A slight change in focus can produce a profoundly different understanding

How to Redistribute Wealth

A constant criticism of the Quantitative Easing and low-interest rate policy of the Bank of England has been that it has favoured those with assets. By implication it has favoured those already rich. This is slightly inaccurate as it has primarily favoured those that have been able to acquire assets on a leveraged basis. These people were not necessarily rich when they started out on their leveraged investment. However, the BoE programme has certainly improved their net worth somewhat. These people are of course often house owners.

The corollary of this criticism is that one way of redistributing wealth is to raise interest rates and reverse the QE programme. Wealth distribution is not normally a consideration in setting monetary policy but perhaps it should be. If the redistribution takes cash out of the hands of those with a low marginal propensity to consume and places it in the hands of those with a higher marginal propensity to consume then the net effect may be what the monetary authority desires, albeit from an unconventional transmission process. But then what is monetary policy today if not unconventional.

To be clear, the concern of the Governor of the BoE, that the recent spike in inflation might be just that, a spike, with the long-term prognosis still deflationary, is not without foundation. However, the UK is already experiencing a labour market shock. The Brexit situation is deterring the inward flow of labour in a material way. Whatever the long-term outcome from free movement of labour, an abrupt loss of supply will have a price effect, at least for a while. Wages are set to rise. The rise may not last very long or be large however as, in the physical absence of British alternatives, the response may be to move straight to capital-intensive labour-saving alternatives. Robots appear to be able to pick strawberries and lay bricks. Nevertheless some wage effect is to be expected in the short-term. The conventional case for a rate rise may thus soon look a little better and whatever the spin, looks matter in monetary policy as much as in fashion.

The initial impact of a rate rise will be to hurt those that have leveraged investments and are funding the leverage through floating rate loans and, specifically, base rate trackers. Well, they have been the main gainers so far so redistributing away from this lot is perhaps ‘fair’. Of course, this category may have relatively high net worth (via their home) but may not have particularly high income. Moreover, if they are budgeting on the basis that current base rates will last for ever they might be in for an unpleasant surprise. There will be casualties. People that live so close to the edge in their finances are always vulnerable to change. It is possible to gain some certainty using fixed borrowing rates.

Five year fixed mortgage rates are quite attractive at the moment. Of course to get the best rate you must have a high value to loan ratio, but with so much equity now in property a great many can probably fix for 5 years at the best rates. Interestingly, 5 year rates may be proportionately less affected by a base rate rise than floating or tracker rates. It depends on what the yield curve decides to do and this in turn depends on how far rates are expected to rise and for how long. One should recall that although lenders may offer a 5 year fix they typically fund off floating rates. Unhedged lenders would suffer as rates rise. Of course lenders do hedge using interest rate swaps. If they have fixed rate assets and variable rate liabilities they can convert the liabilities to fixed rate via the swap market (they swap a variable rate stream of liabilities for a fixed rate stream). They make money via charging a higher fixed rate than the one that they can swap into. Swaps are priced off the yield curve so if the curve does not change much nor will swap rates and nor will 5 year fixed rate mortgages. There are a lot of ifs and buts in here but the point is that it is not obvious what will happen to the structure of mortgage rates if base rates rise from here.

So we know some mortgage holders might suffer if base rates rise but the group as a whole has a lot of equity, much of it gained because of the monetary policy regime of the last 8 years. Not all are individual householders. Many are landlords and no one much cares if they suffer do they? Moreover, they can all alleviate the distress somewhat by thinking ahead a fixing their mortgages. The next issue is who gains?

The simple answer is those trying to acquire assets, like a home, or sitting on cash. There appear to be a quite a few of these albeit more in the older age group and redistributing in favour of this group may not be so popular. Wealth is in their home and this may end up funding their care. Despite the spin most of those of pension age have less disposable income than people seem to think. Any extra interest is likely to be spent. Interestingly, even younger savers might spend more if interest rates rise. It means less needs to be saved to meet a specific saving target (like a house deposit). One of the problems is that cash is still the favoured investment for most people and the return on cash has been poor for many years. A rise in the base rate will significantly boost the disposable income of many and thus spending. It is time to redistribute wealth away from those that have gained so much in the last few years and in favour of those that have been left in rented accommodation and/or are cash rich but income poor.

How much should you save?

The more relevant question for most is; how much can you save? Few can save enough. Nevertheless it is worth understanding something of how much you need to save in order to achieve specific objectives such as retirement income. Nutmeg, the Robo-adviser, offers a neat little calculator to enable you to work this out. Of course, it all depends on what assumptions you make. So let us make it real.

