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The Actuary The magazine of the Institute & Faculty of Actuaries

Politics: Freedom, fairness, responsibility

UK politics has been exploring new territory lately - that of coalition government. Luckily, the new ‘coalition’ has released two lengthy statements that are indicative of the policy agenda for the coming term. This is a short overview of some of the key themes that may be of interest to those in the actuarial profession, allowing those who have not kept up with the pronouncements or been through the 300+ pages we cover here. We will also touch on the process that will be used to check that the plan can be paid for, the Office for Budget Responsibility (OBR), the Mansion House speech of 16 June, Mark Hoban’s speech in parliament on 17 June which clarified the future of the FSA, and the first ‘emergency budget’ - published within 50 days of the election as promised... Remembering that this is a moving target, here is one shot at it!

Programme for government
After the election on 6 May 2010, and the indications that there was a hung parliament crystallised, frantic bilateral discussions began involving the largest parties. The first lengthy 7-page statement, ’Conservative Liberal Democrat Coalition Negotiations - Agreements Reached’, released on 11 May (and available at http://www.publicpropertyuk.com/wp-content/uploads/2010/05/Coalition-Agreement.pdf), gave a high-level view of the way forward as seen by the Liberal Democrats / Conservatives (Lib-Cons). It was arguably released to meet the demand from the media for clarity and direction as speculation as to how the negotiators would bridge the gaps between their two manifestos was rife. There had not been much time to draft this after the election, and as time was pressing, the high-level statement was brief and, on release, a fuller version was promised. This was expanded, and the fruits of further deliberations and discussions can be found in the second, and the more lengthy 33-page statement released on 20 May (and available here http://www.cabinetoffice.gov.uk/media/409088/pfg_coalition.pdf), which offers insight into the government’s policy plans and priorities for the next few years. This publication was made available for comment - and almost 9,500 moderated comments are available for display online (at http://programmeforgovernment.hmg.gov.uk/).

The programme has 31 chapters, and we will highlight certain chapters and draw your attention to matters of actuarial interest:

1 Banking
Regulation will be shaken up (see the ’Beware the (Watch)Dog’ section below).

Britain’s first ‘free national financial advice service’ will be created. As David Gulland, the managing director of RGA UK has been quoted as saying: "We cannot build a robust society unless individuals and households are able to understand the implications of their decisions. It will take many years before we can build a fully ’financially capable’ society but this is a good start and we urge the coalition Government to ensure the service covers a broad range of financial education services including the consumer need for financial protection."

2 Business
The development of alternative revenue streams for the post office is to be considered, and the creation of a "post office bank" has been tabled for consideration.

5 Consumer Protection
Someone in government has clearly read "Nudge: Improving Decisions About Health, Wealth and Happiness" (by Thaler and Sunstein) as they have commented that "We need to promote more responsible corporate and consumer behaviour through greater transparency and by harnessing the insights from behavioural economics and social psychology." Auto-enrolment certainly fits under this heading!

7 Culture, Olympics, Media and Sport
The plans to ensure the roll-out of super-fast broadband across the country should create some employment, education and financial services distribution opportunities, and scope to re-engineer or automate some existing processes.

9 Deficit Reduction
Deficit reduction would not have been a ‘chapter’ in any programme for government until recently. Apart from the OBR, and the spending cuts to be released in the 22 June budget (see below), the central nature of deficit reduction has been reiterated. Unfortunately, reducing the deficit will mean that there have to be some cost cutting measures, and so far this has included a reduction in spending on child trust funds and tax credits for higher earners.

10 Energy and Climate Change
There has been mention of the creation of "green financial products that will give individuals opportunities to invest in the infrastructure to support the new green economy."

12 Equalities
Something that may catch the eye of all actuaries who manage staff is the intention to extend the right to request flexible working to all employees.

19 Jobs and Welfare
Contracts with those involved in "welfare to work" schemes will be rewarded more according to their results.

All current claimants on incapacity benefits will be reassessed "for their readiness to work", and those "fully capable for work will be moved to Jobseeker’s Allowance".

These initiatives may have an impact on current and future income protection claim persistency rates.

22 The NHS
The NHS will be "free at point of use and available to everyone based on need, not the ability to pay".

There are plans to help elderly people "live at home for longer".

Some health interventions may have a material impact on survival, notably the creation of the Cancer Drugs Fund, and a reform of NICE to a system of value-based pricing.

23 Pensions and Older People
An independent commission will be set up to "review the long-term affordability of public sector pensions" (see comments related to the OBR below).

Compulsory annuitisation will be ended, and David Gulland (MD, RGA UK) has said, "Confident consumers who have received appropriate advice or who have used the new national advice services to educate themselves about their choices and the potential risks can benefit from this greater freedom. We are strong supporters of changes that create fairer pricing for annuitants, and the growing popularity of Impaired Life Annuities demonstrates that the market is in a state of flux as more informed consumers and advisers increasingly seek to get a better deal at retirement."

