the mortality and longevity risk. If people live longer than expected, the cost of the annuities could exceed initial projections, potentially increasing the overall liability.
Interest Rate Risk: The initial pricing of the annuity would need to carefully consider interest rate projections. If interest rates fall significantly after annuities are sold, the government might find itself paying relatively high fixed payments compared to prevailing market rates.
Market Distortion: A large-scale government annuity program could potentially compete with private sector annuity providers, altering the dynamics of the UK’s retirement savings market.
Transparency: The accounting for such a scheme would need to be highly transparent to ensure the public and markets understand how annuity liabilities are being managed and how they impact the national debt figures. The Debt Management Office would need to clearly articulate how this new form of liability is integrated into its debt management strategy.
In summary, by directly collecting premiums from individuals for annuities, the UK Government could reduce its immediate borrowing needs from traditional markets, potentially leading to lower gilt issuance by the DMO and a shift in the composition of its liabilities. This effectively uses the capital provided by annuitants as a form of long-term funding, which, if managed strategically, could contribute to the overall management and, in certain scenarios, reduction of the national debt.
Why use an insurance company?
If the UK Government were to provide an annuity product, as it historically has done through entities like the Commissioners for the Reduction of the National Debt (CRND) and National Savings & Investments (NS&I), it could indeed be used as a mechanism to manage and potentially pay down national borrowing. Here’s how it would work and its implications for the Debt Management Office (DMO):
1. Direct Funding for Government Spending:
Premium Inflow: When individuals purchase these government-backed annuities, the premium they pay flows directly into the Treasury’s coffers. This inflow of funds is essentially a form of borrowing from the public, but structured as an annuity liability rather than a traditional bond.
Reduced Gilt Issuance: If the government is receiving significant amounts of premium income from annuity sales, it would theoretically reduce its need to issue new gilts (government bonds) through the Debt Management Office (DMO). The DMO’s primary role is to manage the government’s financing needs by issuing gilts. If a substantial portion of those needs are met by annuity premiums, the DMO could reduce the volume or frequency of its gilt auctions.
Alternative to Borrowing: In essence, the government is borrowing from annuitants to fund its current expenditures or to repay maturing debt. This means the money received from annuity sales can be used to pay for public services, infrastructure projects, or to redeem existing gilts that are coming due.
2. Impact on the Debt Management Office (DMO):
Changed Funding Mix: The DMO’s objective is to minimise financing costs over the long term, taking into account risk. If government annuities become a significant funding source, the DMO’s remit might expand to consider how these annuity liabilities fit into the overall debt management strategy. It would need to balance the cost and risk of annuity liabilities against those of conventional gilts.
Diversification of Funding: Offering annuities diversifies the government’s funding sources. Instead of relying solely on institutional investors in the bond market, the government would tap into the retirement savings of individuals. This can enhance financial stability by broadening the investor base.
Managing Long-Term Liabilities: While the initial premium provides immediate cash, the annuity creates a long-term liability for the government (payments for life, increasing at 3%). The DMO, or a related government body, would need to manage these long-term obligations, ensuring that there are sufficient funds to meet future annuity payments. This might involve holding a dedicated investment portfolio or incorporating these future cash flows into broader fiscal planning.
Potential for Lower Cost of Funds: Depending on market conditions and the perceived security of a government-backed annuity, the implicit cost of “borrowing” through annuities might be lower than issuing long-term gilts. This is because individuals might value the absolute certainty and simplicity of a government annuity, potentially accepting a slightly lower return than they might demand from a more complex market-linked product.
3. Direct Debt Reduction (Sinking Fund Principle):
Dedicated Fund: The government could, in theory, establish a “sinking fund” specifically for the proceeds of these annuities. The money flowing into this fund could be explicitly earmarked for the redemption of existing national debt.
Surplus Allocation: If the government runs a budget surplus (i.e., tax revenues exceed spending), and the annuity premiums contribute to this surplus, then that surplus can be directly used to buy back existing gilts from the market, thereby reducing the national debt.
Refinancing Expensive Debt: The funds from annuity sales could be strategically used to retire older, higher-interest-rate gilts, replacing them with the implicit lower “cost” of the annuity liability, thus reducing overall interest expenditure on the national debt.
4. Fiscal Discipline and Perception:
Signal of Stability: A government offering its own annuity product could be seen as a signal of long-term financial stability and a commitment to meeting its obligations, which could positively influence investor confidence in other government debt instruments.
Public Engagement with Debt: It could also provide a tangible way for citizens to contribute to national financing, potentially increasing public understanding and engagement with the concept of national debt.
Challenges and Considerations:
Actuarial Risk: The government would assume the mortality and longevity risk. If people live longer than expected, the cost of the annuities could exceed initial projections, potentially increasing the overall liability.
Interest Rate Risk: The initial pricing of the annuity would need to carefully consider interest rate projections. If interest rates fall significantly after annuities are sold, the government might find itself paying relatively high fixed payments compared to prevailing market rates.
Market Distortion: A large-scale government annuity program could potentially compete with private sector annuity providers, altering the dynamics of the UK’s retirement savings market.
Transparency: The accounting for such a scheme would need to be highly transparent to ensure the public and markets understand how annuity liabilities are being managed and how they impact the national debt figures. The Debt Management Office would need to clearly articulate how this new form of liability is integrated into its debt management strategy.
In summary, by directly collecting premiums from individuals for annuities, the UK Government could reduce its immediate borrowing needs from traditional markets, potentially leading to lower gilt issuance by the DMO and a shift in the composition of its liabilities. This effectively uses the capital provided by annuitants as a form of long-term funding, which, if managed strategically, could contribute to the overall management and, in certain scenarios, reduction of the national debt.
Oops no idea how that duplicated sorry
IFS YouTube sets out the concerns and the Governemtn annuity is a way of redirecting the UK funds into infrastructure and debt management
https://ifs.org.uk/articles/pensions-climate-debt-three-big-threats-uk-public-finances-0?mc_cid=6471c091b9&mc_eid=ad7fbc9123