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9.59 am
Mr. Howard Flight (Arundel and South Downs): I have great sympathy with the Minister, who will have to defend arguments of 30 or 100 years ago which the hon. Members for Northavon (Mr. Webb) and for Twickenham (Dr. Cable) have described as out of date and paternalistic.
I wish to cover some separate ground in the overall territory. My original focus was on my perception that there will be a massive growth in the volume and proportion of money-purchase pensions over the next decade or so. That is already in train. Companies are moving from personal pensions to occupational defined contribution schemes, and we now have the stakeholder scheme. It is likely that, within 10 years, the proportion of pensions that are not in a final-salary type of scheme will be the majority. No one seems to have thought about how these savings of money will convert into pensions. There is the assumption that annuities were always the way and that that must be the right way of doing things.
Final-salary schemes have been one of the great successes in delivering pensions over the past 20 or 30 years. Such schemes do not have all their money invested in gilts. They have the maximum spread internationally, with about 80 per cent. or more in equities. They pay pensions out of that rolling pot of money. That is why pensions have been so successful in this country, and why about £800 billion was accumulated during the 18 years of the Conservative Government. If the schemes had been forced to invest in gilts, which is what annuities do, the accumulated total might have been a third of £800 billion, with the result that final-salary schemes would have been unable to afford to pay the improved pensions that they are now paying.
That told me that it must be wrong to put such a great deal of money into fixed-interest investment because of archaic rules when people are likely to have a pension for 20 years or more. Despite the success in reducing inflation, that must be wrong from an investment point of view. People who retire at 65 are likely to live to 85, and many who retire at 65 are forced to buy annuities, depending on the scheme to which they belong. I have in mind especially certain schemes for professionals. Even
people living to 75 may have widowed spouses who continue to live for 20 or 25 years. The trustees of any final-salary scheme would say that it would be grossly irresponsible to invest in fixed interest to such an extent.
A second area within this territory can be described as incompatibility. If, as a country, we are to have a roughly balanced budget, self-evidently the net new supply of gilts will be zero. If we are to have a huge and rising pool of money-purchase pension schemes that are obliged to buy gilts, it is simple to see what will happen in that supply-demand situation. Real yields will be driven down even further. Indeed, to some extent, that has already happened over the past two or three years.
The Pensions Act 1995 resulted in an increased pension fund demand for gilts, particularly on the part of mature pension schemes, as a result of safety arguments. As a consequence, the net supply of gilts has been very modest. Real yields have been about 2 per cent., against an average over the past 30 years of about 3.5 per cent. One of the arguments in the equation is that people's pots of money have increased in value because equity markets have performed well and interest rates have been low so that everything washes out. That does not happen, however, when there is a fall in real yields.
Unless there is much more flexible investment in money-purchase pensions for the future, the situation will stay as I have described it--and, indeed, worsen. The more virtuous the Chancellor of the Exchequer becomes in achieving his so-called prudence and a balanced budget, the lower will be the pensions that people will be able to buy with their savings if they are still stuck with having to buy fixed-interest annuities.
There is another immediate problem on which I have focused. I thought that it was well described in a talk given by the Governor of the Bank of England last week. The Governor pointed out that inflation in this country--as in America--is in a sense artificially low because of the financial problems of the emerging economies and the depreciation of their currencies. Mature economies are in a sense importing about 1 to 1.5 per cent. deflation as a result. That is mixing with about 3 to 4 per cent. domestic inflation and we are coming out with inflation at about 2.5 per cent.
The imported deflation will be transient and there is a strong argument that the real underlying rate of inflation in mature economies will be 1 to 1.5 per cent. higher. What is the level of inflation that long gilts are forecasting? It is about 2 per cent. or less if we take 5 per cent. long gilt yields, which take off at 3.5 per cent., which should be the long-term real rate of interest. The assumption is that inflation will stay at about the present level and the sort of level predicted by the gilt market, which is extremely low. As the emerging economies catch up, and unless there are tight countervailing policies, western inflation will be somewhat higher than it is now.