The government has also said that they’ll explore "ways to give people the chance to access part of their personal pension fund early".

25 Public Health
The government has pledged to "encourage behaviour" and help people to follow healthier lifestyles.

This was reiterated in the Social Care and Disability section, where health and social care to "incentivise preventive action" has been proposed.

27 Social Action
The government has pledged to "support the expansion of mutual, co-operatives, charities and social enterprises".

28 Social Care and Disability
There is a pledge to "establish a commission on long-term care, to report within a year". A voluntary insurance scheme, and a partnership scheme as proposed by Derek Wanless will be considered, as will other alternatives.

This is certainly a wide-ranging document, but with the deficit reduction section as a reminder, not everything on the wish list can be purchased.

Paying for the programme
Some commentators have classified the UK economy as ailing more than some of those from southern Europe, largely as a result of the large short-term deficit being forecast. The new government has taken an interesting approach to win the hearts and minds of people: independent research. The OBR was set up and tasked with:

"1. The interim OBR will make an independent assessment of the public finances and the economy for the June Budget. The interim OBR will be given direct control over the forecast and make all the key judgments that drive it.

2. The interim OBR’s first forecast, based on existing policy, will be published in advance of the Budget.

3. The interim OBR will also produce a forecast at the Budget, incorporating the impact of policy measures announced at the Budget."

(p2, http://budgetresponsibility.independent.gov.uk/d/terms_of_reference.pdf from the "Terms of Reference for the Interim Office for Budget Responsibility", which can be found in a letter written by George Osborne on 8 June, and sent to Sir Alan Budd, chairman of the OBR committee.)

The first OBR publication (http://budgetresponsibility.independent.gov.uk/d/pre_budget_forecast_140610.pdf) has been released showing forecasts of the economy covering government revenue and expenditure (including pensions, health, unemployment and other benefits), and more granular statistics, notably consumer characteristics (e.g. disposable income estimates, employment and savings rates).

The headline grabbing figure of this 88-page report was the public sector net borrowing forecast, which has been widely reported, and which is forecast to be between 9.5% and 11.5% (with a 50% probability) for 2010/11 (assuming that the revenue collection and spending plans of the previous Labour government are continued unadjusted). The medium-term public sector net debt has been forecast to rise from 44% (in 2008/9) to 74.4% (to be reached by 2014/15). The projections have very clearly stated, with their uncertainty illustrated in ‘fans’, with all projected estimates being described as a range. While their methodologies can certainly be interrogated and disputed, the attempt to explain the uncertainty of their forecasts should be lauded, and the baseline they have provided is certainly a very useful starting point for any delta analysis. See Appendix A for details.

Actuaries may be particularly drawn to some of the comments hidden in the detail covering sustainability, ageing and public pension provision. Section 5.7 (on page 55) makes reference to an interesting application of the (Myron) Gordon model - as applied in a public environment - to estimate the primary balance required to stabilise the debt ratio, where, expressed as a rate:

Primary Balance = (interest-growth) Debt Payment

This can be thought of as the debt level that can be sustained by a country. The interested reader should enjoy the discussion that follows (5.8-5.13), where the sustainability of the UK debt burden is considered. Particular mention is made to longevity and the impact of an aging population ["...an ageing population, with demographic trends putting upward pressure on health care and pension spending. The annual impact of demographic change on the public finances is projected to amount to almost 4 per cent of GDP by 2049-50" (see 5.21-5.28)” and the public sector pension deficit [all actuaries who have wondered about the size of the public sector pension funding shortfall, may be satisfied by sections 5.36-5.42”. Their analysis shows that the share of GDP that is to be spent on Health, Long Term Care, Public State Pensions and State Pensions, is forecast to increase by 25% between 2009/10 and 2049/50 - from 16.5% to 20.6% of GDP.

This government’s first budget - ‘an emergency budget’, presented on 22 June by the Chancellor of the Exchequer George Osborne (speech available here: http://www.hm-treasury.gov.uk/junebudget_speech.htm) - was when the powers that be put their money where their mouth is, and showed how they plan to channel their resources and implement the programme for government.

Many areas were covered, and the actuary may find the following noteworthy:

>> Competitiveness and company taxation - in particular the reduction in corporation tax, branch taxation and the controlled foreign companies regime

>> The introduction of a banking levy in 2011, of 0.04% in 2011, and 0.07% of liabilities

>> Insurance Premium Tax (5%-6%) and VAT (17.5%-20%) both rise from 4 January 2011, although it is worth noting that life assurance and long-term insurance products remain exempt.

>> The annual allowance for pension tax relief will change from 5 April 2011 with indications being that the annual allowance will be reduced to between £30,000 and £45,000. This may be of personal interest to some of you...

>> ...as will the change to the capital gains tax regime.

>> Compulsory annuitisation at age 75 will be ended.

