doctorIn all the talk about annuities and the poor value they currently offer, nearly all of it has been based on standard annuity rates, ie where there is nothing sufficiently medically wrong with you to affect your life expectancy. However this is almost certainly not the rate you should be looking at.

Go to any of the annuity provider or broker websites, sometimes buried away a little, and you will find a link explaining what they can offer in the way of “enhanced” or “impaired lives” annuities. Legal & General’s web page on this looks like the kind of warning notice you find on the wall of your doctor’s surgery waiting room, with headings like Smoking, Type 2 Diabetes and High Blood Pressure. But in the upside-down world of buying annuities these become good things to do or have.

Just Retirement give some handy illustrations of what various conditions could mean for your income: up 20% for minor conditions like obesity and hypertension, up 30% for “moderate” ones like being a heart attack survivor with a bypass and 40% for serious medical conditions like stage 2 bowel cancer one year in. However, you don’t need to get anywhere near the frankly frightening conditions in the moderate and serious boxes to make a big difference to the income you can receive. provide a very long list of medications (covering every letter in the alphabet except J and Y) which could lead to an impaired life annuity if disclosed to the annuity provider.

As the BBC article from 2012 posted by the Better Retirement Group on enhanced annuities says: “At its simplest an annuity is a bet with the insurance company about how long you will live.”

So on that basis, it makes sense to stack the odds in your favour as much as you can. Which makes the 2007 article in the New England Journal of Medicine entitled, rather dully, Incidental Findings on Brain MRI in the General Population, such an interesting read.

They studied 2,000 people (mean age 63.3 years, range 45.7 to 96.7) from the population-based Rotterdam Study in whom high-resolution, structural brain MRI scans had been carried out. Asymptomatic brain infarcts (more commonly known as strokes) were present in 145 people (7.2%). Among other findings, aneurysms (1.8%) were the most frequent. Benign brain tumors also turned up reasonably often (1.6%). The most extreme case was someone with a large, chronic subdural haematoma, who was subsequently found to have had a minor head trauma 4 weeks before the MRI scan. Some of the scans are shown below.

brain scansBut the really amazing thing is this: only 2 of the 2,000 people scanned (the subdural haemotoma mentioned above and another who had a 12 mm aneurysm of the medial cerebral artery) had any idea that there was anything wrong with them!

Another huge area of undiagnosed disease (and on the list for enhanced annuities) is prostate cancer. According to a systematic review of prostate cancer biopsy schemes by the University of York in 2005, where they quoted from the NHS Centre for Reviews and Dissemination publication on screening for prostate cancer, Effectiveness Matters:

Post mortem studies show that 30% of men over 50, who had no symptoms of prostate cancer whilst alive, had histological evidence of prostate cancer at the time of death. This percentage rises to 60-70% in men over 80 years of age. In other words, most men with prostate cancer die with, rather than from, the disease.

The main reason these studies have been carried out is to determine whether screening for prostate cancer, which kills 3.8% of men with the disease, has saved many lives. The Prostate Specific Antigen (PSA) test that is commonly used to detect prostate cancer in the absence of symptoms is not only prone to false positives and negatives (ie telling you you have it when you don’t and don’t have it when you do – something all screening suffers from to some extent), but can lead to you being offered treatment which may well be worse than the disease. This is discussed further in the excellent The Norm Chronicles, by Michael Blastland and David Spiegelhalter, which questions whether, overall, screening is particularly effective in saving lives.

Effective in preventing death? Perhaps not. But effective in increasing retirement income? Almost certainly.

The latest Association of British Insurers (ABI) facts and figures on the UK annuity market suggest that enhanced annuities have grown in popularity, to 24% in 2012 from 2% in 2003. There is scope to make further large increases in these figures if more people can be persuaded to have themselves screened for some of the most common undiagnosed conditions before they retire.

So don’t necessarily accept a standard annuity rate. And consider getting yourself tested first.

The most interesting figures I have seen so far in all the noise of the Scottish independence debate come from the Government Expenditure & Revenue Scotland report for 2011-12 (the latest figures available). This report compares the effect of various approaches to splitting oil revenues. It does, being a Scottish report, focus on the impact on Scotland. However, extrapolating from their published figures, the impact on the rest of the UK are just as interesting.

