Judging by the recent Budget, it looks as if the third of the three biggest and best ideas that the financial services industry has ever had for looking after the long-term savings of ordinary people has been dealt a massively damaging blow. Just like both the others.
To recap, each of these three big ideas dealt with an important area of risk potentially devastating to the financial wellbeing of people with limited resources.
The first was the managed fund. That dealt with concentration risk, which small investors typically face as a result of insufficient diversification across securities, markets and asset classes.
The second was with-profits investing. That aimed to take care of timing risk – the risk that long-term savers would be committed to a timetable that might fall horribly out of line with market movements and so find themselves obliged to cash out at inappropriate moments.
And the third was the annuity. That was all about longevity risk – the risk that people living longer than expected in retirement would outlast their savings and face dire poverty in their later years.
In principle, when explained, all three of these risk-management ideas were and still are popular with consumers and do much to alleviate some of their biggest concerns about long-term saving.
In principle again, consumers are right to feel their concerns so alleviated. Concentration, timing and longevity risks are three of the most dangerous downsides to the whole idea of long-term investment and providing some protection against them is surely the very essence of what insurance companies exist to do.
In all three areas it was not that the consumer needs disappeared. On the contrary, in a world of increasingly volatile markets and ever-lengthening life expectancy, those needs have become greater than ever.
What went wrong was that the financial services industry so perverted and distorted all three of these big ideas that in the end they all became almost untenable.
As I understand it, the perverting and distorting took slightly different forms in each case.
For managed funds, it was mainly a combination of extortionate overcharging and lazy and incompetent fund management, with a heavy dose of opacity to make sure no one realised what was happening.
In the case of with-profits, opacity played a major role here too. But the chief factor was a serious shortage of actuarial integrity, with actuaries signing up to promises they should never have made and giving in to management pressures they should always have resisted.
And now in the case of annuities, it is different again – a toxic combination of product providers and distributors conspiring to create a dysfunctional market providing unacceptably poor outcomes for the majority of consumers. This has
been exacerbated by a bunch of other factors, including over-cautious regulation and the unintended knock-on consequences of quantitative easing.
Deserving of punishment
What is particularly tragic is that over the years, the industry managed to tarnish all three of these big and important ideas to such an extent that within the sector at least, the hammer blows dealt to all of them have been widely welcomed.
At last, industry experts and commentators have said, these terrible rip-offs are being brought to, or at least towards, a much-deserved end. The fact that in their absence many consumers would inevitably be exposed to hugely dangerous levels of risk has been largely ignored.
Speaking as someone whose pension pot suffered the effects of the biggest stockmarket fall of recent times on his selected retirement date, the timing risk looms largest for me.
If I had, in fact, intended to retire on that date, my pension pot would have been worth about 8 per cent less than if I had been born one day earlier, and indeed 15 per cent less than if I had been born a month earlier. And if that is not the kind of risk which, if understood, would put people off the whole idea of long-term saving, I do not know what is.
But that is old news. The Chancellor’s proud proclamation that “no one will ever need to buy an annuity again” is the current news.
Life’s greatest uncertainty
In principle, annuities are the best way of dealing with what may be life’s greatest uncertainty. We do not know, and in most cases will never know, how long we are going to last.
Without annuities, we are likely to face a pair of counterbalancing risks. On one hand, the most obvious risk is of outlasting our savings and being reduced to dreadful poverty. But on the other hand, the risk is of living a life of great privation and self-denial, only to drop dead in short order and realise as our final thought that we could have been happily tooling around in a Steve Webb-style Lamborghini for our last few years.
Having spent my career in marketing, I am not in a position to defend any of the technical criticisms of the three big ideas.
It has been said that while each product did indeed respond to a genuine and important need, the way that they do so is now simply out of date.
Managed funds, with-profits investment and annuities are all steam-age solutions. At one time, all of them – just like steam locomotives – represented the best we could come up with. But these days, continues this argument, we have far better technology and these old boilers are ready for the scrapyard.
I am not clever enough to judge the truth of that. But in all three cases, it is not true to say that the old idea was dispensed with when a newer and better one became available.
On the contrary, in each case, the only alternative on offer at the time has been to throw the risk back onto the shoulders of consumers, leaving them (and their adviser, if they have one) to grapple as best they can with the dangers of concentration, timing and longevity risk.
These are so obviously unsatisfactory and unreasonable demands to make of individual investors that common sense says the stories could not end there.
A generation after the discrediting of managed funds, a new crop of multi-asset portfolios is looking much like the same idea under a different brand name.
Absolute return funds and other volatility-managing concepts are said to parallel the upsides – but not the downsides – of with-profits.
And I suspect that in 10, 15 or 20 years’ time, a new approach will be found to manage longevity risk. I have no idea what it will be but I am certain that the word “annuity” will not appear anywhere in its name.
Unchanging consumer needs
Once we all get over the excitement of getting rid of the discredited old concept, we gradually realise that the consumer need it responded to has not gone away and indeed is just as big and important as it ever was.
We then have to think of a new solution – with the essential requirement that it must not look or sound too similar to the old one.
These next-generation solutions may or may not eventually deliver better outcomes. But even if they do, I still think that is an entirely inadequate justification for a modus operandi in which the industry comes up with big ideas to meet big consumer needs and then, through a combination of its own greed, incompetence and evasiveness, manages to hollow them out so badly that eventually they become almost entirely discredited in the eyes of the people who created them. We really cannot go on like this. If we do, it is certain that before too long our next generation of big important ideas would start going through the same depressing and damaging cycle.
Lucian Camp is founder of Lucian Camp Consulting