§ Motion made, and Question proposed, That this House do now adjourn.—[Mr. Mike Hall.]9.33 am
§ Mr. Steve Webb (Northavon)
As I look around the Chamber, I see several hon. Members who obviously spent substantial parts of their childhood playing "Monopoly". They will recall landing on "community chest" and hoping either to get a "Get out of jail free" card or, failing that, a card that says, "Your annuity has matured, collect £100"—that was in the days when £100 was worth something. When I used to play Monopoly, neither I nor any of my fellow players had a clue what an annuity was—and, in some respects, not a lot has changed. Yet The Observer newspaper recently pointed out that annuities are no longer something that appear only in Jane Austen novels but have replaced house prices as a topic of dinner party conversations in certain circles.
How has that come to pass? I suspect that I am not the only hon. Member who has received a growing number of letters from constituents who are concerned about the annuities problem. They are worried about low annuity rates and about being forced to buy an annuity at age 75. One example is my constituent from Thornbury, who is in his early 60s. He wrote to say that he had a self-invested pension plan from which he was drawing income in the manner allowed by the Inland Revenue up to the limits, leaving the capital largely intact. My constituent was concerned that, in a decade—the people of Thornbury are very far-sighted—he might be forced to buy an annuity with that pension pot, which would result in the loss of all his capital and leave him with a relatively poor pension. He writes:it seems unjust that I will be compelled to buy this annuity, lose my capital sum, and yet receive no additional income.What are we to make of this issue? I am a simple man and, in my simple way of looking at the world, I like to divide it into the good guys and the bad guys—it makes life an awful lot easier. When I approached the annuities issue for the first time, it occurred to me that the chances were that Her Majesty's Government were the bad guys. That is a fairly safe working assumption.
In this context, what makes the Government the bad guys on first examination is that they force people at age 75, against their will, to convert their personal pension pot or similar into an annuity. Why is that a problem? It is well known that annuity rates are now relatively low—certainly compared with their level at the start of the decade. At the beginning of the 1990s, annuity rates were 260 about double their present value. That obviously means that the pension that one can buy with a given personal pension pot is substantially less than it was in nominal terms. One could point out that the stock market has done relatively well during the same period and that therefore the pension pot would have grown. That would partly offset the difference—but only partly. There is a general perception among people in their 60s and early 70s that they are being forced to buy a product that will yield a relatively poor pension and cause the loss of all their capital.
Why is there a problem with forcing people into annuities at age 75? A typical strategy for money in a pension pot is that it begins life invested in high-risk, high-return, or middling-risk, high-return assets such as the stock market. Towards the end of one's working life, it is shifted into lower-risk assets such as gilts. When one converts to an annuity, for the rest of one's life, one buys a product that is backed by gilts—which are very low-risk but low-return assets. If one does not take out a pension particularly early in life, one could find that half the time one's money is invested in shares and the other half it is invested in low-yielding gilts. It is far from easy to see how, in a rational world, that is a sensible way to invest pension assets. It is difficult to see why, over a lifetime, one would want to invest half the time in low-risk, low-yield gilts. That is not a rational strategy.
§ Sir Robert Smith (West Aberdeenshire and Kincardine)
That problem will not go away because, if the strategy of containing inflation is successful, gilts will continue to be low yield.
§ Mr. Webb
My hon. Friend is quite right: nominal yields will continue to be very low—although there is obviously a problem with perception. We have yet to generate a low-inflation culture. We recall that inflation rates were 10 per cent. at the beginning of the decade and I remember when inflation rates were 25 per cent. under the previous Labour Government. Against that background, nominal rates matter to people's perceptions of whether they are getting a good deal. Stable inflation over a long period would clearly be welcome. I am grateful to my hon. Friend for that intervention as I was about to turn to inflation.
As well as low annuity rates, a second reason for concern is the effect of inflation on people's incomes when they buy annuities. There are annuity products containing escalation that take some account of future inflation. When surveyed before retirement, most people tend to say, "Yes, I would probably get an annuity with some sort of indexation; I would not want my income to be eroded". However, that is not what people actually do because four out of five of them buy level annuities. In other words, they see how much less they would get in the first year and in the next few years if they bought an indexed annuity and say, "Hang on a minute, I would rather have 75 per cent. more in the first year and I'll take a gamble on inflation". While, in theory, one might think that indexed annuities are a good thing, in practice, most people do not buy them. Therefore, we are forcing people to buy a product that is likely to be eroded by inflation.
