John Taylor reflects on the highlights of the IFoA’s campaign on the transfer of risk from institutions to individuals
The IFoA’s Great Risk Transfer campaign (GRT) will only need a brief introduction for many readers, given the past publicity it has had. Since the launch event at Staple Inn in January 2020, a range of information about the GRT has been published, and the final report will be available very soon.
The genesis of the campaign was a recognition that a pattern of risk transfer from institutions to individuals, across a range of settings in financial services, may be occurring. This initial hunch was confirmed by our call for evidence in spring 2020, which suggested there were areas of real concern.
Changing times
Our interim report (bit.ly/3uO85eV) includes a spread showing the striking contrast between the typical circumstances an individual would experience in the 1990s and the circumstances they face today – not only in terms of pensions and insurance, but also in wider areas such as employment and health.
A worker now is less likely to have a permanent contract than a worker from their parents’ generation. They may even be employed in insecure work or on a zero-hours contract – working within the so-called ‘gig economy’. Pre-COVID-19, the Trades Union Congress estimated that one in nine people in the UK workforce is in insecure employment.
Technological advances since the 1990s have allowed the pooling of risk to become more fine-tuned, and premiums now reflect an individual’s unique circumstances much more than they did in the past. Some modern workers may be able to influence their risk ratings by, for example, improving their exercise regime and driving habits – but this is not possible in some cases, for instance if they live in a high crime area and cannot afford to move elsewhere. This can particularly affect those who are not in secure employment.
The past 30 years have seen a major shift from defined benefit (DB) pensions to defined contribution (DC) pensions. Automatic enrolment has widened pensions coverage, which is welcome, but members of DC schemes face investment risk – unlike their now-retired parents, many of whom enjoy guaranteed retirement income from their former employers’ DB schemes. Furthermore, many of those in insecure employment will not have access to any occupational pension provision.
The government’s Freedom and Choice policy, introduced in 2015, has meant most retirees from DC schemes are choosing income drawdown rather than the purchase of a life annuity. This means that, in addition to investment risk, they are also exposed to longevity risk: on one hand, they could run out of money by underestimating their future lifespan; on the other hand, the fear of this outcome could lead them to live an excessively frugal lifestyle.
Improvements in life expectancy during recent decades have been greater than the improvements in healthy life expectancy, so there now is a greater demand for social care services than there was in the 1990s – which only adds to the challenges of financial planning for retirement.
“Members of defined contribution schemes face investment risk – unlike their parents, many of whom enjoy guaranteed retirement income from defined benefit schemes”
The role of GRT
Each of these changes in pensions, work, health and insurance has been significant, but their combined effect is compounded and constitutes a profound change in our society. The IFoA’s public interest mandate impels us to explore the policy implications of these changes. The key attributes we look for in important policy campaigns such as the GRT are:
- They represent significant economic and social challenges for policymakers, and are relevant internationally – our call for evidence proved that the GRT affects a wide range of financial products and services, both in the UK and elsewhere
- They are long-term issues – this applies to the GRT, as the above description of risk transfer in recent decades shows
- They are areas in which there are significant knowledge gaps and varying perspectives on potential policy solutions – up-to-date, high-quality research is an essential tool for analysing policy options for risk-sharing between individuals and institutions
- They are issues where actuaries have the expertise to add value, as well as the opportunities to make an evidence-based contribution to the debate.
This final point is particularly important. Issues that IFoA members feel passionately about should not lead to policy campaigns unless we can contribute a distinctive voice to the discussion. For this reason, the recommendations contained in our final report will focus on the actuarial aspects of this trend. We give a brief preview of two of these – one example from each of pensions and insurance.
Collective defined contribution pensions schemes
In collective defined contribution (CDC) pension schemes, members pool their retirement savings into a single fund and share the risks associated with investment performance and longevity. This risk sharing allows the scheme to invest in assets with higher expected returns than individual DC schemes can. Employer contributions are fixed, so pension levels will vary – and may be lower in some years. However, risk sharing allows schemes to smooth market volatility and thus achieve fairly stable pension levels.
Actuarial skills are very relevant to the challenges of designing CDC schemes in such a way that the benefits are continually adjusted to reflect the funding health of the scheme, and to ensure fairness between different generations of members.
As part of the campaign, we are seeking government action to show employers that CDC schemes are an attractive alternative to DC schemes, and to address concerns employers may have around issues such as regulatory burdens and costs.
‘Re’ schemes
Flood Re is a reinsurance scheme set up in 2016 to promote the availability and affordability of home insurance, including cover for flood damage for eligible homes – especially those that are at the highest risk of flooding. Home insurers must pay a levy to Flood Re that allows it to cover the flood risk in their policies. The scheme has a time limit (2039), after which the market will again price flood cover according to the risk. Flood Re has enabled the affordable insurance of otherwise unaffordable risks to individuals by transferring risk from consumers to institutions – the reverse of the GRT.
As a consequence of the GRT campaign, the IFoA is committed to promoting research into whether the Flood Re model – or variations of it – could successfully be applied to other types of insurance where a number of policyholders are unable to afford cover because of factors they cannot control. Possible examples of these factors include where a policyholder lives, any pre-existing medical conditions they may have, or pandemics. The findings from such research could inform government action to facilitate solutions.
Consumer decision-making
One implication of this increase in risk exposure is the need for individuals to make complex financial decisions, often without access to a financial adviser. Our campaign highlights several important consumer-facing initiatives, bringing several challenges for actuaries – not least in repurposing models, communicating with inexpert audiences and using behavioural economics. Serving this significant societal need will be a stimulating opportunity for actuaries, driving us to develop innovative ways to deploy our expertise.
John Taylor is the immediate past president of the IFoA and is leading the GRT campaign
