Pensions, infrastructure and the Budget: uncreative destruction

George Osborne about to deliver the 2011 Budget, long before any rash claims about insurers investing billions

George Osborne about to deliver the 2011 Budget, long before any rash claims about insurers investing billions

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.

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About René Lavanchy

You can contact me at rene dot lavanchy at googlemail dot com.
This entry was posted in Institutional investors, UK policy and tagged . Bookmark the permalink.

6 Responses to Pensions, infrastructure and the Budget: uncreative destruction

  1. Problem I’m seeing in the UK is that just about everyone and their granny seems to think that ‘pension funds’ (they usually really mean managed funds) will be the source of funding and financing for their particular interest. Over the past few years I heard at conferences and seminars how ‘the pension funds’ will be the saviour of social housing, healthcare, local authorities own medium scale infrastructure programmes etc., etc.

    A harsh reality,meantime, is that the UK actually doesn’t offer private managed funds an awful lot of glittering prizes. UK Treasury Secretary Alexander found this out when he tried to pull a stunt by inviting several top UK pension funds into a Downing Street meeting prior to his Chancellor’s imminent Financial Statement. Despite offering what was reported to be a list of the ‘top forty’ UK infrastructure projects, there was not one taker.

    • René Lavanchy says:

      Interesting thoughts here. I was aware of similar hype in the property market but didn’t realise pension funds were seen as such a panacea across the board. Well part of the problem there is that there isn’t really well thought out infrastructure plan to offer those glittering or even glimmering prizes. Most of those top 40 projects you allude to are not even open to private investment, and are funded by the taxpayer. There is no pipeline of projects designed to be investable by institutional investors, with the exception of the Priority Schools Building Programme, and that is essentially ONE deal opportunity financing several school projects, so hardly a pipeline.

      • And prospects of a pipeline diminished by the ‘revolving door’ nature of UK Coalition Govt Ministers dealing with infrastructure. The Coalition’s first one (an unelected ‘Lord’) made much noise about planning, stability, engaging private sector etc. After lasting some months he went off to a lucrative position in… the private sector

  2. Can’t trace original report on Treasury Secretary meeting with top UK Pension Funds just immediately prior to Autumn budget statement by Osborne Nov 2011. Was sure it was in FT but that always an be a hard source for searching archives. Several FT articles do cover/touch on the UK Coalition Govt’s concept of ‘Top Forty’ infrastructure projects:
    http://www.ft.com/cms/s/0/eff277de-5834-11e3-a2ed-00144feabdc0.html?siteedition=uk#axzz2ywL504mG

    http://blogs.ft.com/westminster/2011/11/how-mondays-infrastructure-plan-is-attempt-to-raise-money-off-balance-sheet/

    http://www.ft.com/cms/s/2/f8dedd8e-2a53-11e2-a137-00144feabdc0.html#axzz2ywL504mG

  3. Pension fund can’t be used for funding and investment purpose as it may involve high risk.

    • Wiiliam the institutional funds’ perspective of (public) infrastructure went through something of a sea change after the 2007/08 crisis and aftermath. Public infrastructure had until then been commonly viewed as a ‘boring’, low return, long-term business with ‘meddling’ regulators. After the Great Recession took hold, public infrastructure, especially utilities related, became a much more attractive prospect because of the low risk perceived – it turned out that the long-term basis and the regulatory oversight that accommodated robust pricing and revenue streams offered stability and a degree of planned certainty in a far more unstable global environment. (Something of the same order as the flight to ‘quality debt’ over the same period?).

      This trend is slowly coming down the scale – only this week one Scottish Local Authority pension fund has set aside a £30 million fund solely for investment in social rented housing in Scotland.

      All of which suggests that the failure of the ‘Top Forty’ infrastructure programme etc. in the UK can be fairly and squarely put down to sheer incompetence on the part of Chancellor Osborne and the Treasury Secretary Alexander?

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