Inflation of only 3 per cent. for a decade would knock a quarter off a pensioner's real income. That means that as people get older—as they reach 80 or more—their living standards may fall dramatically. That issue will be 261 increasingly important as the Government force people who buy stakeholder pensions to convert them into annuities and as more occupational schemes move towards defined contributions. That is why I initiated this debate.
As well as low annuity rates and the effects of inflation, a concern about forcing people to buy annuities is the inevitable loss of capital. When I first heard that argument, I thought that people wanted to have their cake and eat it. I thought that they were saying, "I'd like a pension—probably the same pension that I would have got anyway—and I want to keep all my capital." That seemed to be rather like saying to a car insurance company, "I'll buy my car insurance and if, after 10 years, I haven't claimed, I'd like my premiums back." Clearly, that would be unacceptable, but people are not saying that. They want a blend of a particular level of pension income and a particular level of preservation of capital. They have saved for their old age and taken the view that they might sacrifice part of their pension income now to preserve some of their capital to pass on to their children.
In principle, there is no reason why we should not allow pensioners to do that, subject to tax and other considerations to which I shall turn in a moment. In principle, there is no reason why we should want to force pensioners to sacrifice all their capital at the age of 75 if they were prepared to forgo some of their pension income in return for keeping part of their capital. On the face of it, therefore, the Government are the bad guys because they have removed from people, or are not allowing them, a choice at the age of 75. That choice will not, by any means, be appropriate for all pensioners, but it is appropriate for growing numbers of them.
I have read the report of the proceedings of the Standing Committees that considered the Welfare Reform and Pensions Bill and the Finance Bill, and this issue was discussed twice. The Government rest their defence for the age-75 limit—which seems somewhat arbitrary—on two main arguments. First, the dreaded Inland Revenue wants its slice of the cake. The argument is that if people were allowed to keep their money in the pension pot, they might inconveniently die, so they would never get their annuity and the Inland Revenue would never get the tax.
That concern is unfounded. If people who have begun to draw down income from their pension pot die, their spouse or dependant can convert the pension into an annuity that can be taxed anyway. if that is not the case, a special 35 per cent. tax rate will apply to those funds. I suspect that 35 per cent. is much higher than the rate that the Revenue would typically receive from an annuity, so it might receive more money if a few more people popped their clogs before they took out annuities.
If draw-down has begun, tax is not a problem. The only problem seems to arise if draw-down has not begun and the pension pot has not been touched. There is no reason why the law should not state that at 75, or another age, people should take out an annuity or begin draw-down. It is not beyond the wit of the Inland Revenue to ensure that it gets its tax take, while preserving choice for pensioners.
The Inland Revenue objection does not stand, but there is one closer to home for the Minister—a Department of Social Security objection, which is that pensioners might spend, spend, spend and blow the pot on riotous living. 262 That might be welcomed, but the concern is that they would leave themselves in penury and throw themselves on the mercy of the stony-faced DSS.
I am not entirely convinced by that line of reasoning. First, as the Minister knows, there are strict Government rules on the amount that can be drawn down from a pot. There are clear limits on that, and one cannot simply blow a fund in one go. If we consider the sort of funds that we are discussing, we realise that draw-down will be appropriate only in larger funds. Some say that it would be suitable only in funds of over £100,000 and others say that £250,000 and over would be a suitable size. The idea that someone would blow £250,000 from a pension pot and then throw themselves on the delightful mercies of income support is pretty far fetched.
Secondly, there is no reason why there should not be further constraints on draw-down if the age limit of 75 were to be raised. Stewart Ritchie of Scottish Equitable, who is a member of the Government's pension provision group, has suggested that at age 76 or 77 there could be a slightly tighter limit. Instead of being the total amount that one could draw from a similar annuity, the limit could be a percentage of that figure. Obviously—I borrow Mr. Ritchie's example—we do not want to allow people aged 100, whose life expectancy is one year, to blow the entire pot, lest they inconveniently live to be 101. A safeguard is necessary, and that could be ratcheted in, but there is no reason for an absolute cut-off at age 75.
The final reason why the "people will just rely on the state" argument is not convincing is that most pensioners, particularly those who have carefully invested—such as my constituent, who has invested his money himself—are not about to go to the Ritz or Monte Carlo to blow all their money. They are very cautious, and they are motivated by the desire to pass on money to their children. The idea that they would spend all their money and throw themselves on the mercy of the state is implausible.