Scotland and oil

The net borrowing in the Public Sector Accounts for the UK as a whole is shown in blue at the bottom next to the Scottish position with no oil revenues, with the deficits of an independent Scotland and the rest of the UK shown both in £ billions and as a percentage of their respective GDPs above under two separate scenarios. One assumes oil revenues are split per capita, the other that they are split by geographical share. I have assumed no change to economic activity in the UK as a whole due to independence, an assumption I admit may be shaky but for which I have seen no authoritative alternative to date.

On this basis, the rest of the UK’s deficit in 2011-12 as a percentage of its GDP would be 7.7% with a per capita split and 8.5% with a split by geographical share, compared to the 7.9% of GDP for the UK as a whole in the Public Sector Accounts. So one measure increases the rest of the UK’s deficit as a proportion of GDP (the approach the Scottish National Party prefers) and the other reduces it.

That is presumably why it was worth the UK Government relocating to Aberdeen for today’s cabinet meeting to discuss the future of the oil industry. There is a lot at stake.

Source: Flikr Creative Commons by Thomas Galvez under license

Source: Flikr Creative Commons by Thomas Galvez under license

Patrick Collinson’s article about bringing in auto-annuitisation and a national annuity service has prompted some discussion.

As he said:

It won’t solve the problem of overcharging by the City while workers are saving to build up their pension pot. It won’t solve stockmarket underperformance. It won’t solve the biggest issue for annuities – that we are continuing to live longer and longer. But a National Annuity Service could at least make sure that one of the biggest financial decisions anybody faces isn’t a case of pension pot luck.

Peter Kane, Corporate Relationship Director at Standard Life, felt that the biggest challenge was that most employees in the UK are not saving enough and the average level of fund at retirement (before an annuity is even considered) is insufficient. He’ll get no argument from anyone about that being a big challenge, but there has been a great deal of discussion about it and there will continue to be so. It does not in any way diminish the importance of what he refers to as “the annuity issue”.

Matt Dorrington, Pension Consultant at Capita Employee Benefits, thinks what we need to consider is who will hand hold these people and how are they remunerated for their services. The reason a national annuity service would be set up of course is if the Government decided that the pensions industry was not hand holding enough and requiring to be remunerated too much.

Joe Robertson, Member Nominated Director at The Pensions Trust, was concerned about the computerisation required to process the information to allow enhanced annuities for the masses. Is that why there has been so little encouragement to people to access the much better value annuities their personal information could buy them for so many years (up to 24% of annuities were enhanced in some way in 2012, but only 2% were in 2003)?

If the Government were to step in with a cheaper annuity advice and broking service, would this lead to commercial annuity brokers leaving the market, or to their charges coming down to closer to the state broker’s rates? Commercial brokers might well still offer a wider range of options, justifying higher fees. If auto-annuitisation only applied for pension funds up to a certain level, with funds above this level not needing to be surrendered to the national service, might there still be a market for advising high net worth individuals?

These are just some of the many questions which would need to be answered, but such a service could potentially significantly improve outcomes for many. If nothing else it could reduce the current very wide variation in outcomes, although this may of course lead to those who currently navigate their way around the system quite cannily ultimately being worse off.

I would like to see an additional service provided by the new broker if it ever came into existence: to index market annuity rates against the relative cost of annuities under the Pension Protection Fund’s (PPF’s) Section 143 basis in any given month (this gives the amount of money the PPF currently requires schemes to have to purchase an annuity when their sponsor has failed so as to avoid entry into the PPF). Obviously even standard annuity rates vary by postcode, but it would provide a check on market prices increasing beyond what movements in the underlying investments used by annuity providers would justify.

But of course the real problems are at the bottom end. According to the Association of British Insurers (ABI), 30% of annuities were purchased with less than £10,000 in 2012. For annuities purchased with £20,000 or less, this percentage increases to nearly 40% for external annuities (ie when people “shop around”, as apparently they now do in 48% of cases) and nearly 60% for internal annuities (when they don’t).

