When the hardline conference motions used to roll in calling for the nationalisation of the top 200 industries, John Smith would jest that we should replace the term “industries” with “chip shops”. These days there are few opportunities for such humour in the Labour Party, but sometimes this means Labour avoids advocating an obvious state solution, even when it represents much better value than a typical annuity.
George Osborne’s Budget pension reforms are, in fact, a case in point. No one can doubt that locking pensioners into poor value annuities was no longer tenable. Giving those reaching retirement age greater freedom to make their own investment and spending decisions also makes plenty of sense. The concern is that the risks associated with such freedoms may result in some pensioners falling back on the state later in life. This not only means many living out their final years in penury but also the taxpayer having to find extra funds to cover social care or benefits such as housing benefit.
The Conservatives want to suggest that those who raise fears about the personal and fiscal consequences of Osborne’s reforms are accusing pensioners of being bad people, stupid and irresponsible to the core. But did we accuse working age people of irresponsibility when we introduced opt-out defined contributions pensions for all?
The problem is a simple one: someone reaching retirement does not know how long they will live, and many underestimate how long they will. Someone who turns 65 this year will, on average, live to 85 (84 for a man and 86 for a woman) and annuities, for all their faults, take away the risk of failing to judge your life expectancy correctly.
The solution is equally simple. While continuing to offer retirees the freedom to pay down a mortgage, buy a Lamborghini or even a chip shop, the state should offer its own annuity. It has a vested interest in doing so because it will pick up the tab if Osborne turns out to be less prescient than he would have us believe. The state can offer value for money because it does not have to make a profit. If the state were raising funds through the bond market it would pay out a perfectly respectable interest rate, currently somewhat above 2.5 per cent for a 10 year bond. On this basis, someone investing £100,000 in a state annuity would be likely to do better by about £12,000 over a remaining 20 years of life than with a private sector annuity.
Indeed, because of the potential risk to the public finances the state may want to be more generous than this. All it needs is clear and transparent actuarial calculations and payments could be made with those for the state pension. The insurance industry would howl but it would have little cause for complaint because the market failure is obvious and Osborne has already driven a stake through its less than generous heart. Besides, the state would not be a monopoly but act as a competitor to the private sector: as a spur to efficiency and innovation. And with a state annuity, freedom would be underpinned by security.
Many suspect Osborne of alighting upon his pensions reform with more than a thought given to the short-term fillip to the public finances, as the newly retiring enjoy their unexpected freedom, and with little regard for the long-term impact on the public finances. A state annuity has the potential to provide a very substantial medium-term boost to the public finances while simultaneously warding off a potential fiscal time bomb. If the state annuity was sensibly generous, and the default position for three quarters of a pension pot, with retirees (anyone 55 or older) having to opt-out rather than opt-in to the state annuity, as many as half or more of those reaching retirement might take up the states offer and use their pension pot to pay for a guaranteed lifetime income.
With roughly 650,000 people becoming eligible in a year, and an average pension pot of close to £30,000, if half of retirees used three quarters of their pot (the remaining quarter being taken as a tax-free lump sum) to buy a state annuity, the public finances would be better off by around £7bn in the first year and still better off each year for many years to come. Over the lifetime of a parliament, the public finances might be boosted by as much as £30bn. Of course, there is a debate to be had about how we treat this on the public books, but without doubt the impact on the government’s finances would be exceedingly positive in the early years.
Where else can Labour so readily demonstrate that it can improve the public finances, provide financial security and raise living standards? And all this without nationalising any chip shops.
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