It seems that there could be little objection to allowing greater flexibility at age 75. A choice could be allowed between the purchase of an annuity and the commencement or continuation of draw-down, subject to certain restrictions.
I want to draw the attention of the House to another group of people who may also, in some sense, be the bad guys in this story—those who sell the income draw-down policies. They have not done themselves any favours in recent years. The early evidence on those policies reveals that tighter controls on the charges and conduct of those companies might be needed to go hand in hand with the reform of the age-75 threshold that I have already suggested.
This morning's Daily Mail contains a salutary warning about the possible mis-selling of income draw-down policies. It says that for two thirds of a sample of the 50,000 policies sold, there appears to be little documentation demonstrating why the policy was recommended. The Personal Investment Authority suspects that such a lack of documentation is often a proxy for mis-selling.
§ 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 263 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, 264 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.
In conclusion, I repeat my call for the Minister to introduce greater flexibility into pensioners' choices at the age of 75. I believe that pensioners should be given a choice, and that the arguments about possible loss of tax revenue or increased benefit expenditure do not stand up. However—this is an important caveat—I also believe that investors need to be protected, and that the regulation of draw-down schemes needs urgent attention. If the Minister will promise to do both those things, he may convince me that he is, after all, one of the good guys.
§ 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 265 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: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.
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.
We are not simply talking about the disadvantages of annuities as they operate at present. There are alternatives in the market—some of which my hon. Friend has 266 described—but they need to be balanced against the costs. Draw-down schemes, or schemes with built-in equity elements, have commission costs. Above all, there are risks if one wants to pursue a high-return option to an annuity. However, the fundamental point is that individuals should be able to make that choice for themselves. That is the essence of this debate. There are alternatives in the market. The industry is sophisticated; it can provide them, especially now that, with the advent of the Financial Services Authority, its products will be regulated. Individuals should be able to make the choice for themselves.
I read from the report of an earlier debate that the Economic Secretary is promising a review of the problem. The results are expected in the autumn; we look forward to them. We look forward to much greater flexibility than the Government have demonstrated in the past. If the Government could unpick some of the rigidity and paternalism that have characterised British policy on pensions for the best part of a century, they would do us all a considerable favour.
§ 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 267 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 bout 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 268 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 269 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 270 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.
I very much hope that the investigation by the Revenue, which the Government are using as a stalling mechanism to avoid answering the questions, will not be a pathetic fudge and a minor change to the draw-down regime. What is required here is a radical, rational reform based on what works in America, parts of Asia and other parts of the world. Pressure for that reform is coming from voters of all political shades. I believe that the Minister has had many letters from his constituents, so he knows how people feel about this matter. It should not be a 271 cross-party issue; it is something that the people of our country want, and I hope that the Government will get a move on with it.
§ Sir Robert Smith (West Aberdeenshire and Kincardine)
I echo what the hon. Member for Arundel and South Downs (Mr. Flight) said: the review should be wide ranging and constructive. In introducing the debate, my hon. Friend the Member for Northavon (Mr. Webb) talked about the Government being the bad guy. I think that he meant Government with a capital G—
§ Sir Robert Smith
Well, perhaps the bad guy does not yet have a political label, but the political label will stick to the bad guy if the Government do not produce something constructive and far reaching out of the review.
I thank my hon. Friend the Member for securing this useful debate. The three speeches that we have heard so far will help me to explain the matter to my constituents and to help them see that there is a way forward. All three of the previous speakers hinted to the Government that they can proceed constructively by recognising that the elderly are not profligate and want to make effective provision for their retirement. The Government must realise that the nearer people get to retirement, the more nervous and cautious they become about their financial position. Although this problem may not arise until they reach the age of 75, people who are only approaching retirement phone me up in my constituency surgery because they read in the papers that financial analysis shows that the problem will not go away.
The gilt market is changing. As the hon. Member for Arundel and South Downs said, it could change even more dramatically if the Government achieve their claimed economic objective. That worry hangs over people. They should be able to relax and enjoy their retirement, having made reasonable financial provision, but, instead, they are uncertain about their future. An extremely strict set of rules is making it difficult for people to see how they can proceed in a flexible way. I hope that the Minister understands that concern and accepts the need to tackle the problem.
I have always worried when I see new products or new tax systems being introduced to encourage people down certain savings routes. New products are marketed effectively in terms of attracting people down certain tax routes to encourage them to save, but if one does the arithmetic, one finds that charges eat up most of that benefit. Moreover, by tempting people into various ways to save, one distorts the market. As has already been said, much of what should go to savers is taken away in fees, which are hidden in the whole investment structure. Thus, clarity and information are needed, as was said in Monday's debate on the regulation of the financial services industry.
