Discounting the future

There is a paradox at the heart of policy on saving for retirement.

Many people, especially young people, clearly discount the future very heavily.

This is, no doubt, in part because we instinctively prefer jam today.  It’s a strong behavioural bias.  In part, it reflects that life is tougher for young people entering the labour market now: salary growth has been subdued; housing is more expensive; student debt is a significant drag on personal finances.

So, there’s a strong tendency to save too little for a future that seems a long way off and instead to deal with the more pressing demands of the present.

By contrast – and here lies the paradox - the cost of retirement has never been discounted at a lower rate.  With people living longer and continuing low interest rates, what you need to save to achieve any particular level of income in retirement has never been higher.

Consequently a high personal propensity to discount the future meets an ultra-low discounting of future liabilities. 

This is not a great combination.

It’s on my mind now because resolving this paradox was at the heart of discussion at this month’s 24th Pensions and Savings Symposium. It’s one of the best events of its kind and enables policy makers, regulators and the industry to exchange views informally about the key challenges we jointly face.

As with many public policy challenges, there is no silver bullet.

We can probably expect people’s behaviour to adapt to the changing environment.  Increasing numbers of people are choosing to work into their 60’s and 70’s.  This income will help to fund retirement.

Auto-enrolment into workplace pension schemes certainly helps to counteract the behavioural bias to discount the future and will, other things being equal, increase saving over time.

Tax policy can help by ensuring that incentives to save remain transparent and, as with the Lifetime Savings Allowance (LISA), evolve to reflect the aspirations of young people in particular.

The industry needs to match clear incentives with straightforward, good value products that are easy to understand, and easy to access.

And, of course, many people will also need sound advice if they’re to navigate a world they find intimidating and complex.  Inertia is at least in part a function of lack of confidence.

And this is where FSCS comes in. 

Research we commissioned last year showed that cost was not the only thing deterring people from seeking out professional financial advice.

Trust was also a factor; and specifically, a lack of confidence that they would be protected if they received bad advice. This was the largest “trust gap” in the research that also showed financial services is one of the least trusted industries in the UK.

Instances of bad advice are few and far between, but when they do occur they can have a devastating impact on retirement savings which take a lifetime to build up.  We see that now with SIPP-related claims arising from advice to transfer retirement savings into a SIPP and then to invest in illiquid and risky assets.

That’s why I believe it is right to take a fresh look at the level of FSCS protection for negligent advice – currently £50,000 - as part of the current FCA review of our funding.

I can see a sound case for harmonising retirement savings limits. This has the support of MPs with 60% supporting harmonisation according to our research.

There is little logic to protecting retirement savings in insurance products without limit, but to restrict protection for mis-selling to £50,000.  This is confusing for consumers and corrodes confidence. 

And it leaves consumers with retirement pots in excess of £50,000 in a quandary because it makes no sense to break the pot up for the purposes of seeking advice.  An adviser needs to see the full picture.

So people may apply different discount rates to the future, but they need an assurance that FSCS’ protection is clear, consistent and comprehensive. Harmonising the limits is one more potential step toward that goal.