A few weeks ago, I wrote on these pages to explore the Prime Minister’s prediction of an “enormous” insurance market for pre-funded care insurance emerging in response to the Government’s plans to ‘cap’ people’s care costs in England.
The Government’s long-awaited announcement on the ‘capped cost’ model finally emerged this week: a £12,500 standardised ‘living cost’ contribution; a £123,000 ‘upper capital limit’ means-test threshold; and, a £75,000 ‘cap’ on the amount of financial support individuals are excluded from owing to their wealth.
On the morning of the launch, the creator of this care funding model – Andrew Dilnot – took to Radio 4’s ‘Today’ programme to clarify that he also did not expect to see pre-funded insurance emerge in response to his plans.
This viewpoint was reflected in a shift to emphasising pension saving by health secretary Jeremy Hunt in presenting the plans to the House: “by creating the certainty that this is the maximum they will have to pay, they can then make provision through insurance or pension products so that they are covered up to the value of the cap.”
Readers of Money Marketing will of course be familiar with the concept of ‘disability-linked annuities’, so it seems appropriate to explore how the Government’s measures – which will be implemented in 2017 at the earliest – might allow people to ‘cover’ their £75,000 liability through pension saving.
It’s worth beginning by stating the obvious: among the 790,000 people approaching 65 each year, around 30-40 per cent don’t have any pension saving, so clearly can’t use pension saving to address the £75,000 liability.
Among those with a pension, around half are in defined-benefit schemes with no prospect of their employers suddenly rewriting the rules in the near or long-term. So, when we talk about linking pension saving to covering a £75,000 care liability, we are only talking about a third of retirees with defined-contribution workplace or personal schemes, although both auto-enrolment and the wider trends to DC will see this number grow in decades to come.
So what is the prospect for DLAs – annuities that pay out a higher income upon individuals reaching an objective threshold of disability – taking-off in light of the Government’s ‘capped cost’ reforms?
For the sake of argument, I’m going to assume that there is a standardised, effective, objective measure of disability in use (which there isn’t) and a network of validated, trained assessors across the country (which there aren’t). Instead, I want to focus on three issues: affordability; demand constraints; and, consumer experience.
First: affordability. Assuming someone has a 1-in-4 chance of requiring a £75,000 capped disability-linked payout, this implies an effective premium of at least £18,750, which would be the amount of someone’s DC pension pot they would effectively have to forgo income from in order to have up to a £75,000 payout for care costs upon reaching a defined, objective threshold of disability.
Unfortunately, as we all know, the average size of a DC pension pot at retirement is less than £30,000. Recent IFS analysis of those aged 60-64 in the UK found the median size of DC pots is £20,000. Workplace pension reforms will push this figure up in time, but not by that much. If we assume that individuals would use up no more than a quarter of their DC pot on protecting for care costs, this implies we are looking at individuals with more than £80,000 of DC savings, which the IFS analysis reveals is around 10% of all DC pension savers.
The conclusion: only a tiny minority will ever be able to afford a DLA.
Second: demand. Will annuitants want DLAs? We all know that people frequently make poor annuity choices. The inadequate take-up of inflation and survivor-protection poses a real headache for policymakers. But for individuals to opt for DLAs, we would have to assume they will opt for protection from care costs, despite many opting for higher immediate incomes over protecting for inflation or the income needs of a partner – income risks which are pretty much guaranteed.
The conclusion: without compulsion or defaulting, voluntary demand for DLAs will be negligible. And if the Department of Health were to start angling for regulations to do this ahead of survivor and inflation-protection, it would be a safe bet that the Department for Work and Pensions would have a few words to say on the matter.
Third: consumer experience. In short, DLAs would encounter much of the issues I have previously described in relation to pre-funded insurance. To genuinely understand these, you have to understand how both the current care system and the ‘capped cost’ model would really work, and a blog of mine elsewhere may help the uninitiated.
But it’s worth noting in particular that interaction with the ‘cap’ would rule out any provider guarantees that: individuals would not have to pay anything more toward their care costs; that a person’s £75,000 ‘meter’ would start once they claimed on their insurance; and, that they would not run out of money before they reached the cap. It’s therefore difficult to see how many annuity providers or IFAs will rush forward to offer DLAs to retirees.
Now, there are other issues arising in relation to DLAs, not least the punt that a DC annuitant would have to make that rules on care funding when they are 65 will not have changed when they need care closer to 80.
However, on the basis of this simple analysis, I think the conclusion is pretty clear: the ‘capped cost’ model will result in negligible – if any – use of DLAs in future.
James Lloyd is director of the Strategic Society Centre