Why is this, when legislation allows people to take the first £18,000 of pensions savings as cash (the so-called “trivial commutation” rules)? Part of the answer may lie in the latest report from the Pensions Institute entitled How do savers think about and respond to risk?. Of particular relevance I think is this finding:

One clear preference stands out: the reluctance to dip into long-term savings to meet a shortfall in short-term savings goals and vice versa. This provides support for the idea from behavioural finance that people have different “mental accounts” for their savings goals and are reluctant to “borrow from” them for other purposes (ie the mental accounts are not fungible). This holds very strongly for the long-term fund: only as a last resort are most people prepared to dip into this to meet short-term savings goals. A slightly bigger percentage of people are, however, prepared to use their short-term fund if they face the risk of a shortfall in their long-term savings goals.

I think at least part of the reason for the high demand for small annuities is this unwillingness to convert money which has always been seen as long term savings (and for which, as another part of the report makes clear, most people are generally more willing to accept a lower, but more stable, income than to risk significant falls in the asset value) into a form which could end up meeting short term needs instead. Of course, part of the reason might also be lack of awareness that the option not to buy an annuity exists. A state broking service may therefore help here too.

In view of the particularly poor value offered in the market at the lower end (£5,000 buys you around £5 a week, not increasing and which does not include anything for your spouse) and the persistent demand in spite of this, I would like to propose one further step. I think the Government might want to consider creating a section of the PPF for small pots. Say, those up to £18,000?

It is in no way what the PPF was set up to do. And yet. The administration expertise with handling large volumes of small pensions is already in place there. And, if the terms offered were on a S143 basis, it should not create any additional funding burden. What ever they make think of it, employers with pension schemes have become accustomed to dealing with the PPF.

If the PPF were able to take small pots on similar terms to those currently only available to larger annuities in the market, and the market were then left to provide annuities for everyone else, outcomes might be improved at all levels.

The PPF as an annuity provider of last resort? Perhaps this is an idea whose time has come.

Economists have recently developed a new term, to describe the nature of income inequality in the United States in particular. They call it fractal inequality, although I am unsure whether Benoit Mandelbrot, the inventor of the whole idea of fractals, would be that impressed. He died in 2010, with the application of fractals to financial markets that he presented in his 2004 book The (Mis)behaviour of Markets, still waiting to be fully taken on board by the risk and investment communities even after the 2008 crash.

A fractal is something that looks pretty much the same however much you zoom in or out on it. A cloud is one example. An equally beautiful example is the Mandelbrot Set (shown below), where a remarkably simple formula creates shapes of infinite complexity.

Source: Wikimedia Commons. Created by Wolfgang Beyer with the program Ultra Fractal 3.

Source: Wikimedia Commons. Created by Wolfgang Beyer with the program Ultra Fractal 3.

The reason it has come up in economics is that people are paid unequally. Very unequally. And even within the 1% of people who are paid unequally from the other 99%, people are paid unequally. To the extent that it starts to look a bit fractal. See what you think of these two graphs, taken from the HMRC personal income by tax year statistics:

earnings of 1 v 99income of 1

So what about increasing inequality between the 1% and the 99%, as discussed from a US perspective in the first link above? In the UK it has certainly increased, but the rate depends on which time periods you compare. The range provided by HMRC is from 1999-00 to 2011-12. In this period of 12 years, the total income 99% of the population live below increased by 52%, compared to an increase of 41% in the median income (ie the total income 50% of the population live below). Compare this to the 7 years from 1992-93 to 1999-00, during which the total income 99% of the population live below increased by 54% (ie more than the 12 years for which records exist since) compared to a 25% increase in the median income.

The message seems to be that it’s getting worse but not as badly as it used to be.


DA optionsThe Defined Ambition consultation ended on 19 December but the lobbying has continued. Camps have now formed around the various options.

Steve Webb, the Pensions Minister, and Alan Rubinstein, Chief Executive of the Pension Protection Fund, have been enthusiastic supporters of something called the pension income builder, which increases the guaranteed pension accrued each year with part of the annual contribution, with the remaining contributions invested in a collective defined contribution (DC) arrangement.

The Collective DC more generally, where returns are smoothed between members in an attempt to reduce the volatility of returns on individual DC, has also had some very vocal proponents. Considering it was originally ruled out as an option by the Department of Work and Pensions (DWP), has had 10 objections to it raised by the Association of British Insurers (ABI) and has been accused of not reducing risk so much as moving it around between members by Lord Hutton, this is a little bit of a surprise.