In a way, people are being mis-sold, especially if they are buying non-inflation-indexed gilt annuities. They are buying a flow of income that apparently is expected to depreciate at only 1.5 to 2 per cent. per annum, but which is highly likely to depreciate by 2 to 3 per cent. per annum, all things being equal.
There is a problem at both ends of the scale. The dinner party conversation aspect, to which the hon. Member for Northavon alluded, is self-evident. I received a fascinating letter from one of my constituents, who has been one of
the pioneers of high-tech venture capital investment. He wrote along these lines: "Over the past 20 years, I have pulled together all my friends and a good bit of our self-administered pension funds have been invested in high-tech companies. They have done incredibly well and there is a huge amount in our pension pots. It seems ridiculous that now we are coming up to 75--we are still keen to continue investing in this way, thereby creating jobs--we must tip the whole lot into annuities. At the very least we should be obliged to tip into annuities only the minimum to keep us off the state in future." That argument, as advanced by those who have generously provided for their pensions, is irresistible and unanswerable.
There is a powerful argument at the other end of the spectrum, which applies particularly to women. I hope that the Government will pay due heed to the report that is to be produced by Oonagh McDonald's committee. It is being worked on. There are hundreds of thousands of people with small money-purchase pension accumulations of £40,000 or £50,000. Many of these people are cautious and responsible women who have worked part-time. It is interesting that most of the people living in West Sussex--it is allegedly a prosperous part of the world--who have written to me are in that category. They to me along these lines: "It is unjust. I have struggled to put £50,000 in my money-purchase pension scheme. I shall be forced to buy an annuity with it and to chuck the capital away." They know that they can often get better running returns merely by investing in, for example, a portfolio of high-yield and corporate bonds. The returns from an annuity will be pretty poor and people are offended about losing their capital.
I am persuaded by Oonagh McDonald's view that, for people in that category, the paternalistic 19th-century argument about keeping them off the shoulders of the state is not worth anything. They are likely to do much better with their £40,000 elsewhere. If there were any chance of their relying on the state, they would be relying on it already. They are being treated like those who were threatened with the workhouse about 100 years ago. There is a strong case for a liberal attitude towards modest pension fund accumulations.
Mr. Webb:
May I raise another issue relating to annuities that we have not covered? I should be grateful for the hon. Gentleman's views on the open market option. My concern is that a lot of people who build up a pension pot do not grasp the fact that they can buy someone else's annuity. They could suffer significant losses. Does he think that the regulation of that area is adequate?
Mr. Flight:
The hon. Gentleman is absolutely correct and--at a tangent--another territory is relevant. When individuals surrender any form of insurance policy, there is no obligation to tell them that they could sell it for a sum significantly larger than that for which they could cash it in. It is desirable, would be relatively simple and no great regulatory burden, for people to be obliged to be told that they could sell any insurance policy, rather than cashing it in with the insurance company.
One answer to the conundrum is to make available annuities with more flexibility, such as equity-linked, variable draw-down and term annuities. America presents an interesting range of choice, and South Africa presents
an even more interesting range. Ironically, South Africa's thinking is in advance of ours--it was much prompted by the trade unions, which objected strongly to their members being locked into financing the state. That is what having to buy an annuity amounts to. They rightly saw that pension accumulation offered, particularly for black Africans, a chance of a little economic freedom in accumulating their capital. Therefore, South Africa has a much more rational, flexible scheme.
People who buy an equity-linked indexed annuity are affected by a devious and unpleasant Inland Revenue rule, the effect of which is that they do not get the full benefit if such annuities do well. The Revenue says to insurance companies, "Keep the rest as a windfall profit." The gist of how the rule operates is that the Revenue correctly says that companies must allow for equity returns to fluctuate--they cannot take everything that is made in one year. However, if the bad years are not bad enough and the reserves do not get used up, people do not get the full benefit of what their annuity makes beyond what the companies are allowed to take. Not surprisingly, equity-linked annuities are not terribly popular and I am amazed at how clever and perceptive my constituents are. I pay tribute to them: they know of all those wrinkles and they have taught me a great deal that I did not know about this territory merely by raising all those points with me.
