Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday 29 March 2014

Pensions and neoliberal fantasies

As those in the UK will know, one of the major changes announced in the recent budget was to ‘free up’ defined contribution pension schemes so that recipients were no longer forced to buy an annuity with their pension, but could instead take the cash sum and spend or save it how they liked. This has been generally praised by our predominantly neoliberal press. The government’s line that this was a budget for savers and pensioners has been accepted uncritically. Giving people the choice of what to do with their money - what could be wrong with that? After the budget the UK press were full of stories of new pensioners trying to cancel their annuity contracts.

So if I suggest that those who are due to receive a defined contribution pension in the next few years and who want to invest their money prudently are likely to be worse off as a result of this budget, that might come as a bit of a surprise. The reason is because of three things economists (who are not automatically neoliberal) worry about: adverse selection, moral hazard and myopia. I will translate these in turn, in ascending order of importance. But before I do a very simple point. Annuities are a good idea, because they insure against uncertain lifetimes. So unless you know your date of death with be earlier than for your age group, you should invest a large part of your pension in some form of annuity.

Moral hazard. Pensioners can now take the risk that they will not live for long and blow their pension on expensive holidays, knowing that if they are wrong and live longer they can always fall back on the welfare state. A reasonable state pension should avoid this (because those receiving it do not qualify for welfare payments), but the IFS believe (pdf) this will only be partially true in the UK.

Myopia. As Tony Yates points out “there is abundant evidence from the experimental and other empirical literature in behavioural economics and finance that we are i) terrible at paying proper attention to the wants of our future selves [usually neglecting them] and ii) terrible at responding rationally to risk.” We know (IFS again) that people underestimate the life expectancy of their age group.

Adverse selection. If everyone has to take out an annuity, annuity providers can make a reasonable guess at how long people on average will live. If instead people can choose, annuity providers face an additional uncertainty: are those not choosing to take out an annuity doing so because they believe they will not live as long as the average for their age group? If that is true - which it almost certainly is - then annuity rates will fall, because those still taking out annuities will live on average for longer. A greater concern is that this additional uncertainty will reduce annuity rates still further, as annuity providers require an additional margin to compensate them for the extra risk they face. In theory, the market could collapse completely.

I do not mean to imply that any of these, or even all three combined, are sufficient to justify compulsory annuitisation. What they do show is that the naive ‘choice must be good’ line may be neoliberal, but it is not economics. What does seem pretty clear is that the budget will lead to a reduction in annuity rates, so a perfectly reasonable headline after the budget would have been “Chancellor cuts incomes for new prudent pensioners”. If you do not remember that headline in your newspaper, perhaps you should change newspaper.

There is another neoliberal fantasy, and that is that private provision must be better than public provision. Yet pensions illustrate one area where this can be the opposite of the truth. Defined contribution pension schemes suffer from intergenerational risk. Suppose that those arguing real interest rates will stay low for a long time are right (secular stagnation). That means that the generation receiving their pension during this period will end up with a lower pension income that those that go before or after them. Indeed it is just this effect which has made annuities unpopular and which the government is playing to. People would like to insure against this kind of risk, but the problem in this case is that we need an insurer who in effect lives forever, so they can smooth out these good and bad times. There is just one economic actor that could do this, and that is the state. The state could do this in many ways, ranging from some form of unfunded government pension scheme to providing insurance to annuity providers.

As Tony Yates notes, you can see additional government borrowing during severe (liquidity trap) recessions as just this kind of intergenerational risk sharing. He also points out that there are time inconsistency issues when the state performs this role, although I would add that if the old continue to vote more than the young these may not be critical. If Roger Farmer is right (pdf), these issues involving uncertainty over generations may have consequences far beyond pension provision, and again the state may have a key role to play. Unless, of course, you are a neoliberal who will not countenance such things.

This post was inspired by this from Tony Yates, and also drew heavily on this post-budget briefing by IFS economist Carl Emmerson. For a much more detailed analysis (based on the government’s earlier proposals but also of relevance now) see this study (pdf) by David Blake, Edmund Cannon and Ian Tonks. 


  1. A lot of criticism towards the media lately. While I can certainly agree that the media is bad at reporting on issues that have any kind of complexity, that's probably more because they lack experts (having a reporter who is an expert in his field doesn't net the newspaper any extra profit).