As my hon. Friend the Member for Northavon said in an intervention on the hon. Member for Arundel and South Downs, we must ensure that people are informed about their right to sell insurance policies rather than cash them in. Apparently, there is a requirement that information should be provided, but it is not provided in a way that gets through to people. Many people make 272 extremely bad financial decisions and one sometimes wonders why they ever considered them in the first place, yet they do so in their droves. Therefore, the market is clearly not working efficiently and effectively. As other hon. Members have said, products need to be competitive and people need to know that they can switch supplier, which is an effective way of ensuring a better return on an investment.
The Government must accept that this is not a temporary problem. They must also accept that the new structure of the economy that they have created means that we need new solutions. Even inflation at 1.5 to 2 per cent. amounts to a lot of inflation over someone's lifetime. In planning for their future, people must take into account the fact that investments are eaten away even by low inflation.
The purpose of this debate was to encourage the Government to look at the review and see that it is wide ranging. It is a real problem for many investors, but the potential for solutions exists.
§ Mr. Webb
My hon. Friend mentioned the effect of inflation. Will he reflect on the fact that, at 2 or 3 per cent. inflation, after a decade, people's investments are down by a quarter? If people retire at 60 and live to 80 and beyond, the oldest pensioners will be by far the poorest. Does my hon. Friend think that any policy implications follow from that?
§ Sir Robert Smith
The Minister will recognise that Liberal Democrat policy is immediately to tackle the problem of pensions for the elderly by providing a narrowly targeted benefit. Given the historical provisions that were made, the oldest pensioners are the poorest. By tackling that problem now, the Government could provide immediate relief for those who cannot provide a solution for themselves—they cannot go back and rearrange their financial affairs.
When constituents first brought this problem to my attention, they wondered whether there was a magic solution somewhere in Europe, which has had a culture of low inflation. Before this debate, I was discussing with colleagues whether they would welcome a helpful intervention suggesting that we look in that direction. I was advised that pensions provision in Europe is a bit of a scandal—
§ Sir Robert Smith
I would not go quite as far as that.
In Europe, the unfunded state system has provided people with a security blanket and they have not needed to get involved with products that deal with a low-inflation market with long-term benefits for pensioners.
This debate has given the Minister some useful meat from which to come up with some effective solutions. If he does not do so, the "bad guy" label will stick to the Government.
§ Mr. Michael Trend (Windsor)
First, I congratulate the hon. Member for Northavon (Mr. Webb) on securing the debate. It is clear, however, that the Liberal Democrat party has seen the bandwagon roll past it in the past few weeks and it is making a desperate scramble to board it. 273 The campaign to scrap the compulsory purchase of annuities has been driven by the Conservatives, particularly my hon. Friend the Member for Arundel and South Downs (Mr. Flight), who spoke so well today. It is our clear view that the requirement to buy an annuity at the age of 75 should be abolished.
§ Sir Robert Smith
The hon. Gentleman should be careful when talking about bandwagons. The Liberal Democrat bandwagon in this debate consists of three Members, whereas the Conservative bandwagon consists of only two.
§ Mr. Trend
I do not need to remind the House that this is a Liberal Democrat debate. I notice that no Labour Member has spoken—let alone spoken with enthusiasm—in the Minister's welfare reform week, which is supposed to be so important but which is going like a damp squib.
The Government should act without delay because, with every day that passes, large numbers of people who have worked hard all their lives to save for their old age are seeing their efforts cast back in their faces. We are told that the Government have asked the Inland Revenue to consider the matter, but the Government cannot continue to hide behind such obvious delaying tactics. The growing sense of unfairness with the current compulsory system has been looming on the radar ever since the Government came to power. The fact that people are now really hurting and are complaining vociferously to their Members of Parliament about their predicament shows that the Government have already left it too late to make an appropriate change to the law. They must act now.