I utterly support the points that were made about the need for thorough review, more competitiveness and better regulation of draw-down alternatives. We have all been told that the Revenue is conducting a review of draw-down arrangements. I hope that it is wide ranging, because it should deal not only with the fancy formulas relating back to how much people can draw, but with the regulatory regime. I was amazed to find that, once people have taken a draw-down at 65, they cannot change the fund manager for 10 years. That is utterly against the spirit of the Government's stakeholder pension proposals and is quite inappropriate.
I do not know their validity, but I note that surveys show that about 98 per cent. of people approaching 75 who are required to purchase annuities seem to be unhappy about that. That issue came on to the screen in a modest way, but is now important. I suggest that citizens understand the problems and that forcing people into relying wholly on fixed-income securities for 10 or 15 years of retirement when long gilt yields have fallen below 5 per cent. and inflation is artificially low is a bad risk-return mix, even though their pots may have benefited a little from that. They know that that is not a wise use of their pension savings and they are becoming increasingly annoyed that they have to do it.
For the reasons outlined by the hon. Member for Northavon, I think that the Revenue and the Department of Social Security have been extremely reactionary. I consider the Revenue's arguments to be completely bogus. It will probably get more tax under draw-down; if the investments do that much better and if the income averages more than that under an annuity over the period of retirement, it will get the tax on that and on the lump sum at the end. It is likely to do better as a result of more flexibility.
If the Revenue argues that the timing of the cash flow is painful, the 35 per cent. tax on any sum that is left over could be increased to 40 per cent. That would not make
much difference. If there is a statistical cash flow argument, it can be addressed. Whenever I read its arguments I think of Messrs Slow and Bideawhile because they represent bureaucratic obfuscation and thinking that comes from the 1920s, not from today. There has to be one or other method for the Revenue to satisfy itself that it is getting its fair tax take.
Another great argument is cited: "Ah, but we must do everything to make sure that people do not blow it all and then come on the state. People are living much longer." My response is twofold. First, if the Labour Government feel so strongly about that, it is rather strange that they have put in place a massive incentive for people not to save, not to accumulate pensions and to become dependent on the state. The pension top-up, with its link to earnings rather than to inflation, is a generous incentive to come on to the state for people who have either managed to avoid getting locked into a pension scheme or have done the very minimum. It is strange that the Government are providing a huge incentive to do something that they describe as profligate.
Secondly, we should look at behaviour. Any Member of Parliament with parents knows that people become more and more cautious with their money as they get older. Often, the problem is getting relatives to spend their money and have a decent standard of living. I have never seen a profligate 79-year-old burning up the town. I am sure that there must be one or two, but it is entirely false and unrealistic to assert that all those people over 75 will blow the lot as soon as they get the green light. Under present draw-down arrangements, they cannot do that.
I am increasingly coming to the view that even draw-down arrangements should be more flexible and more liberal. South Africa has providence scheme pension arrangements. People get their money and they can do what they want with it. Interestingly, most buy flexible equity-linked annuities, because all the administration is done for them, and time-termed annuities, which are still a useful instrument. There is no evidence, even in a country with a much lower standard of education than ours, that the money gets blown. South Africa has put in place a modest state old-age pension for those who have no other provision, so it has the moral hazard issue about which the Government--I think somewhat bogusly--are so concerned.
There is a big issue to be addressed, purely from the angles that I referred to at the beginning of my speech. If nothing is done, and if we still have a balanced budget, a huge and growing volume of people with money-purchase pensions will be condemned to buying gilt-based annuities. That will give them a very poor deal. Real yields will be extremely low and no pension fund manager would argue that the risk-reward mix was right. We need imaginative, radical thinking about restructuring the whole area.
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