    In other words, I don't agree that the British medias poor reporting makes it right-wing or neoliberal or whatever. I get the sense that when the media applauds the current government, they don't do it because the government is doing right-wing things, they do it because it enacts policies that are popular and easy to understand. (We need to be Responsible with our debt! We must give people Choice! etc.)

    That said, I enjoyed reading a concise explanation of the case for keeping pensions in annuities!

  2. But isn't it the role of proper journalists to be intelligent, or at least ask intelligent questions?

    The move is entirely in line with Osborne's inclination, which is to be a political agent rather than an economic one. It's also in line with general policy since the late 70s, which is to move risk onto the public, and provide more opportunity for private profiteering.

  3. I find Hugo's above comment problematic; firstly the populist press D/Mail, D/Express, Sun and increasingly the Telegraph and Times have an exceedingly and increasing Right Wing bias to their presentation of their "News". The Times is now both a 'tabloid' in name and by its biased analysis. Go over the budget coverage in all those news papers and see if there's anything like 'the pensions deregulation' socially chaotic issues identified by the principal of Oxford's Hertford College, Will Hutton in last Sunday's Observer.

    Moreover if the FT or Observer has clever less gullible experts why not the wealthy D/Mail or Times.But of course we know that *to* really understand what's happening to the UK -its qualities like the FT and the Observer will tell us. The others have a vested interest in pretending everything is rosy.

    Furthermore years ago we could trust the independent BBC for good analysis and a grasp of what's happening to the UK; no more their coverage including R4 is only little beyond the Breakfast TV sofa level with the morning's Tory Tabloid news agenda; they have replaced clever experts with media 'churnalists' ( re-hashing that agenda). To my astonishment I find my self drifting to Sky News channel or C4 news where I know I will get a cogent, more insightful analysis.

    1. You may be right but the arguments I've read so far (from Prof Wren-Lewis as well) have not been that convincing. The FT and Observer are geared toward a more informed part of the population which will always remain very much a minority. If it is the case that other newspapers are becoming more right-wing (and not just more populist) then that's probably because there is a demand for it. All over the western world there has been a strong rightward shift in policy over the last two decades or so, no doubt with an accompanying shift in attitudes.

      One reason why I'm distrustful of the argument is that it seems like too much of an easy excuse and a very hard to disprove (as you no doubt already know, a theory is useless if it's impossible to disprove).

      Because my father is a lawyer, I grew up hearing him complain how the big newspapers keep misusing the legal terms and completely misunderstanding legal cases. That is a typical (but unfortunate) part of the media society that we have. It doesn't suggest that there is any conspiracy to keep the facts hidden.

      I apologize for the length of this comment, didn't mean for it to get this big.

  4. During my 30 years with NASA retirees could take a lump sum then sometime in the 80's that was eliminated. Of course during that era the option of a defined contribution plan was added to the defined benefit plan. I chose to stay with the defined benefit plan. Worked well for me vis those retirees who took the lump sum. The best plan is to marry much above your station to a woman whose wealth much exceeded yours. A plan available to only a few.

  5. Isn't the logical thing to use your pension to buy rental property? Not good for the housing market as a whole, but will give better returns to the pensioner than an annuity, and the properties can be inherited after death.

    If so, then politically this could be seen as catering to the current government's core demographic.

    1. Two basic points. First, property is a risky asset, so its return is bound to be higher than a safe asset. The relevant thing to compare it with is investing in equities. The income from an annuity will be higher than the return from a safe asset, because you lose the capital.

      Second, obviously you do not want to annuitise all of your wealth if you want to pass on an inheritance. The tricky question then is how much of an inheritance you want to pass on. If you are lucky enough to have enough wealth that you think you can live off the interest and pass on the capital, then an alternative you should think about is buying an annuity that will give you the same income, and giving your children the remaining inheritance now, so that they can invest it now and accumulate the interest (rather than having you spend the interest). What an annuity does then is remove the uncertainty your children face about when they will receive their inheritance. But with that level of wealth, you should also pay for some proper financial advice!

    2. «use your pension to buy rental property? [ .... ] will give better returns to the pensioner than an annuity, and the properties can be inherited after death.»

