Pensions policy in the UK has become remarkably incoherent. We are bombarded with pension reforms, but the ones that have tipped us into Wonderland are the last two. First, so-called ‘pension freedoms’ announced last year, and coming into force in a couple of weeks, where people can cash in the whole of their pension pots and spend them at will. Second, to be announced in the budget on Wednesday, that anyone who has an existing annuity – somewhere between 5 and 6 million people – will be able to sell it in a new secondary market, for a lump sum, which they can spend at will.
Now behavioural economists and sociologists will tell you that when faced with what seems a large lump sum today, compared with a small income stream in future, people have all sorts of competing things going on in their lives and their brains. Ordinary lives are filled with debt, mortgages, house-maintenance and so on, but also wanting some of the consumption marketed to us so relentlessly as part of the ‘active ageing’ rhetoric. We are not successful adults if we do not go skydiving, on cruises, holidaying in Ibitha, remodelling our kitchens or dressing like Dame Judi. Add to this, for older generations, the needs of our adult children and grandchildren: in low wage jobs or unemployed, struggling with housing, students burdened with unprecedented debt before they even start their first job, high rates of divorce and separation with not enough money to go round; and their own consumption desires that are fuelled every day by our modern consumption based economies. And people find the calculations difficult to compute and hold in their heads, and future income has less value to them than current. A lump sum is an attractive proposition, even at a heavy discount.
So I think we have wandered through the looking glass. And here is why. Even without evidence, you do at least need a theory that suggests something will work, and you need to have a reasonable theoretical expectation that things will be better. Simply announcing that “markets work” and so all you (government) need do is create a market is palpable nonsense, as any competition theorist will tell you. So where is the theory to support what is happening? What is our reasonable expectation of actual outcomes? My 10 point argument now follows.
1. We don’t trust people to save between the ages of 16 and 64. We have spent a decade looking at this problem, and after evaluating the evidence, devised an incredibly complex scheme whereby they have to make virtually no decisions at all for the whole of their working lives to end up with a combined pension from the state and auto-enrolment, that should keep them from poverty in old age. Every minute element of this scheme has a default to compensate for non-decision making. Interestingly, the default investment for NEST focuses very heavily on trying not to lose money, with compensating low returns expected over the long run. It’s defaulted but with substantial inequalities between people already built into the system.
2. Be that as it may, we are saying although we don’t trust you to save *at all*, we do wholly 100% and unequivocally trust you to spend. Here you are, have it all. But how does the theory, on which we have relied so heavily to build the new single tier pension and auto-enrolment, apply now? To the spending? How can people be so bad at saving, but so good at spending? They can’t, as alarming and badly managed levels of consumer debt show. The new ‘pension freedoms’ are devoid of any theory other than ‘ if we throw a chunk of money at the market, we will get innovation by providers and it will all work efficiently’. So that bears some further examination.
3. What was the context for the new pension freedoms announced last year? What drove government to do this? There was an intense frustration with the annuity market, which had been analysed to be a *market that just wasn’t working*. I can remember sitting in a consultation at the Treasury back in about 2001, with everyone scratching their heads about why the public weren’t exercising their OMO rights. Since then we’ve had report after report. The annuity market is inefficient. The information asymmetries are too great. The charges lack transparency and are too complex. The product is too complex for most people to understand. People don’t behave rationally. People don’t shop around. The captive market issue (inertia) is too powerful. Pricing is complex, since life expectancy has become an uncertainty. Equilibrium between supply and demand has not settled at its optimal level; prices are too high for the products sold. In all, the annuity market simply does not work. The financial services industry had had 15 years to fix this, but reports were still saying the same thing. Except now the fsi complained about the degree of regulation too, which pushes up the price for the consumer.
4. Why is there so much regulation of the financial services industry? Because of market failure after market failure. Since the financialisation of the world of the ordinary citizen in the 1980s, mis-selling, duped consumers, poor performance, opaque charges, distorted markets through commission – in short, competition simply not working the way it should. ‘Innovation’ led to thousands (literally) of products, but far from making the markets work more efficiently, they have led to consumers being over-charged for portfolios that often do little more than track the stock market, on average, or worse. With consumers none the wiser. So the market failures that have been analysed to death in the annuity market, apply far more widely.
5. Now all of this was the case since long before the global economic crisis of 2008 that sent interest rates tumbling close to zero and made annuities a somewhat ridiculous product to compel people into. The cohort differences between people forced to annuitise in different years were dramatic, and wholly inequitable. Why should your income for life depend on exactly how old you are, and what date you retired? Drawdown options were only available to the very wealthy – for the rest of the population the privatised elements of the system had become intolerable.