You are 30 years old and expect to retire at 68. You want to save for a private income of £25k pa in today’s money. You will be saving monthly and continuously. If you assume average inflation of 2% (the BoE target), a nominal return of 5% (so real 3%) and a 75 basis point fee (0.0075 typical), you must save £591 per month. If you do this through a pension scheme you should get tax relief and an employer contribution so the amount you actually give up from disposable income should be a lot less. How you fund and wrap savings is a separate issue. Here we will concentrate on what the invested amount needs to be irrespective of how it is funded. Let us look at the assumptions.

First, the fee. If the fee were zero you would only need to save £504 per month. You are paying the manager £87 per month, which is rather a lot. If you can avoid or reduce fees this can make a huge difference. Passive management is normally much cheaper than active and frankly, over the long-term, no worse. If you are in an employer scheme, the employer may subsidise the fee. It is advisable to look carefully at the fee structure and your options. If you opt for passive funds you may be able to get total fees down to 35 basis points (or even less), so let us go with this assumption. Your monthly saving need is now £543.

Second, the inflation assumption of 2%. The assumption is the Bank of England will be successful on average over time. The compound average inflation rate since 1997 (when the BoE was made independent) is about 2.75%, somewhat higher than the target. However, over the next 38 years it is not unreasonable to assume the BoE will hit the target, on average.

Third, the return assumption. The evidence for equity returns over very long periods (over 100 years) is that 5% real is not unreasonable. The initial assumption is thus quite pessimistic compared to the past. The investment will occur continuously over 38 years so there is good reason to expect a result that converges on the long-term expectation. Hence we can risk raising the return assumption. Bear in mind that dividend yields are quite high at the moment (3% plus common) and the strategy involves dividend reinvestment a 5% real equity return assumption is not absurd. This gets us to the 7% nominal often used in projection.

If we assume 7% nominal (5% real), 2% inflation, and a fee of 35 bp, we get an invested amount needed of £351 pm. This sounds much more manageable. If we deduct £100 pm for tax relief and employer contributions (arbitrary) you could get a pension of £25k pa in today’s money by saving a mere £251 pm or £3012 per year in deferred disposable income. This is still a lot for many 30 year olds that need to make rent but it is less daunting than number we began with. So what is the purpose of this blog?

My experience with people and money (all ages) is if the amounts seem impossible then people do nothing. In this case they do not save anything. If however the numbers seem manageable and can have meaningful outcomes they are more likely to respond. What is required is consistent saving over a long period rather than a lot of saving right from the start. One can always step it up as income rises. It is also vital not to fall for the hype of the financial services sector. Low cost passive equity investments will do just fine. Finally, tax relief and employer contributions can reduce the amount of disposable income. Look at the possibilities.

Finally, and my coup de grace did you know that you can invest up to £3600 pa even if you have no income and pay no tax and that it will cost you only £2880? This is almost enough to get £25k pa in today’s money in 38 years.


Protest Votes and Null Votes

On November 12, 2013, I published a blog entitled None-of-the-above: innovations in democracy. It was a response to Russell Brand urging people not to vote. I suggested that a formal null vote (none-of-the-above) might meet the needs of the emotion driving Brand’s call and avoid the potentially disastrous consequences of protest voting. The original blog post is well worth reading (even though I do say so myself). The key paragraph is reproduced here:

Many have responded by making protest votes. We vote for a minority and somewhat extreme party which we do not expect to be elected (and would be horrified if it was). It is a protest! However, the minority party will be encouraged by this and draw strength from the vote. It will not interpret it as a protest vote but as a statement of support. It might even encourage a few voters with latent extremist views to support such parties. The protest vote does not necessarily communicate to the ‘political system’ about what we are actually concerned. It is barely better than not voting at all and in some respects more dangerous.

The events of June 2016 and June 2017 would appear to have borne out the observation. The referendum was less about desiring Brexit and more about punishing someone. It was about giving some ill-defined elite, symbolised by David Cameron, the finger. Unfortunately the result  was to poke ourselves in the eye. The success of the Corbyn Labour Party was down in part to many young voters seeing Labour as the most effective way of removing Theresa May’s Tories from power. It was a protest vote. Many young pro-EU Remain supporters voted for Labour even though Labour clearly committed to Brexit in the manifesto and no one that had been awake since last June could be in any doubt how Corbyn and McDonell feel about Brexit. Now we are being told over 80% of the country voted for Brexit and many of these young Remain labour voters are upset.