The new government’s plans were also subjected to the same OBR forecasting exercise, and this independent ‘black box’ has quantified the marginal impacts that these revised Lib-Con plans will make (http://www.hm-treasury.gov.uk/d/junebudget_complete.pdf). In support of the headline phrase "The Government has therefore set a forward-looking fiscal mandate to achieve cyclically adjusted current balance by the end of the rolling, five-year forecast period", here are some headline numbers that an actuary may wish to bore people with at a dinner party:

3: the number of areas covered by the budget: deficit reduction, enterprise and fairness

£8bn: increase in net tax increases

£11bn: the size of the welfare reform savings

£32bn: the plans saving from spending reductions by 2014/5

£29bn: total consolidation projected to come from increased taxation for 2015/6

£99bn: total consolidation projected from decreased spending for 2015/6

£128bn: total consolidation projected for 2015/6

If that’s not enough, here are some percentages that, quoted to enough decimal points, will certainly act as a sedative:

70.3%: the peak that debt as a percentage of debt will reach - by 2013-4

0.8%: projected government surplus in 2015/6

80%: target level of deficit reduction to come from reduced spending (with 20% to come from increased taxes)

77%: actual level of deficit reduction forecast to come from reduced spending (with 23% to come from increased taxes).

Beware of the (Watch)Dog
This article, while focusing on the governments new plans - and how they intend to prove that they can pay for it - would be incomplete without referring to the latest regulatory developments that will affect firms in the UK financial services industry. On 16 June, at the annual Mansion House speech, George Osborne commented that: "The FSA became a narrow regulator, almost entirely focussed on rules based regulation... How do we ensure less box-ticking and more exercise of judgement? I can confirm that the Government will abolish the tripartite regime, and the Financial Services Authority will cease to exist in its current form. We will create a new prudential regulator, which will operate as a subsidiary of the Bank of England (BOE)."
(The speech is available at http://citywire.co.uk/money/full-text-of-george-osbornes-mansion-house-speech/a407601.)

The Bank of England (BOE) governor, Mervyn King then gave some more background when he said: "We shall aim to avoid an overly legalistic culture with its associated compliance-driven style of regulation. That is an important reason for the separation of consumer protection and market conduct from prudential regulation. We must reverse the seemingly inexorable trend towards more regulation and more regulators. That did not work in the past and is not the right response now." (http://www.moneymarketing.co.uk/1013599.article?cmpid=MME01&cmptype=newsletter)

This was followed up the following day by a ’Statement to the House of Commons by the Financial Secretary to the Treasury, Mark Hoban MP, on Reforming the Institutional Framework for Financial Regulation’ (available at http://www.hm-treasury.gov.uk/statement_fst_170610.htm). In this speech, he declared that, learning from the recent crisis and the way debt levels spiralled out of control:

"We will ... place the Bank of England in charge of macro-prudential regulation by establishing within the Bank a Financial Policy Committee (FPC). And we will also create two new, focused regulators: a new prudential regulator under the Bank of England (BOE), headed by a new Deputy Governor; and a new Consumer Protection and Markets Authority (CPMA)."

The FPC will be created in the BOE, which will look "across the economy at the macroeconomic and financial issues that may threaten stability and it will be given tools to address the risks it identifies... [The FPC” will have the power to require the new Prudential Regulation Authority [PRA” to implement its decisions by taking regulatory action with respect to all firms."

A PRA will also be set up as a subsidiary of the BOE, and "will conduct prudential regulation of sectors such as deposit-takers, insurers and investment banks."

"...a new CPMA will take on the FSA’s responsibility for consumer protection and conduct regulation. The CPMA will regulate the conduct of all firms, both retail and wholesale - including those regulated prudentially by the PRA - and will take a proactive role as a strong consumer champion. It will have a strong mandate for ensuring that financial services and markets are transparent in their operation, so that everyone - from someone buying car insurance to a trader at a large bank - can have confidence in their dealings, and know that they will get the protection they need if something goes wrong. The CPMA will regulate the conduct of every financial service business, whether they trade on the high street or trade in high finance."

"The CPMA will maintain the FSA’s existing responsibility for the Financial Ombudsman Service (FOS) and oversee the newly created Consumer Financial Education Body (CFEB)."

It is clear that the FSA as we know it will be scrapped - and the series of comments which followed in quick succession was a clearly orchestrated rendition of the "FSA death march"!

This update was perhaps best suited to presentation as an evolving blog that could have been regularly updated to present new and improved information as it was released. This reminds me of an actuarial joke: Two actuaries took a shot at a target. One missed to the right, and the other to the left. They congratulated each other for hitting the target on average!

Has our political solution led us to a similar outcome, where the combined vision is better than either parties’ "misses"? The process so far has surprised many sceptics. May the discussions continue freely, fairly and responsibly!_____________________________________________________________

Greg Becker is a product development actuary at RGA