6. But I am not making the case here *for* the proposed reforms. Apart from government wiping aside annuities, and creating a new market for existing or different new financial products, which they have done pretty much overnight, what has changed? What is different? The underlying position, the underlying *reasons for the market failures in the financial services industry* set out in points 3 and 4 above remain so. They long pre-dated the annuity crisis of low interest rates. So all that we are doing now, is re-directing people into slightly different markets for financial services that suffer from all of the exact same problems as the last 30 years. The warnings about this in the industry are legion. Innovation and competition do not of themselves create efficient markets, when the reasons for market failure (in what for decades have been innovative and competitive industries) remain the same. And if the only answer is more regulation, then we are creating even more pricing distortions, making the products even more expensive. I haven’t heard anyone suggest any other answers.
7. As with all social policy change, there will undoubtedly be people who will benefit from the changes, but this is far from the whole story. What my twitter stream seems most alarmed and concerned about, for the moment at least, is the scores of buyers out there for the annuity streams at great profit to the purchasers and great loss to consumers, i.e. us. Not forcing people to annuitise in the first place is *very different* from having compulsorily sold people bad value annuities at a time of unprecedented low annuity rates and then saying they can sell those very bad investments on, losing more money in the process. This has disaster written all over it, as many in the industry are predicting. And so am I. This disaster will be unmonitored, untracked, unmeasured and unknown, yet financially perilous for many people.
8. The cultural change brought about by the mere announcement of ‘pension freedom’ is immense since it will be hugely attractive to people who need, or want, the money. All political parties are in favour, and once in force, I can’t see that we can ever go back. Even though the announcement to come on Wednesday about existing annuity holders being able to sell will need to be enacted by the next government, the drive for it became irresistible when the new pension freedoms were announced last year.
9. As is the drive from now for the ability to cash in DB (Defined Benefit) streams. How can we intellectually justify the difference? We can’t.
10. So this is the direction of travel – an intellectually flawed pensions policy which is now wrongly so called – it’s a tax privileged savings policy. For now at least. Once people see it as such, why should it have greater tax privilege than ISAs? Or any other savings product? – Some might argue, why should savings have tax privilege at all? Add to this another question, why should employers be compelled to contribute? This is starting to look far away indeed from the wage/pension settlement of the past, where pensions were a form of deferred wages, to help people have a period of life before frailty or death when they no longer had to sell their labour, something in which we could at least imagine that employers had a stake. And then it’s the markets unleashed on the people, when there is a lack of evidence that people do well when that happens. The moral hazard for government having to pick up the pieces in means testing has been mooted, but we need to remember that behind each statistic about means testing is a real old person, living in poverty, often at a time of immense need. And the structures, constraints and systems that have led to that being so, were created by us.
At a packed event of pensions hustings hosted by the PPI and Just Retirement last week, Paul Lewis, chairing, ended by asking the besuited men and women in the room how many supported the idea of the new pension freedoms, and how many opposed. Only a handful of us declared ourselves opposed.
I’ll end with a thought or two about pensions and the political economy. Steve Webb has until these last two reforms been an outstanding Pensions Minister. He has driven reforms through that will be of immense benefit to women, to ordinary people, in future, and achieved things that no-one would have thought achievable. The warmth and admiration for him in Parliament and elsewhere is palpable. But he is, lest we forget, an Orange Book liberal. What might I imagine is the true free-marketeer’s overall vision for pensions? That the role of the State in pensions is simply to prevent poverty, and the rest is up to the market. If almost everyone ends up on the poverty line, the true free marketeer will either be surprised at that (scratch head), or think at some level that this is what people must want and so it is what we should give them. So the idealised form of that, in the UK context, might be a flat rate pensions at or barely above the absolute minimum politically acceptable poverty level, and beyond that, at most, perhaps some tax incentivised savings schemes for people to do with what they will, but perhaps nothing at all, with no age or other constraints. For the true free-marketeer. Hmmmmm.
In the great pensions policy experiment that is the World, research tells us that increasing the marketised elements of pension systems results in growing inequalities. The Social Democratic voice, that seeks a welfare state that provides for all people to have excellent healthcare, social care, and an income in retirement that allows them to participate fully in a society that moves at an ever faster pace, is absent from British politics. For me, we need a state pension system that has income maintenance, and not just bare poverty prevention, as part of its function. Barbara Castle, I do believe, had the right vision and the right idea. We need to take markets out of what is essential for welfare and well-being.
Are the reforms coming into force in a couple of weeks reversible? Are the ones to be announced on Wednesday stoppable? I fear not. We are entering an era of new inequalities in later life, new types of inequalities, and we are creating them.