Come Together (And Share Risk)

The Queen’s Speech this week suggests that one of the dividing lines in politics is vanishing.

There is no more debate between collectivism and individualism, we are all collectivists now, specifically in terms of sharing risk. The trivial example is the damage caused during riots. There will be a Draft Bill during the next session by which the risk of having your car damaged by rioters will be collectivised. We’re all in it together, even when the revolution begins.

The much more substantial example is pensions. The Government will introduce legislation to make it possible to have collective pension funds. Amid the promises from Ministers that these will raise performance we should reflect that they are unlikely to deliver the benefits claimed for them unless joining them is compulsory and staying in them is compulsory too. Without compulsion some will judge that their interests are better served by being outside the scheme; and they may be the very same people who are likely to make the higher contributions that help to cross-subsidise those with the lower ones. Perhaps no one can judge early in life if they are likely to be a high or low contributor, a net winner or loser in a collective scheme, but that may become clearer over the life course, or it may be younger contributors who see that in part their contributions are being used to top up incomes for those who have already retired. Those losing out from being in the collective scheme – who are contributing to others winning – will want to leave and then no one will be winning, unless the collectivisation is forced.

The Government’s other Pensions Bill may be the counterweight to this one, remember how the Chancellor promised freedom and choice for savers as recently as the Budget. Collective pensions will require that there is on the whole no freedom and choice during the accumulation phase while pension contributions are being made. But perhaps collectivisation during working life can be balanced out by freedom and choice during retirement, or the decumulation phase of the pension plan. Perhaps. Though on the other hand this isn’t how collective pensions work in other countries, the collectivisation lasts all the way through to the end of life. And, even when the Chancellor was speaking about freedom and choice, he was offering plenty of collectivisation at the same time, a government-backed Pensioners’ Bond to suck in the money released by freedom and choice on retirement and even a State Pension Top Up, fundamentally a government-provided annuity with what are likely to be the best rates in the market.

This collectivisation of risk is apparent elsewhere too: in flood insurance (where those who don’t live in areas prone to flooding contribute to the insurance costs of those who do); in social care where the individuals’ liability for costs will be capped (albeit loosely); and that is on top of one of the biggest forms of collective insurance, the guarantee that the government provides of the money we have on deposit in banks.

On one analysis, this collectivisation of risk is the logical or at least justifiable corollary of a more complex world, in which for example we live longer and are exposed to risks, such as those arising from climate change, far beyond any one person or group’s control. But that notion of what we can control and can’t is an important one to grab hold of, the problem of collectivising risk is that, once we’ve done it, the incentives for those affected by risk to manage it become much weaker. We shouldn’t force individuals and organisations to manage risk just for the sake of it, but sometimes managing risk rather than collectivising it might provide better outcomes for them as well as society as a whole.

The easy example here is the US mortgage market prior to the crash. I’ve just finished reading Fragile By Design, a brilliant history of the Game of Bank Bargains. The authors show how the Bank Bargain in the US prior to the crash suited everyone: individuals got mortgages with low or no deposits and little or no credit checks; the originators of those mortgages sold them on to government agencies – Fannie Mae and Freddie Mac – and were then free to make more; and the government agencies bought them because they were under political pressure to show scale. Risk was collectivised, and partly as a consequence no one really knew where it had gone or how serious it might turn out to be.

A much more contestable example is illness. This is a risk that we have collectivised. We pay taxes to insure ourselves against the cost of treatment for any illness we may have. However, that does mean that we have marginally weaker incentives to keep ourselves healthy. What’s the alternative? Well, the alternative is what proves my point that we are all collectivists now; the alternative is to have some element of charging for healthcare that sharpens our incentives back up again. Yet we can’t talk about this in the UK, even though such charging is a normal part of the health system in, for example, that well known hotbed of market fundamentalism, the Republic of France.

Back to pensions though and collectivisation in this area has a different downside. The reality is that we simply don’t save enough for our retirement now that we’re going to live for so much longer. Collective pensions may have some merits but, when Ministers suggest that they will transform the performance of pension savings, I worry that they are being pitched as a form of financial alchemy and an alternative to saving more. The fundamentals of risk may stay the same but the collectivisation of risk may create the illusion that something has changed whereas all that has happened is that risk has been put somewhere where it’s less visible (the US mortgages example again) or kicked down the road for a future generation of younger savers to pick up.

Collectivisation can in this sense become an alternative to advocating a change in individual behaviour by which consumption falls and savings go up. Perhaps it’s no surprise why it’s popular.


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