Not only did I warn about the danger of protest votes in 2013 but I screamed loudly (on Twitter at least) about the folly of Remain voters choosing Labour. The LibDems offered a clear commitment to avoid Brexit or at least provide a second referendum. These young voters ignored me (and the others) and proceeded to vote against May rather than for a Remain party. Voting against things is not a good idea. And if you cannot find something you are for, what does it say about you?

The Brexit stance of Corbyn was quite clever. He managed to attract enough UKip voters (probably formally Labour) in key marginals, and still win the lions share of the pro-Remain youth vote. He was able to achieve the latter because the contempt for May’s Tories overwhelmed rational thought. The two main parliamentary parties are both pro-Brexit. They are both committed to leaving the single market. The claim that over 80% support Brexit is now de facto true, whatever the polls say. the reason is that voters keep voting againstt things and not for things, which, frankly, is dumb. This might be easily resolved by introducing a null vote to the ballot paper.

EU, Single Market and Customs Union

There seems to be considerable confusion about matters relating to the EU. Those not easily bored can go to the various EU websites for clarification. Most are easily bored. In this blog I will attempt a brief synopsis of some of the key concepts that will be thrown around as the UK exit is negotiated or hopefully aborted.

Membership of the EU means being bound by the Treaty of Rome and its various updates. The latest is the Treaty of Lisbon. Individual states may have negotiated opt-outs from aspects of the Treaty. The application of EU is ultimately the jurisdiction of the European Court of Justice (ECJ). This is NOT the European Court of Human Rights (ECHR) though the two are frequently conflated by the press and Brexit supporters. The European Commission is the civil service of the EU, not the law making body. However, only it can propose legislation. Power rests with the European Council (the heads of government for each member state) and the European Parliament. The exact distribution of power depends on the issue but the EP has been gaining power steadily.

Both the European Council and EP  are elected bodies so the idea that the EU is undemocratic is clearly nonsense. Ironically the idea has been promoted by UKip, who have gained many representatives to the parliament owing to its democratic nature. Westminster has been less kind to Ukip. Many decisions of the European Council require unanimity so loss of sovereignty is not quite complete. Lesser decisions are based on qualified majority voting so large countries still have great weight in the Council. Triggering article 50 means leaving this arrangement. It will happen automatically after two years unless the process is short-circuited. The clock is ticking.

The EU has constructed many institutional frameworks as it has evolved, some overlapping. The two that we will hear most about in the next few weeks are the Single Market and the Customs Union. The Single Market is exactly what it says; a single market. The member states of the EU operate as if there are no barriers when it comes to goods, services, capital, and labour. Economic activity is as if it is internal to a country. Note the members of the EU must therefore have a common external tariff. So what is the purpose of the separate Customs Union?

A customs union involves a common external tariff negotiated by a collective body representing the members. Each member cannot go off and negotiate with third parties on its own. Moreover, the Customs Union may involve more countries than the Single Market (Turkey for example). Norway is a member of the Single Market but not the Customs Union. This means Norway can have its own arrangement with Turkey even though it otherwise operates tariff free within the Single Market. This creates Country of Origin complications but is otherwise workable. Norway has no restrictions on imports from, say, France, but may impose high tariffs on imports from Turkey. It is vital that French imports of Turkish goods cannot be disguised and exported to Norway as this would create a profitable arbitrage and negate Norway’s attempt to negotiate separate customs arrangements.

It is now (I hope) possible to see why Norway comes up so often. The UK could in principle leave the EU, remain in the Single Market, and leave the Customs Union. Of course this is in practice impossible. First the Single Market requires free movement of labour. This is not optional. The Brexit support rests on restrictions on free movement. Second, the Norway arrangement basically involves Norway being a member of the EU without a seat at the Council table or in the EP. The UK may as well stay in the EU and just leave the Customs Union. This would allow it to strike its own deals with China etc provided country of destination abuses could be blocked.

The red line that is free movement will ultimately force the UK from the EU and the Single Market. There is then no point in staying in the Customs Union as this means only the EU can negotiate trade relations with China etc.The UK will then need to negotiate a free trade deal with the EU and everyone else. This is the best the UK can achieve as long as free movement remains a red line; and if free movement is not a red line why leave? This is why I regard a hard Brexit as inevitable if we leave. There is no way the UK can negotiate a free trade agreement in two years.


Policy Insanity

It was Einstein that reputedly said to keep doing the same thing yet expect different results is a sign of insanity. It is thus both disturbing and exasperating to see policy makers keep banging out the same nonsense and declaring confidently that all is well and will be well.

