‘Pension freedom’ versus ‘pension security’

The weekend edition of the Financial Times has a debate on pensions between Alan Higham of Fidelity Worldwide Investment and the the Thatcher’s Pension Reforms project.

,Alan Higham, putting the view of some but by no means all in the industry, says the government’s reforms, dubbed ‘Pension Freedom’, give savers a chance of a better income in old age. ‘Retirement has changed, just like society has’, he argues, and the people need more freedom to manage their finances in this more complex world. A reformed financial advice profession, he thinks, can be trusted to guide them in making the necessary choices. [Read the article here]

In the same issue of the FT, I take a rather different view, one that comes directly from the work being done by this project on the pension reforms of the Thatcher era. I’m all in favour of freedom in principle, but people also need security. That need has lain at the heart of pensions for as long as they have existed. People need to understand that in embracing ‘freedom’ they may (on reflection I would say almost definitely will) reduce their security in old age. This is mainly because by going it alone they will abandon the benefits of risk pooling, will lack the information and expertise to make the right decisions, and, sadly, because recent history suggests many of them are going to be sold inappropriate and/or costly products by unregulated firms. [Read the article here]

Hugh Pemberton
Principal Investigator, Thatcher’s Pension Reforms project.

 

 

The budget and pensions: some lessons from history

Thatcher’s Pension Reforms has received a gratifyingly large amount of traffic over the past week as the budget loomed. The project has only been going a few months and is very much in ‘information gathering’ mode at the moment, so we did not feel able to contribute directly to that debate in any detail. However, we do hope to issue some interim findings within a few weeks, so please sign up for email notifications, or follow us on Twitter at @tpr1980s. In the meantime, here is an initial statement of intent.

Nonetheless, looking more generally at more than a century of pension reform in Britain it is easy to highlight at least two key ‘lessons of history’ to be borne in mind when reading the Chancellor’s 2015 Budget Statement.

First, there is always a tension between ‘freedom’ and ‘safety’ when it comes to pensions. Freedom for the individual consumer has its virtues but the experience of many decades is that many (if not most) consumers are ill-equipped to understand the complexities of ensuring a constant stream of income from retirement to death. The findings of the First Report of the Pensions Commission in 2004 (pp. 208-9) have not been magicked away over the past decade: people are not good at estimating probabilities or understanding risk, they shy away from complexity and from products they don’t understand, and when they don’t they are easily influenced by those who present their options to them.

Bearing in mind this lesson, ‘pensions freedom’ (i.e. the freedom to cash in an existing pensions annuity coupled with the Chancellor’s removal of the 55% tax constraint on doing so) could prove unwise over the long term and the warnings from pensions professionals about this should be listened to. This is not about buying Masaratis with the proceeds, it is about people making important financial decisions about complex issues that they are ill-equipped to grasp and the risk that they will be taken advantage of. Much will turn on the quality of independent advice on offer from the new Pensions Wise service.

Ultimately, however, what people want is the security of knowing they will not suddenly find themselves without adequate income at the end of their life: i.e. what they want is an annuity, they just want a better rate than they’re getting at the moment as a consequence of quantitative easing. To this extent ‘pensions freedom’ is something of a red herring.

Second, choices on pensions are the most long-term of all public policy decisions and this exceptionally long-run horizon does not sit easily with the short-run priorities of day-to-day politics. Decisions made for the short-term can have unexpectedly large long-term effects. The change from indexing the basic state pension to prices rather than earnings is a case in point. Introduced in 1980 to get the State off the hook of mounting costs at a time of concern about public spending levels it had marked distributional effects over time – as can be seen in this graph from the IFS’s History of State Pensions in the UK, 1948-2010 (p. 13), the value of the BSP relative to earnings falling by about 40% over the ensuing quarter of a century.

BSP-declining-real-value

In this context, the Chancellor’s decision to reduce the lifetime allowance from £1.25 to £1 million and then to index that sum to CPI from 2018, if sustained over many years and if we return to a world of consistently rising real incomes, would over time work substantially to reduce the value of that allowance relative to earnings (real incomes growth of 3% p.a. over a quarter of a century would nearly half this ratio). In short, the Chancellor may turn out to have introduced a measure that will over time effect a surprising number of people.

Hugh Pemberton
Principal Investigator on the AHRC Thatcher’s Pension Reforms project and Reader in Contemporary British History at the University of Bristol, UK

New project members

We welcome two project members:

Research AssistantDr Aled Davies

Dr Aled Davies

Aled recently completed a doctorate entitled ‘The City of London and British Social Democracy, c. 1959 – 1979′ at the University of Oxford. He is interested in the formation of Thatcherite economic and social policies in postwar Britain.

List of Publications

Doctoral Researcher: Thomas Gould

Thomas will be conducting research into the actuarial profession in the 1980s.

Thatcher’s Pension Reforms – Project Launch

Based at the University of Bristol, and funded by the Arts and Humanities Research Council (AHRC), this three-year research project will explore the roots, implementation, and consequences of the Thatcher governments’ reforms, and reveal the ways in which they contributed to Britain’s twenty-first century ‘pensions crisis’.

It will mine a rich seam of hitherto unexplored records and data: a combination of newly released archival material available as a result of the government’s decision to move from a 30-year to a 20-year rule for record release backed up by additional freedom of information requests, oral history interviews, ‘witness seminars’, and a rich array of other primary sources.

The project will be led by Dr Hugh Pemberton from Bristol’s Department of Historical Studies in the School of Humanities, with Professor Roger Middleton as co-investigator. Dr Pemberton is an expert on the history of postwar Britain. Formerly a business analyst in the life and pensions industry, he has published on the history of Britain’s system of pension provision, both public and private, as well as on the history of postwar British governance.