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One day we’ll kick ourselves for scrapping collective insurance

The taxpayer ends up footing the bill anyway. EPA

After initially celebrating the new-found freedom to spend their pension savings how they want, people are now waking up to what scrapping the annuity really meant.

One reason for forcing people to buy these income-for-life policies on retirement was that they then don’t have to worry about incorrectly guessing when they’ll die. Compulsory annuities’ main point, however, was one of social justice: they ensure no one is forced into destitution through living an unexpectedly long time, by allowing cross-subsidy from the savings of those who die sooner.

This may be hard luck on those who live only a few years into retirement, but if their higher mortality risk is known in advance at least annuities reward them with a higher income. Now they’re allowed to, those who expect to die sooner are already abandoning annuities, causing sales to slump.

Annuities are the latest example of “risk pools”, set up in the 19th and 20th centuries to smooth over the unevenness of personal fortune, before largely being swept away in the more individualistic 21st. The now-endangered principle is compulsory insurance. If everyone is forced to protect against the “average” risk, everyone pays a premium they can afford. This principle reached its height with “National Insurance” against illness, unemployment and other big life-cycle risks. The luckiest, who are least likely to encounter a major adversity, pay more into the system than they are ever likely to claim. This makes it possible to extend coverage to the unluckiest, even though their payouts are likely to exceed their contributions.

Without compulsion, people who know they’re low-risk will pull out of such an arrangement – either joining a better-off pool that can provide them with cheaper cover, or not bothering to insure themselves at all. Once the low risks go, those left in the pool find their premiums rising until they too are forced to go unprotected. This has been the fate of unemployment and sickness insurances when the whole population isn’t forced to take them. Those least likely to lose their health or job opt out, refusing to pay extra for those who seem certain to do so.

In the US, the Republicans’ latest weapon against “Obamacare” is early evidence that only the older and more vulnerable are signing up to the President’s health insurance plans. Unless younger, fitter people also join, Obamacare is another pool that “adverse selection” is destined to drain.

Risk escalation

There are two main reasons why governments have been withdrawing support from compulsory insurance. Most obviously, few voters like being forced to buy things. This holds true even if it’s an insurance that most need, and even if most people would pay less for it if the privileged minority is thrown into the same pool.

There’s also been an escalation of some types of risk, which means that even the biggest pools don’t always allow private insurers to cover them. The state then gets dragged in – as with anti-terrorism insurance after 9/11, and flood insurance after Britain’s recent inundations.

But if they don’t contribute to the cost of collectivised risk, governments end up picking up the entire cost of those who can’t insure themselves individually. The boom and bust in mortgage securitisation was an especially regrettable case of governments trying to transfer social provision to a privately-financed insurance pool, whose implosion left them picking up the pieces at vast public cost.

Collateralised mortgage obligations (CMOs) might have worked as a way to widen home ownership if sub-prime borrowers’ debt had genuinely been bundled with that of prime borrowers. But the different risk “tranches” were allowed to separate. Private investors grabbed the good loans and left banks with the ones that were prone to default, forcing government bailouts.

Battles ahead

Long-term care is probably the biggest of the looming battlegrounds, where governments face a stark choice between forcing everyone to insure themselves or using taxes to finance the uninsured majority who then fall chronically ill. Society is ageing: few can predict if they’ll be bedbound for years or jogging till they drop, and even fewer want their inheritances spent on parental senescence.

Such a society is likely to rediscover the attractions of compulsory care insurance. If it does, that decision to scrap annuities will look increasingly like a step in the wrong direction.

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