Japan has a deflation problem that is rooted in the banking crisis that I became aware of in 1990. I was a fixed income strategist with Morgan Stanley International at the time. I did not expect the problem to still be with us in 2017. At the time the US was experiencing a Savings and Loan crisis. This was tidied up in a few years. The legacy of the Japan banking crisis remains. On March 27, 2013 I published a blog explaining why I thought only debt monetization would break the Japan deflation mentality. I have since written many blogs reinforcing this view and explaining how. The idea has received support from some prominent economists. Still Japan continues with conventional policy and expects different results. Madness.

In 2010 I joined SocGen in a poorly defined advisory role. The first order of business was the Greek debt crisis and the resultant euro zone crisis. It was obvious at the start that Greece could not exit the crisis without debt relief and that the problem of contagion posed an existential risk to the eurozone. Nevertheless, the German lobby insisted on Greece paying back its official debt and undergoing a dramatic and painful reform programme. The rest is history and the eurozone survived largely because of the creative response of the ECB, typically against German opposition. The German position has been explained in many ways but my direct experience can confirm that sheer vindictiveness was not uninvolved. The Greek ‘can’ has been kicked down the road repeatedly. We are at the fourth programme. The Greek economy has been crushed and many reforms put into place. Still there is no end to the crisis and no debt relief. Madness.

There is a popular antipathy towards ‘red tape’. It has contributed to anti EU sentiment which has been widely presented as a source of stifling red tape. The reality is that red tape is there to protect the public. In the property sector, health and safety red tape has been steadily eroded. The fact that so many Tory MPs are commercially connected to this sector is purely coincidental. The catastrophe at Grenfell Towers will be subject to a public inquiry and is already subject to a criminal investigation. The fire started because a fridge exploded. Fridges are not supposed to explode. The fire spread rapidly up the outside of the building. The cladding is implicated. Cladding related fires appear quite common. Do you want more or less red tape?

Policy makers are often individually intelligent people. The collective stupidity and insanity we consistently observe thus remains a mystery. I can confirm that Social Psychology does not offer clear and unambiguous guidance. The best explanation available is that institutions absorb individuals as components of a larger organic entity, much like humans are made up of bacteria, amongst other things, and these institutional entities pursues their own interests and not those of the wider society. Whatever the truth, collective insanity seems a human social condition.


Hard Brexit, Soft Brexit, No Brexit

My first though at a title was ‘stupid is as stupid does’. I am quite exasperated at the number that voted Labour and are now claiming they did not vote for Brexit. The Labour position on Brexit was made clear in the manifesto. Labour supports Brexit. If you vote for a political party at an election you are voting for its manifesto. Ergo, you are voting for Brexit. The Liberal Democrats offered a no Brexit option. At the very least Remain Labour voters could have voted tactically and helped the LibDems in places such as Richmond. Thanks for nothing. You shot yourselves in the foot as well as us in the head.

The Labour manifesto may have had as much to do with the electoral outcome as the motivated youth vote. In many Labour marginal seats, where the Tories expected to make gains on the back of a collapsed UKip vote, many UKip voters opted for Labour. This would not have occurred without Labour’s clear Brexit stance. It was the old Labour voters returning to Labour that had as much to do with the electoral outcome as the new young voters. Some young voters understood the Labour position on Brexit but saw it as a ‘soft Brexit’ option. It seems many people are confused by the issue and are using terms that they do not really understand. Nothing new then.

A hard Brexit means leaving without an agreement with the EU. A soft Brexit means leaving with a negotiated agreement. There are a large number of possibilities for soft Brexit. The issue that seems not well understood is the matter of free movement of people. It is as important to the EU to have free movement as it is to our domestic xenophobes not to have free movement. This is where the irresistible force meets the immovable object. The question we should ask ourselves is what kind of deal is on the table if we insist on restrictions on free movement? Both the Labour and Conservative party insist on this restriction. Indeed it is the issue that enabled a small majority for the Leave camps. It is the promise that clawed back some Labour voters from Ukip.

The answer is probably not much of a deal. The Norway model, to which so many pay lip service, is not on the table. Norway has free movement. Indeed the Norway model is worse than just staying in the EU. The Swiss model requires free movement. The Turkey and Canada models do not require free movement but they are simply tariff agreements (actually the Canada arrangement is slightly more and similar to Norway and Switzerland on market access but carries more obligations). EU import regulations still apply. The alternative is to adopt World Trade Organisation rules or move to the Hong Kong and Singapore models which involve unilateral free trade. The latter means we drop all our tariffs and trade restrictions. The latter favours the City of London but not manufacturing, except perhaps the production of very high value added goods.