May I give the House a flavour of the sort of correspondence that Members of Parliament are receiving? One person has written:I have saved long and hard so that I would not suffer financially in my dotage and the value of my pension pot is worth even more than the value of my house. I resent very much now that I made this great effort only to find that, even with the addition of my state pension, I still fall short of the amount that is considered to give one an adequate lifestyle in retirement.… It is unacceptable to have absolutely no control over what is probably the largest amount of money that most people will have in their lifetime at a time when it is giving the lowest return.We have heard many arguments about taxation. There are various ways in which the Revenue and the clever people at the Treasury could work out a compensating scheme for the Government. It has been suggested that people could be required to keep in a conventional annuity enough to cover at least the level of the minimum income guarantee. There must be dozens of other ways of achieving the aim, but my correspondent says:I would be quite willing to pay a lump sum to the Government equal to the income tax allowance made to me while accruing my pension if I could have the freedom to do what I wanted with the capital.I am not sure that I would be prepared to do that, but it is another suggestion made by one individual who feels desperate enough to put such a deal to the Government.
274 All hon. Members who have spoken have said that the Government fear that people might go in for high living. My correspondent says:The Government may fear that some would go out and buy, say, a Ferrari with the money and then fall back on the state to support them. However"—this is the key point—people who take the matter of their retirement seriously and save for it are hardly likely to do this.We all agree that annuities involve a balance of risk. The choice of schemes for pensioners is wide and, to many, it must seem bewildering. Should they buy a fixed annuity or one that increases from a lower level of initial payment? Should it be linked to the retail prices index? Should it be a joint survivor annuity so that their spouse will benefit after their death? Should they opt for a guaranteed minimum length of payment? Should the annuity be "with proportion" or "capital protected"? Should they take the income in arrears or in advance? How often do they want payments?
The central point about the current position, which others have made, is that the current rates are low. The Association of Unit Trusts and Investment Funds paper, which has already been referred to, says that a man aged 65 with a pot of £100,000 could reasonably expect to get a guaranteed five-year fixed annuity with no escalation of about £9,000. A guaranteed five-year annuity with 5 per cent. escalation would be about £6,000. A guaranteed five-year annuity index-linked to the retail prices index would be about £6,500. That compares with a figure seven years ago of between £15,000 and £16,000. The drop has been substantial and must be very scary to people coming up to making such difficult choices about what sort of annuity to opt for.
Behind all the complicated choices and the consequences that flow from them there are two fundamental uncertainties: first, how long a person is likely to live; and secondly, what is going to happen to long-term gilt redemption yields. An individual could answer all the questions that I asked earlier in the most intelligent and appropriate way, sign up for an annuity on a Monday and die on the Tuesday. That would be bad luck, but there is nothing to be done about it. On the other hand, a life company could offer very generous payments to a heavy-smoking, heavy-drinking, overeating, never-exercising, highly nervous elderly man who then lives for decades. There is nothing that the company can do about that. An annuity is for life. Jane Austen rightly said that it was "a very serious business".
I want to speak up for the annuity. Somehow, its popularity, based on the conversion of capital to income guaranteed for the full term of life, has persisted down the centuries that divide us from Miss Austen's world. For those able to save money for their retirement—thankfully, that is now a large number of people—the annuity continues to be a popular choice. At an important level, annuities are regarded as the fairest way of sharing the risks of our mortality.
As the hon. Member for Northavon said, it is most interesting that, despite the wide range of annuities on offer today, and despite the actuarial information that 275 should help people to make the right choice, the industry average for those who buy level-term annuities is 83 per cent. The AUTIF document refers to an office that surveyed people about to retireand found that most wished to buy an escalating annuity because they thought it was sensible to provide for future rises in the cost of living. But when it came to the actual purchase, the vast majority opted for a level term annuity.Level-term annuities are popular because they answer an important psychological need, as well as giving people the guarantees that they require at that age.
There is a third party in the deal between the individual and the life company—the Government. The Government have obvious tax interests, but they must not be allowed to override other interests. The Government are also the final regulator of the balance of risk between the individual and the life company. A key Government responsibility is to ensure that the means of saving and providing income for oneself continues to be seen as a fair and reasonable way of sharing risk. As long as all those involved in the long chain from the young saver to the elderly pensioner retain a sense that the system is broadly fair, there is every reason to believe that the annuity will remain a popular means of providing for oneself.
I ask the Minister to imagine what it must feel like to be a 73 or 74-year-old who, through their own hard work, has saved tens of thousands of pounds for their old age. As the long-term gilt redemption yields have declined, that individual will have noticed that the cost of annuities has roughly doubled over recent years. They will get about half as much to live on as someone who saved the same amount and retired a few years ago. Their prospects will be substantially bleaker than they might reasonably have expected. Someone in that position knows that they are going to get a bad deal. They have done everything that successive Governments have urged them to do, passing over some of the pleasures of life to be able to stand on their own two feet in retirement, but the system has stuffed them. The Government control the system.
