Does pensions “freedom” offer the right choices?
Today (almost*) anyone over 55 can get their hands on their pension and take it as cash. It is all about “freedom” and “choice”, we are told. Those of us who are sceptical of the policy are therefore immediately labelled as opponents of freedom. We are the snooty paternalists opposed to choice who “do not trust” people to make the right decisions.
But this “do not trust” and “choice” is a bit of a linguistic trick. There are many areas of life in which my choice is restricted. I cannot for example choose to drive on the right hand side of the road in an uninsured car at 80 miles per hour.
This is an obvious case where the restrictions are not just for my benefit but for society as a whole. But there are many areas where I am either forbidden from doing things in my own interest – or, and more relevantly here, strongly discouraged from a course of action.
For thirty years, from roughly 1980 to 2010, we relied on freedom and choice to get people to save into pensions. It was not so much to do with the state or the employer – who had shared the duty in the post-war settlement – but the individual.
It catastrophically failed. By the time we drew up a final balance sheet two out of three private sector workers were not saving in a pension. So rightly, public policy stopped “trusting” people. Instead we now auto-enrol people into pensions savings. They can exercise the freedom and choice to opt-out, but we do not make it easy for them. “Not trusting” people has dramatically increased pensions savings with opt-out rates much lower than people expected, especially among the young.
There is a huge amount of behavioural economics evidence about why we are not very good at making decisions about pensions. We underestimate both average life expectancy and our chances of living longer than that. We do not understand the effects of compounding inflation over decades (especially, one suspects, when it is at current low levels). We do not know how to balance the benefits of income years in the future against the cost of giving up spending today. With decisions so important as pensions, we find making choices so tricky that we end up making no choice and doing nothing.
For a classic economic market to deliver optimum outcomes we need rational players and perfect information. Markets in long-term financial services are about as far as you can get from these conditions, perhaps explaining why the OFT found the DC pension market one of the most dysfunctional that they have ever studied.
Auto-enrolment and the creation of NEST, as a low-cost, standard setting, not-for-profit provider unable to cherry-pick employers were all carefully designed to work for consumers and non-engaged employers. Since then further safeguards such as charge caps for auto-enrolment pensions have been introduced by this government, presumably because we “do not trust” people to use available low cost pensions and the market was failing to eliminate them.
But the thinking behind “freedom and choice” is very different. For sure there is a problem with how people turn their cash pension pots into pension income in retirement. The annuity market has failed. Cliff edge retirement (one day you work, the next day you don’t) is less common than it once was. Longevity pooling makes little sense until you are in your late 70s given increased life spans. People have all kinds of pension pots and commitments. All these are good reasons to change.
But “freedom and choice” does not start with setting out these issues and thinking through how best to serve consumers in the future, and as the Pensions Commission did for saving, ask whether we need new products and new institutions. Most of all it does not think through what choices consumer wants to make and how we can set up structures that help them make sensible choices (even if we give them the same freedom of opting out that savers have).
Instead the market is being asked to sort out the problem. People are not being given the choices that they might want to make (such as they do when considering the size of a cash lump sum when they start a DB pension) but made to take up the role of individual market participants making the kind of purchasing choices needed to make a market work. And the whole approach is based on the premise that for-profit solutions can sort out the problems, even though we had to create a new institution for pension saving.
This is despite all the evidence of systematic market failure and mis-selling in pensions over the decades. There are some nods to this. 45 minute Pensions Wise advice sessions are meant to make up the information problems, though even the equally excellent TPAS and CAB are not going to overcome this. Full page adverts from the FCA warning against scams also suggest that a lack of trust in a self-correcting market.
So the issue is not whether people should have more freedom to use their pension savings in different ways, but whether a market free-for-all is the best way to deliver the best outcome for people and remedy the current problems?
My answer to that is no. The correct question is how can we give people what they say they want from a pension which is a regular predictable income that lasts as long as they live and keeps up with the cost of living.
That implies collective risk-sharing and risk-pooling, not individualised consumer behaviour. DB pensions may be increasingly rare in the private sector, but that is not because their members thought they did not have enough choice and flexibility.
But the direction of policy is now against pensions as income, and instead as pensions as tax incentivised savings pots. Indeed the photo taken from yesterday’s Sunday Telegraph shows this taken to its logical conclusion – a pension that is never taken as income but used entirely to avoid tax.
This approach reminds me of the choice in public services debate. Under the last government we were all meant to choose our surgeons and our hospitals, and the money attached to our treatments was meant to introduce market disciplines into the NHS. Yet the kind of choices that patients mostly want to make are about convenient appointment times.
*Those who cannot get at their pensions cash include those in unfunded public sector pensions (think health, teachers and civil service). Those in any defined benefit pension (ie those that promise to pay a particular income when you retire) will first have to transfer the money into a DC pension (a cash pot) which is almost certainly a bad thing to do, and may be quite hard to do in practice.