Hopes that the British government might have a coherent plan for infrastructure were dashed when chancellor George Osborne delivered his Budget speech a couple of weeks ago. It didn’t go entirely unnoticed that his reform of the pensions system – loosening up the rules on pension products to remove much of the incentive on people to buy annuities to provide retirement income – didn’t seem very joined up with other parts of his thinking.
The relevance of this for infrastructure is that the long-term, steady stream of retirement income that annuities provide obviously mean that they need to be funded from investment products that provide a long-term steady income themselves. Infrastructure projects and infrastructure-type companies, such as airport and port owners, provide an opportunity for such products and recent years have seen more and more annuity cash invested in this way.
Analysts widely predict that the annuity market will now shrink drastically as it loses its so-called ‘compulsory’ aspect (you are not legally obliged to buy an annuity, but you don’t get the tax breaks that are associated with pension saving if you don’t). Which means less cash to finance infrastructure.
This would be bad enough if it weren’t the case that the same chancellor who has just done this has spent the past three years or so trying to persuade insurers and pensions funds to, er, finance infrastructure. The Treasury’s National Infrastructure Plan holds out hopes for £25 billion of investment from insurers alone, and some of those insurers are annuity providers. And that £25 billion already looks a long way off.
Now, shrewd observers may note that the annuity model is neither perfect nor universal. Annuity providers in the UK have come in for a fair amount of criticism recently for providing poor returns, as this recent article in MoneyWeek highlights. Moreover, as I’ve blogged about before, the Netherlands is powering ahead in getting pension funds to invest in infrastructure, and there are very few annuities in the Dutch pensions market.
Most pension schemes over there don’t require the purchase of an annuity and are invested collectively, which keeps costs low – a key sticking point for pension funds looking to invest in infrastructure but put off by the prospect of having to pay fees to advisers who understand how the bits of infrastructure they’re investing in actually work on a technical, regulatory and financial level.
Both the Netherlands and France have generous state and occupational pensions which crowd out the market for annuity products. However, France is increasingly looking to insurance companies to finance infrastructure, and French insurers – notably AXA and Aviva France – are responding.
So annuities may not be missed or needed for infrastructure investment, right? Well, maybe, but the rapid collapse of the annuity market will leave a vacuum. Products will emerge to replace them, of course, but it will be a slow trickle, not fast enough to slake the UK’s thirst for new infrastructure investment. Osborne may be hoping for some creative destruction resulting from his announcement, but he has not created much to replace it: no tax breaks for an alternative pension product geared towards infrastructure, for example. Wouldn’t that be a good sign that he actually had an infrastructure plan?
Whatever the annuity model’s faults, the fact that there are currently a lot of them around provides an aspect of standardisation and dependable supply of funding to a market, the infrastructure finance market, that is very hard to impose cookie-cutter financial products on.