What the Chancellor should have said in the Budget about pensions
Mr Speaker, I now turn to the future of pensions. I know that the policy of pensions auto-enrolment has wide support across the House and is proving a great success. Opt-out levels have proved lower than even the most optimistic forecasts.
But while we may have got people saving again, and made sure that most are now members of low cost schemes with sensible default investment strategies, we have yet to sort out what happens when people retire and want to start turning their savings into pension income.
There is a growing realisation that the annuity market is broken. People do not shop around for the best deal. Annuity rates are low partly because people are living longer, partly because interest rates are low and look to remain so, and partly because people are not getting good value for money.
But there are still two advantages inherent in annuities. Firstly, they pool mortality risk. They are an insurance policy against living longer than you expect. Secondly, they provide what people expect from a pension – and that is a regular and predictable income in retirement.
And we must face up to the inevitable impact of increased longevity. If people are living longer, then they need more pensions savings to give them a comfortable retirement, and I signal today that over the medium term we will need to raise minimum contributions.
Some have suggested to me that I should simply sweep away the requirement to annuitise. They say people should be given the individual responsibility to do what they want with their pensions savings, and we should ask the pensions industry to innovate and use market forces to deliver new products.
That approach of course appeals to me as a Conservative, and I certainly want to give people more choice about what they do with their retirement pots.
But I also know that last time a Conservative government talked about personal responsibility and encouraged pensions company innovation the result was the great pensions mis-selling scandal – a reputational hit from which even the better parts of the industry have yet to recover.
I therefore recognise that the classical economic market does not work for much of pensions. If we cannot get annuities to work – when products are relatively easy to compare – then there is no chance of an unregulated market in income decumulation products not ending up with many consumers ripped off.
Some, of course, say that we can make markets work by educating consumers sufficiently to both end the asymmetries of information that stop proper markets functioning and also overcome the behavioural biases long reported in the annuities market that make people underestimate how long they will live and give insufficient value to income in the future compared to income today.
But I do not believe that a single face to face guidance session for all retirees can overcome these problems. I also have severe doubts that we could set up a proper scheme to deliver this quickly, as we would need to assemble a great number of advisers with no vested interest and with knowledge of the benefits system and other financial issues for older citizens with limited means as well as the traditional financial advice toolkit.
I also worry that sweeping away an admittedly flawed system will undermine the good parts of what we have today. I would not want to make changes in the name of choice, only to find that an unintended consequence would be to make annuities an even worse buy, when they do provide the security that many want and need.
As we celebrate the success of auto-enrolment we should reflect on how we have got here. It started when the previous government set up a genuinely independent Commission – far too independent for the Chancellor of the time. They proceeded carefully by looking at the evidence, talking to all those involved and cannily coming up with solutions that could win political consensus.
Their key insight was to combine choice with defaults for those who did not want to make a choice for pensions saving. They also recognised the need for a new not-for-profit institution governed in the interests of low and medium paid savers, not as a monopoly supplier but as both a pace setter and with a public service obligation to ensure every employer could meet their obligations.
We now need to do the same again for the post-retirement spending phase of pensions. So let us combine far more choice with universal access to default decumulation vehicles run purely in the interests of scheme members.
We a need a similar process of consultation and consensus building done independently from government to get this right, but let me suggest some starting points.
People want regular and predictable income in retirement, so I would counsel against thinking of pensions as simply a savings pot.
But we should be open to rethinking traditional annuities. As most people now live beyond 75 we may not need to pool longevity risk in the first stages of post retirement life. And as we know from the discussions about Defined Ambition, guarantees are expensive.
So it may be better to think that we should work out the best way of achieving a target income. This may not be backed by a guarantee but would be supported by sharing risk between scheme members including those still working and saving, although this of course will needs caution and the highest standards of governance. But this approach works elsewhere particularly in the collective pensions of the Netherlands.
And we should be prepared to ask whether the state can usefully be involved in providing post-retirement income. Some have suggested longevity bonds. Some have said the state could provide bulk annuities. Perhaps there is a role to add a new automatic stabiliser to the economy by providing an underpinning guarantee to support pensioner income in the worst slumps.
I am happy to kick start this discussion and help prepare the way for more choice by increasing the age by which people need to annuitise for two years and making drawdown easier while we wait for the new Commission I have set up to do its work.
But I recognise that the worst thing I could do today would be to pre-empt a serious policy exercise with some back of the envelope policies designed for partisan headlines tomorrow. Pensions is too important for that.