Lord Hutton, former Secretary of State for Work and Pensions and chair of the Commission on Public Service Pensions Commission, is dismissive of the whole defined ambition idea. Recently he said that the Government should stop “banging on” about defined ambition and let the pensions industry focus on applying defined benefit (DB) investment strategies to DC schemes. He is a particular fan of the Liability Driven Investment (LDI) approach, common in DB schemes protecting their funding position, being applied more consistently to DC. Hutton has recently joined Redington, an investment consultancy, so I imagine we can expect to hear a lot more from him on this subject.

Much has been made of the Dutch system, which has a “second pillar” of large industry-wide pension schemes. This has suffered from the same economic pressures which have dogged the UK system since the turn of the century, but has arguably retreated from straight final salary benefits – first to career average retirement earnings (CARE), then to risk sharing via variable contributions for employers balanced by variable benefits for employees, and currently renegotiating again  in the wake of the 2008 crash – in a more orderly manner. I tend to feel that the main reason the Dutch system is better than ours is the same reason that their flood defence system is better: they put a lot more money into it. Nine times as much in the case of flood defences, and contributions into their second pillar average 20% of salary compared to the current average into DC schemes in the UK of under 8%. They also make you buy an annuity, make you join and don’t let you opt out. Despite this it remains remarkably popular with the public.

As you can see, there are a lot of acronyms flying around, and relatively little discussion with the people who these schemes are likely to end up getting foisted on. The Association of Consulting Actuaries (ACA) carried out a survey of smaller firms which revealed that what they wanted was:

  • Members to receive more from their savings;
  • Increased transparency and trust in the companies who provided pensions;
  • No collective schemes; and
  • More tax concessions.

This last point is unlikely to be conceded, with the Institute of Fiscal Studies joining the increasing clamour this week to limit the generous tax exemptions to employers and members with occupational pension arrangements.

But has anyone asked members of pension schemes? Very few, as far as I can see. The most notable being the Pension Regulator’s survey of DC pension members in 2012. When those still actively contributing to these schemes were asked which of a long list of things would encourage them to take more interest in their pension, the three things they wanted overwhelmingly most of all were:

  • Someone making clear to them how much they needed to save;
  • Being able to talk to someone to understand their pensions better; and
  • Clear communication from their employer and their pension provider.

Notice how concerns about guaranteed benefits did not feature here. When asked, 85% had some understanding that their pension income was not guaranteed, and even more (94%) had an understanding that contribution levels were a key factor in determining that income. While 78% thought their company or personal pension would be one of their main sources of income in retirement (the next highest was the state pension with 22%), only 24% were confident that their current level of contributions was going to provide an adequate income. So they know they have a problem.

What they are asking for is a step change in financial education so that they can begin to tackle that problem. So could it be that all of the groups we have heard from above are trying to solve the wrong thing entirely?

As far as the regulatory environment is concerned, I think the document Defining Ambition produced by the National Association of Pension Funds (NAPF) before the consultation probably summarised the situation best. Joanne Segars stopped short of supporting any particular solution and instead laid out some of the main options and where they sat on the scale of risk (which I have reproduced above) to the member.

Segars suggested that we shouldn’t “sweat the small stuff”, and should instead concentrate on providing a flexible continuum of regulation to cover the whole scale of risk, otherwise any new approaches would be snuffed out by HMRC’s and TPR’s lack of flexibility and overly complex approach before they even got going, much as cash balance schemes have been over the last 20 years. I felt that this was just fence-sitting at the time, but have since realised that she was right. We have all been “banging on” for too long about things about which prospective members simply don’t care.

Assuming a relaxation of the regulations which doesn’t yet exist, we actuaries have piled enthusiastically into debating slight differences between our different pet schemes, standing toe to toe and swapping model results like punches, while seemingly forgetting all about the member.

