Advising HM Treasury on pension policy
25 July 2016
HM Treasury officials used algorithms created by Dr Edmund Cannon and colleagues to inform government pension policy.
In 2010, the UK government ended the compulsory purchase of annuity pensions at the age of 75, meaning a Minimum Income Requirement (MIR) was needed before people could opt out. Officials at HM Treasury used algorithms created by Dr Edmund Cannon, Reader in Economics, and his colleagues to set the right level for this MIR. The Treasury subsequently described this contribution as the ‘best’ and ‘most thorough’ assessment during the consultation process.
The team's research in this area began in 2000 as part of an Economic and Social Research Council (ESRC) project on retirement behaviour. "At that time there wasn’t much data available on the factors that should influence annuity rates and policy," explains Dr Cannon. "We started to address this gap by collecting historical data on the UK voluntary annuity market for the period 1957-2002."
Previous annuity rates were fair
This initial work showed that there wasn’t much wrong with historical annuity rates. In fact, the research by Cannon and his team showed that annuities had been fairly priced.
After the publication of these findings, Cannon and his colleague Professor Ian Tonks were asked by the Department for Work and Pensions (DWP) to analyse the compulsory-purchase annuity market further. HM Treasury described the resulting report (2006) as "the most comprehensive ever UK annuities pricing survey".
As a result, the Treasury also confirmed that it was happy that a compulsory annuitisation policy was still appropriate.
Responding to pressure to scrap compulsory annuitisation
Despite this, pressure started to grow from the press and some MPs to scrap compulsory annuitisation – to the extent that both the Conservative and Liberal Democrat parties included policies to end compulsion in their 2010 election manifestos.
Crucially, however, the Conservative manifesto contained a caveat that this should not result in higher state spending. This resulted in a major consultation on the issue when the Conservatives and Liberal Democrats went on to form a coalition government.
Cannon and Tonks were to play a major role. Together with Professor David Blake of Cass Business School, they were invited by Prudential, one of the major providers of annuities, to produce two reports for the Pensions Institute that discussed reasons for retaining the compulsory purchase requirement.
Contributing to new government policy
More importantly, the reports discussed the appropriate level for the Minimum Income Requirement before people could opt out: £14,100 for an individual, and £20,000 for a couple. The calculation was to prove key in the subsequent formation of government policy.
"Our methodology was based on working out the appropriate annuity to ensure that a pensioner or couple received no means-tested state benefits before the age of 100. This was based on the observation that the probability of a male aged 65 surviving this long was 8% and that to be sure that a pensioner never received state benefits regardless of how long they lived, would set the Minimum Income Requirement too high." – Dr Cannon
This methodology was ultimately accepted by HM Treasury. Indeed, the Treasury used the same algorithm to calculate the Minimum Income Requirement in an appendix to the government’s response to the annuities consultation. The final calculations were reached after correspondence between Cannon and the HM Treasury, and the precise level of the Minimum Income Requirement used in the 2011 Finance Bill was based upon Cannon’s methodology.
Following the consultation, Prudential wrote to Cannon and Tonks, describing how their work had been regarded by the Treasury "as the best and most thorough assessment received during the consultation process…it has played a significant role in guiding policy decisions on this issue."