The fact that one group of pensioners who have worked hard and saved hard are getting a bad deal because they are being forced through no fault of their own to take out annuities erodes general confidence in the system. The Government cannot want that. Let us charitably assume that, one day, the Government sort out their muddle on stakeholder pensions. What if the dark cloud surrounding compulsory annuities rains down on that pet scheme? The previous Government saw how annuity rates were going and changed the law in 1995 to allow income to be drawn down directly from the pension fund until the pensioner reaches the age of 75. Enabling pensioners to defer the purchase of an annuity for 10 years or more was a sensible and popular measure. New financial products were developed to offer better choices to pensioners.
However, the problem facing those coming up to 75 is now substantially worse than that which faced the earlier generation. Government policy must respond and develop. The previous Government acted to ensure the basic sense of fairness in the system. Those who have waited may well have been gambling on a rise in annuity rates, but that gamble has clearly not paid off. They, and a new generation facing this area of difficulty for the first time, are looking to the Government to remove the age limit. We are asking for greater flexibility, so that people coming up to 75 can make their own informed decisions. 276 The Government should at once free people from any artificial, arbitrary, unfair restrictions and let responsible people make their own decisions.
§ The Minister of State, Department of Social Security (Mr. Stephen Timms)
I welcome the debate and congratulate the hon. Member for Northavon (Mr. Webb), as others have done, on his success in securing it. The issue is important and, as several hon. Members have pointed out, it is attracting a great deal of attention at the moment. I also welcome the hon. Member for Windsor (Mr. Trend) to his place, and congratulate him on his appointment. I know that he will not take it amiss if I tell him that we shall miss the energy and vigour that his predecessor, the hon. Member for Grantham and Stamford (Mr. Davies), brought to our debates on such matters—but that, if he does not match him in terms of the length of his contributions, there will be no complaints from us on that score.
I also congratulate the hon. Member for Windsor on the fact that he has been able to make a policy announcement in his first contribution in his new role. Indeed, I have here the Conservatives' press release of yesterday announcing that, as the hon. Gentleman has told us, they intend to scrap the requirement.
It is not entirely clear to me, either from the press release or from what the hon. Gentleman said today, whether the Conservative proposal is to change the age from 75 or to abolish the necessity to take out an annuity at any stage. I must add that the outrage that he has expressed about the unfairness of it all would be a little more convincing if it were not for the fact, which he mentioned towards the end of his speech, that it was a Conservative Government who introduced the requirement in the first place. No doubt, I shall come back to some of those points in due course.
Let me reassure the hon. Member for Twickenham (Dr. Cable)—I have not consulted the 1888 report to find inspiration for what I have to say to the House this morning. I pay tribute to the expertise in these rather arcane matters that has been shown by everyone who has contributed to the debate so far.
First, I shall say something about the reformed structure that we are introducing for the pensions system, so as to provide background to the concerns that have been expressed about annuities. There is a pressing case for reform. It is true that pensioner incomes have grown faster than working incomes over the past 20 years, mainly as a result of the success of occupational pensions—but that overall average picture masks the fact that a significant number of older people have been left behind by the improvements that others have enjoyed. Some pensioners have prospered; others have not. That is why it is important to give priority to extra help for those who need it most urgently.
Every pensioner household will benefit from the £4 billion package that we have introduced for the life of this Parliament, but the lion's share of the extra money will be aimed at the least well-off. Through the minimum income guarantee, which several hon. Members have mentioned, pensioners receiving income support are now at least £160 a year better off than they were before April.
Next April, the guaranteed level will increase in line with earnings, which will bring another 20,000 pensioners within the minimum income guarantee. As we aim, 277 in time, to uprate that guarantee in line with earnings, those whose income is just above the guarantee—a group often of particular concern, rightly so, both to hon. Members and to their constituents—will gradually be brought within its scope as its level rises. After next April's increase, a pensioner couple over 80 will be about £8 a week better off in real terms as a result of the changes that have been made since last year.
That is a substantial boost, and we can give it because we are ensuring that the extra money is available to those who need help most. The hon. Member for Arundel and South Downs (Mr. Flight), who is not in his place at the moment, described that as an extremely generous arrangement; I am not sure that I would go quite so far as that, but it represents a great improvement for the people who, rightly, look to the Government to provide improvements.