      I reckon that's exactly what the government hopes most would-be pensioners will think, thus resulting in a huge boost to property prices, yet another turn in the "eternal" debt-collateral spiral so beloved by everybody. Most DC pension pots are probably large enough to pay a 25% deposit on a 2-up-2-downer in the South East.

      But also: given that the assumption here is that the return from buy-to-let is going to be higher and less risky than that of annuities that are sold in a very large, competitive financial product markets, and will also achieve this without drawing down capital, unlike annuities, this points to a strategy to lift massively the standards of living of the UK:

      Stop investing time effort and capital in high risk, low return businesses like agriculture, manufacturing, catering, transportation, research, etc., close down all offices, factories, farms, and invest solely in buy-to-let properties.

      Why should pensioners be the only people benefiting from the buy-to-let money machine? Why should the State waste precious resources building roads or hospitals or schools when investing in buy-to-let would give taxpayers much higher risk-free returns, allowing taxes to be cut substantially?

      Or perhaps the government's plan is to add another mass of greedy speculators to boost property prices, in a massive pump-and-dump scheme, and their calculation is that the stupendous debt-collateral spiral will collapse when the other side is in government, and they will be blamed for it.

      And the other side can't do anything about it, because for so many voters redistributing from unproductive, undeserving workers to productive, deserving property rentiers is an awesome idea, and none of those voters realize or even want to be told that they are asset stripping themselves.

  6. Another thing that might change is your access to risk capital. What signal will it send if you do not put your whole pension into the project, now when you can (if I understand you correctly)?

    Furthermore, we know (with as much certainty as we ever can know anything in social science) that entrepreneurs tend to be overly optimistic about their own projects. This is great, and I would be all for society giving them access to capital at an expected monetary loss (since the social return on new inventions generally is greater than the private return) – but it is simply irresponsible to let, and now possible force (because of the signaling issue mentioned above), these dreamers to bet their pension on it.

    (My brother is a serial entrepreneur, but I am very glad that he never has had the option to use his pension money for any of the projects. In the end, I would of course have to pay for him if he went completely broke.)

    1. «it is simply irresponsible to let, and now possible force (because of the signaling issue mentioned above), these dreamers to bet their pension on it.»

      That's an expression of the same kind of mistake that our blogger makes in the main post: that under a neoliberal logic doing so is not irresponsible, it is just and fair: because it is right and fair that losers must lose, just as it is right and fair that winners must win. For every loser dreamer that bet their pension wrong, there is a winner wealth-creator on the other side of the bet whose wealth increases.

      Things like «moral hazard», «myopia» and «adverse selection» are pluses, not minuses, as they are tests that separate winners from losers. The neoliberal thatcherite yearning is for social darwinism,

      But my impression is that the government only uses social darwinist inspiration to serve what is actually a crony agenda, because they know very well what are the likely outcomes: that the "best and brightest" will win big thanks to friendly government support, as in the massive bailout of FIRE sector jobs after the "best and brightest" run their employers into bamkruptcy by looting them along with insufficient risk reserves.

  7. USS triennial valuation coming out very soon. The current regulatory measures of pension fund solvency seem to me to be very much 'neo-liberal'.

  8. Worth noting that a lot of popular support for this comes out of the corruption and oligopolistic practices in the annuity industry.

  9. From experience rather closeby I can confirm that buying a tractor (aka a Lamborghini (the example often used in this discussion) is a very bad investment.
    Basically a rubbish policy. Pensioncosts are already a huge financial drag in the future, because of aging and too little (pre-)funding if not simply unaffordable. No reason whatsoever to make the problem even worse. This will simply increase the (unfunded) costs of the elderly. Via spending but also via informal transfers to mainly children.

    Effectively more saving should be done, as it is unclear that in the future with increasing competition tax revenue can be increased substantially to pay for all that. Simply donot buy that that will be possible. European rates in general look way too high compared to the rest of the world and that on top of already high wagelevels.
    Pensions are income for people that have basically no other alternative (except maybe their children) a reason why they should be as safe as possible.

  10. VPAssociates strongly recommend that you get expert tax advice from an authoritative buy-to-let property tax source to help you make these savings on your buy-to-let property deals.


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