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Mr. Howard Flight (Arundel and South Downs): Is the hon. Gentleman aware that some companies will not allow draw-down recipients to change investment manager once they have started draw-down, which is surely outrageous in the present climate?
Mr. Webb: The hon. Gentleman, who is very learned on these matters, and to whose contribution I look
forward, makes an important point about the regulatory framework within which the policies operate. There is considerable concern about that.
To give the House an example, the market leader in draw-down policies has produced statistics for them. Three years after the policies are taken out, they have to be reviewed to establish whether the pot is running down too quickly, in which case the amount being withdrawn has to be cut, or vice versa. The policies were introduced fairly recently, so we are starting to see the first round of three-yearly reviews. The alarming statistic is that one in three customers of the market leader whose policies have been reviewed since 1 January have had to accept cuts in their income. The average nominal drop is 20 per cent., which is substantial, because one must add on 10 per cent. of inflation over three years. People who have large pots can, it is hoped, cope with such fluctuation, but it is of concern to people whose income is borderline.
What has been the problem with those draw-down policies? Why has income from them fallen considerably? I shall briefly explain the three main reasons. The first, as I said earlier, is the fall in annuity rates, which are now substantially lower than they were three years ago, so the amount of money that people can get from an annuity based on a given pot will have fallen. In other words, if people had bought an annuity three years ago, they would have a higher lifetime pension than they do, because of the fall in annuity rates. Obviously, the converse would be true if annuity rates were rising, but the prospects of a significant rise are not particularly bright, so that problem may be with us for some time.
The second reason why many people are experiencing a fall in their income from draw-down policies is what is catchily known in the trade as mortality drag. If 63-year-olds have bought an annuity at age 60, the annuity provider will not have been sure that they will live to 63. Some people will have died at 61 or 62, and will have given the provider profit, allowing the company to put a little extra money into the annuity. If the annuity is recalculated for purchase at age 63, people have given away the fact that they lived for the preceding three years, so the annuity company considers them a worse risk and the annuity rate would be lower. That tends to reduce the amount that people can get from draw-down policies.
Charges are the third reason why some policies are not yielding good results, and this issue is of considerable concern. Moreover, if an income is drawn from the pot and the balance of the pot is then used for investment, that must battle against falling annuity rates, against mortality drag and against the fact that a big chunk of the money will be taken in charges. Against that background, unless the money is invested very well and the stock market does well, there is a risk--as the one in three people who took out draw-down policies three years ago and who now face a fall in their pension found out--of a fall in income.
I mention that situation to remind the House that income draw-down is not a one-way bet and may not be suitable for many pensioners with relatively modest pots. None the less, my judgment is that we should give pensioners--especially those with large pension pots, who may be more financially sophisticated--a choice. We need to tighten the regulation, but I am aware of no reason for allowing people draw-down for 10 years--during which all these problems can occur--and then suddenly,
when they reach of 75, telling them that we cannot allow it any more. That is an arbitrary cut-off point, and there are easy ways around the problems that I have cited.
Dr. Vincent Cable (Twickenham):
I congratulate my hon. Friend the Member for Northavon (Mr. Webb) on presenting this important subject for debate and on the clarity with which he dissects even the most arcane problem. The problem of pension policy and annuities is especially arcane.
About three months ago, I submitted a written question to the Treasury, asking when it proposed to revisit the regulation--I believe of 1921--that makes annuities obligatory. The answer that I received had the tone of lofty condescension and complacency that we have come to expect from the Treasury at its worst. That provoked me into looking into the problem of pension policy.
I want to emphasise the scale and extent of the problem. There are probably about 5 million potential annuitants. That very large number includes not only the personal pension holders that my hon. Friend the Member for Northavon mentioned, but a large number of people in defined contribution occupational pension schemes, many of which are linked to annuities--often with very little choice--and people who have made additional voluntary contributions. In terms of numbers, the problem is extensive.
The scale of the problem in terms of its impact on individual pensioners also needs to be emphasised. Figures recently reproduced by the Library showed that, for a 65-year old pensioner with a pension fund of about £100,000, the annuity value had collapsed from about £11,000 in 1990 to £5,500 today.
In many senses, the problem is getting worse, for two reasons. First, as my hon. Friend the Member for Northavon has described, it is getting worse as a result of trends in the gilts market. It may be assumed that gilt rates are at an all-time low, but that is almost certainly not the case. Various factors are continuing to drive down gilt yields. If we succeed in joining economic and monetary union in a few years' time, one of the effects will be to push down the long-term cost of capital--that is one of the reasons for doing it. Long-term German bond rates are even lower than our gilt yields. That will be a factor pushing down our gilt yields even further. Barclays Capital recently did some long-term projections, which suggest that gilt yields could go as low as 2 per cent. Powerful economic forces are pushing down gilt yields, and therefore annuity rates, even further.
Another factor working in the same direction is the fact that actuaries are constantly taking into account revised assessments of life expectancy. As individuals, we may be able to get our revenge on the actuaries by living
longer than we are expected to, but collectively, by definition, we cannot. The impact of that is necessarily to drive down annuity values.
I want to make a fundamental point on policy. Quite apart from the complexity of the matter and the impact of low annuities on individual pensioners, an important issue of principle is involved. It is a simple libertarian issue about whether people should have the freedom to make choices about how they manage their own personal finance. In this country, we have a tradition that is extraordinarily paternalistic and illiberal.
I quote from an 1888 report on which, I believe, the Government still draw heavily, which defined the basis on which state pensions should be dealt with in the 19th century. It argued against paying lump sums to pensioners as opposed to supplying a steady income stream. That report, written 110 years ago, said:
Let me summarise what appear to be the central objections to annuity payments--at least in the rigid framework in which they operate today--from the pensioner's standpoint. There is an advantage to others--notably the Inland Revenue, which has a steady stream of income to tax--but the disadvantages are essentially four.
First, as my hon. Friend explained at length, in practice most annuities are level annuities, so the pensioner is exposed to inflation risk. Inflation prospects currently look extremely good, but it requires only a fairly plausible set of circumstances, such as a collapse in the value of the pound, to take inflation back up to levels at which the value of such annuities is substantially eroded.
Secondly, in present circumstances, annuities represent an extremely bad deal. People get a return of roughly 4.5 per cent. when they could be getting 8 per cent. in building societies, or 15.5 per cent. if the private companies were able to deliver the return that they are promising. It is an extremely bad deal in relation to what those companies claim they can earn in the market.
Thirdly, conversion into an annuity involves handing over wealth. That issue has been covered at length.
A fourth point, which I believe my hon. Friend, in his other capacity as our social security spokesman, would usually emphasise, is that low annuity rates are an enormous deterrent to the Government's long-term policy on pensions. The Government are trying to promote the idea of stakeholder pensions. They have not gone for compulsion, so they depend on psychology and motivation, and yet they are doing so in a context in which anyone thinking ahead and looking at the way in which their pension policy will play out will be enormously discouraged from pursuing it.
"The payment . . . of a lump sum is open to the obvious objection that in the event of improvidence or misfortune . . . the retired public servant may be reduced to circumstances which might lead to his being an applicant for public or private charity".
That is exactly the attitude that prevails today, except that for "public or private charity" one should read "income support". We fundamentally object to that paternalistic, illiberal view of personal finance, regardless of the specific circumstances of many of our constituents.
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