In addition, in the winter, every pensioner household will receive a £100 payment towards the cost of fuel, which will benefit about 10 million pensioners in more than 7 million households. The minimum tax guarantee, with additional uprating of pensioners' personal income tax allowances, means that, since the Budget, 200,000 pensioners have been taken out of income tax for the first time. Two thirds of pensioners now have no tax to pay.
A range of substantial changes have therefore already been made. Looking to the future, our election manifesto recognised that we need major reforms to ensure that future generations of pensioners can look forward to a decent retirement. Our review led to the Green Paper on pensions, published just before Christmas.
Everybody who can save for retirement has a responsibility to do so; in turn, the Government have a responsibility to provide security in retirement for those who cannot save enough, and to regulate effectively the private pensions system—an aspect of which is the focus of our discussion this morning.
Our strategy for the future, as laid out in the Green Paper, rests on four interlinked pillars. The first is the basic state pension, uprated at least in line with prices each year. That will not be means-tested or privatised. The second is the minimum income guarantee, which I have described.
The third pillar is the state second pension, and the fourth is our new funded stakeholder pension. The new state second pension is being designed to ensure that, in future, everybody with a lifetime of work and contributions behind them will build up a right to a pension that will be above the minimum income guarantee when they retire. In due course, we expect that pension to become a flat-rate scheme for those on lower earnings, with moderate and higher earners contracted out into funded pensions.
The fourth pillar—the stakeholder funded pension—will be a new type of private provision, combining the low overheads and high security that characterise occupational pensions with the flexibility of the best personal pensions. Those are being designed particularly to help those on middle incomes, from roughly £9,000 a year up to average earnings. However, they will benefit those on higher incomes as well.
§ Mr. Trend
With regard to both pensions in general and stakeholder pensions in particular, the Minister's 278 document, released yesterday, did not seem to say anything about the costs, which were supposed to be 1 per cent. In the light of that paper, and of other consideration that the Government are undertaking, can he tell us whether he still expects the costs to be that low, or whether they will be higher?
§ Mr. Timms
We are issuing a series of consultation briefs about the design of stakeholder pensions. The first, issued on 2 June, was about minimum standards, including costs. We are consulting on the view that we expressed in that paper. As the hon. Gentleman rightly says, another document was issued yesterday, about employer access to stakeholder pensions. Our aim is that every employee in the land who does not have access to an occupational pension scheme should have access to a stakeholder pension in the future.
The hon. Gentleman is right to say that we did not revisit the subjects covered in the paper of 2 June, but that is because the subject matter of the next document was different. Four further consultation briefs will be published before the end of July, and will cover the full range of the decisions that need to be made about the details of stakeholder pensions.
We are driving a hard bargain on behalf of scheme members with our proposal for a 1 per cent. charge. We think that that is right, and that the Government and the industry need to work hard on stakeholder pensions to persuade people whose main knowledge of personal pensions is that they were mis-sold to lots of people in the past, that stakeholder pensions will be dependable, good value, and a good place to invest their savings.
That is the basis for the view that we expressed on 2 June. I have been heartened by the positive response to that proposal so far. We are considering the matter and consulting, and we shall listen carefully to what everybody says. The proposal has lit a spark of enthusiasm about stakeholder pensions.
The Welfare Reform and Pensions Bill sets out the basic legislative framework for stakeholder pensions. There will be a series of documents between now and July about the detail. We have a structure for pensions reform that is well thought through and has been widely welcomed. There has been lots of comment about the detail, and our task now is to get that right.
I readily acknowledge the widespread concerns about the requirement to annuitise a personal pension or a money purchase occupational pension arrangement. I have received numerous letters from hon. Members and constituents. The hon. Member for Arundel and South Downs said that I must have received many letters from my constituents, but in fact I have probably received more from his constituents, via him. Several hon. Members have also tabled parliamentary questions on the matter, and I have had discussions with both them and the pensions industry.
The present position is that members of a personal pension scheme must use their fund to buy an annuity by the time that they reach the age of 75, and—this has not been mentioned today—members of money purchase occupational pension schemes must buy an annuity when they retire. Before reaching 75, but after the age of 50, holders of personal pensions may draw income directly from their fund, subject to upper and lower limits. We have already had some discussion about income 279 draw-down. We plan to introduce parallel arrangements for members of money purchase occupational schemes shortly.
The current arrangements for annuity deferral until 75 have been in place for three years, as the hon. Member for Windsor said. The Inland Revenue is conducting a review of how well the arrangements are operating and will assess the need for any changes later in the year. The review is considering annuitisation by 75. I reassure the hon. Member for Arundel and South Downs that it will be a wide and thorough review, and not the pathetic fudge that he feared. The results will be published in the autumn.