Suddenly the most important contribution in Defining Ambitions seems clear to me: that of Morrisons’ HR Director about how they introduced a three year financial education and advice programme (called Save Your Dough) throughout their workforce ahead of their auto-enrolment date. They realised that they needed to help their employees understand their finances first before they would understand that they could make a difference to their long-term finances by saving into a pension. They involved Alvin Hall to add some celebrity glitter to the process, but also involved their main union USDAW. And they used a lot of different communication tools, from booklets to podcasts to online modellers to short films and video diaries in addition to the more traditional information sources and face to face sessions. They trusted that they had good people who would make reasonable decisions given sufficient accessible information.

I am sure there are other examples of such good practice out there, but we have not encouraged them with our endless debates about DC plus v CDC v DB minus and everything in between. The small stuff has been sweated quite enough. Let’s help firms talk to their members better instead.

A little history: less than 80 years ago, in 1938-39, there were only 3.8 million income taxpayers. This was clearly not enough for a nation on the brink of World War 2 and by 1948-49 (statistics were only collected every 10 years in those days) the number had almost quadrupled to 14.5 million, or around 29% of the UK population (estimates are approximate as there was no census in 1948). Today, there are around 30 million taxpayers, or around 47% of the UK population which, even allowing for the 16-17% uplift in the number of taxpayers caused by the move to individual taxation (rather than counting married couples as a single tax individual as previously), represents nearly a 40% increase in the proportion of the population paying tax since the late forties.

The latest Her Majesty’s Revenue and Customs (HMRC) release on income tax paid by percentile of taxpayers has been seized on by others in the continuing political battle over a future 50% tax rate, but I want to focus instead on one of the other political slogans thrown around in the last few years: the Oxford English Dictionary’s word of the year for 2011 (despite the fact that it is two words) the Squeezed Middle. That the middle has been squeezed is not in doubt, as the graphs below will show. But is this a failure of the income tax system? I think the data suggest otherwise.

First of all, if we look at the proportion of earnings subject to income tax that are paid as tax, they are probably a lot lower than you would think. Obviously this does not include national insurance contributions or Council Tax, both of which are considerably more regressive, but as you can see the percentage did not get above 15% until the top 30% of taxpayers in 1999-00 and the top 12% in 2011-12, with the proportion reducing for everyone below the top 10% of taxpayers until you get to the more complicated interaction between tax and benefits for the bottom 15%. The Squeezed Middle has not been squeezed by the tax man.

percentage tax

We need to be a little careful here, as there has been an effort to move people out of tax through increases to the tax threshold above inflation between 1999-00 and 2011-12. However the percentage of the population paying income tax resulting from this has hardly moved (if anything, it has increased slightly since 1999-00 when it was around 46%), so although the comparison may be approximate, in my view it should still broadly hold.

But the Middle has been squeezed, as the following graph (of earnings in excess of consumer price inflation (CPI) by percentile) shows:

real earnings

Yet even here, the impact of tax has reduced the depth of the squeeze. At the top end, the top 1% do not on average appear to have seen the sort of runaway increases in earnings seen in the United States. To see what has happened at the lowest point of the smile, the median point where exactly 50% of taxpayers earn more and 50% earn less, we can track the median earnings in 1999-00 terms (adjusting for the increase in CPI since then) up to 2011-12 as follows:

median real earnings

It is clear that the squeeze has been an entirely post 2008 crash phenomenon, with real incomes increasing quite reasonably until then. Interestingly, the tax burden as a percentage of income had already started to fall before the crash, with the process accelerating since then.

The Government’s proposal to target a budget surplus by the 2018-19 tax year, to be achieved by spending cuts rather than tax rises, means that this tax burden is unlikely to change if the Conservatives or a coalition they dominate win the next election, according to the Institute of Fiscal Studies, with 60% of cuts in public spending still to come. Labour have also committed to a budget surplus by the end of the next parliament, with a 50% tax rate reintroduced, but only to the top 1% of taxpayers and offset by a reduction in the starting rate for everyone to 10%. So whoever wins the Middle appear to be safe from an increase in income tax at least.

Both parties appear to be depending on increases to incomes (and/or possibly spending unsupported by incomes which could generate more VAT revenues) amongst the Middle so that unincreased tax rates can still meet the gap between their spending plans and the tax take elsewhere. So let’s all hope that the Squeezed Middle start getting paid properly soon.