The rate for a level annuity has fallen sharply over the past five years. Apart from the change to a low inflation environment, people live about 10 years longer than they did 50 years ago, and there have been sharp increases in longevity in the past few years. That continuing trend clearly affects the annuity rates that can be offered, as the fund will have to cover a greater number of years in retirement.
Before writing off annuities, we should consider the whole story. I have some sympathy with the points made by the hon. Member for Windsor on the subject, although he seemed to be arguing both ways. He said that he was in favour of annuities and then said that people who had to buy them were getting a terrible deal. We must ensure that we do not encourage the view that taking out an annuity means bad value, which is often not the case.
§ Mr. Webb
I was not remotely attempting to write off annuities, although they may not be appropriate for everyone. We are in favour of choice. People of 75 who are allowed to continue with draw-down and to keep a capital sum might be better placed to pay for their own long-term care, whereas those who buy an annuity get a pension stream that will never cover long-term care costs. Might that be another attraction for the Government of more flexibility?
§ Mr. Timms
That is an interesting point. As the hon. Gentleman knows, we are considering the arrangements for long-term care and will make an announcement in due course. There are attractions in various forms of flexibility that are not currently available and we need to keep an open mind. Throughout this debate, hon. Members have been asking for greater flexibility, and no one has suggested that there is a panacea that would allow us to convert a lump sum pension pot into an income stream to support people through their retirement.
The current arrangements are easy to criticise, but it is hard to come up with genuinely radical alternatives. There is certainly scope for discussing the details and whether it might be appropriate to have extra elements of flexibility. The great virtue of an annuity is that it provides a guaranteed income for the remainder of a person's life, however long that turns out to be. That is an important virtue.
It has been suggested this morning that it is rather patronising to be concerned that people will blow their savings on a Ferrari when they retire. Whatever the other considerations, the Government would need to think long and hard before signing up to an arrangement that could lead to people facing a sudden financial crisis in their 80s or 90s. I have seen some suggestions for alternatives that are quite open about the fact that they run out after 280 25 years, on the ground that most people do not live longer than that after retirement, but it would be wrong to go down a route that could lead to a crisis for people at exactly the time in their life when they would least want to be confronted with one.
Annuity rates have fallen, but so has inflation. Lower inflation means that the purchasing power of a fixed-value annuity is now maintained much better than it was in the past. The rates for index-linked annuities are especially interesting. Five years ago, an indexed annuity would have produced an annual pension, for a man aged 65, of £6,600 from a fund of £100,000. The comparable figure today is about £5,800: a reduction of only £800 a year and a much smaller fall than that in the rate of level annuities.
That comparison is instructive and it is as well to bear those figures in mind in considering whether the value offered by annuities is significantly worse today than it was five years ago. The evidence does not support that thesis. Over the same period, people's pension funds have enjoyed the benefit of substantial stock market growth, and fund growth has helped to mitigate the effects of the fall in annuity rates.
The open market option for holders of personal pensions means that fundholders can shop around.
§ Sir Robert Smith
People nearing retirement will not have had the full benefit of stock market growth, because their fund should have been managed in recognition of their age.
§ Mr. Timms
That is a fair point, but, if one compares the past 10 years with the previous 30, it is clear that returns on equities have been very much better.
Life offices that act as annuity providers have a very good track record for security. There has been no significant failure associated with them, owing to the underwriting process that secures the payment to an annuitant so that the liability is matched to suitable assets. That feature, guaranteeing income, is the real strength of the annuity system.
There are already forms of annuity, such as with-profits annuities, that allow pensioners to share in equity growth; but that inevitably exposes the pensioner to increased risk. The hon. Member for Arundel and South Downs suggested that those were not widely taken up because of Inland Revenue rules. I do not agree. I think that it is the inevitable risk that has deterred people. They are available as an option for those who want them.
We have considered whether there is a viable alternative to annuity purchase that would guarantee income for the rest of the annuitant's life, but none has so far been identified. The Treasury is open to suggestions from the industry.
The value offered by annuities is not as poor as is often suggested. I have seen no evidence that the providers of annuities are making exceptional profits, which they would be if some of the criticisms that have been levelled at them were valid.
Stakeholder pensions are identified in the Welfare Reform and Pensions Bill as money purchase schemes. I want stakeholder pensions to enjoy—