A soft Brexit will probably sit somewhere between the Swiss model and the Turkey/Canada model. The reason is the UK is a leaving member whereas Turkey and Canada have never been EU states. Prior membership, over 43 years, has established institutional linkages that offer more scope for continued cooperation, if there is a will. Nevertheless, the EU 27 hold all the cards (despite what the Leavers tell you). They will offer the UK continued linkages that benefit the EU. The number of shapes a soft Brexit might take is thus large.

In short if we are happy to accept free movement we may as well stay in the EU. If we insist on restricting free movement our best outcome is a customs union with some continued institutional linkages. If we cannot agree even this then we will end up with a WTO rule book or unilateral free trade.


A Hung Parliament: now what?

Two years ago, ahead of the 2015 general election as a hung parliament was predicted I wrote a speculative blog entitled A Grand Coalition. Most is still valid today. It appears we have arrived at a hung parliament. The difference is that we have since had a referendum on EU exit and parliament has ratified the outcome and both the Labour and Conservative Party are committed to some sort of exit from the EU. It is unlikely that one or the other alone will be able to form a government that has  mandate, or the stability, to negotiate a drawn out Brexit process. Could a Grand coalition work, at least on the issue of Brexit?

If no coalition is agreed then it is likely that the UK will fall out of the EU after two years with no agreement. A hard Brexit. A grand coalition to negotiate Brexit would allow a mixed team to hammer something a little less painful. On one important principle, restricting free movement, the two parties appear to be in agreement. Indeed it seems very likely that the hung parliament result came about because Labour included this principle in their manifesto. It did mean the Liberal Democrats were unable to come to an arrangement but it won Labour many old voters ( past voters and aged voters) that had defected to UKip. This paid off electorally.

The problem is the EU. Any restriction on free movement is likely to be met by the EU with disdain. There may be some kind of free trade deal possible but the experience of other non-EU countries is that restriction on free movement is met with obstacles by the EU. Given how many EU citizens already live in the UK and in other EU countries this is likely to be a serious issue for the EU again. The result may be a near hard Brexit in any event, even with a coalition. So very little has changed.

One of the odd aspects of this election is that young people voted for Labour despite its manifesto commitment to leave the EU and restrict free movement. It is unclear why they did not vote for the LibDems. The latter offered a much cleaner pro-EU position and a chance to reject any exit. My suspicion is that it reflects muddled thinking and that they do not understand that once you ask for restricted movement you risk hard Brexit. Clarity of thought was lost in the anger and contempt at the arrogance of the Theresa May government (which I can understand) and in the euphoria in voting for a party for the many and not just the few (a brilliant slogan). The problem is, what now?

If either the Tories or Labour try to negotiate Brexit alone there is a high probability of a hard Brexit. If Labour try a coalition with the Tories, albeit restricted solely to the Brexit issue, it will fail leading to a hard Brexit. Even if the two parties can somehow cooperate (could be as entertaining as Fargo), how will the idealistic youth react to a coalition with the party of the few? The election was the easy bit Jeremy. Now shit gets real.

Democracy in Danger

The title of this blog is taken from the June edition of The Psychologist. By virtue of a couple of degrees in Psychology and the annual fee I am allowed to use MBPsS after by name. I never do because I have never been employed as a Psychologist. I do however continue reading the magazine and follow-up any research or books that grab my imagination. The June edition is very interesting.

Psychology entered the political sphere a long time ago. It has actively supported specific groups to achieve ’emancipation’.Women, gays, racial diversity are among the many causes that have found active support from the Psychology community. The support goes beyond research. Of particular interest is a little note in this edition (p13) entitled Left and Right equally Blinkered and Biased by Dr Christian Jarrett. In this there is reference to research that indicates that liberals dominate the Psychology, and science, professions and that liberals are just as inclined to be biased and myopic as the alt-right. Anyone reading my blogs from inception may have noticed that I have been drawing attention to this repeatedly.

A little further along (p18) you will find another note, From Crisis to Cornerstones of Culture, referring back to an ongoing debate about the reliability of published research in the biomedical sciences. It has not been reliable if you are wondering. The article is about progress but the evidence is a bit sketchy that much progress has been made. So, so far we have left-leaning scientists are biased and in biomedical spheres published research may not be wholly objective. Comes as no surprise to me but odd that these notes appear in an edition dedicated to democracy in danger.

The lead piece is entitled Democracy in Danger by Roger Paxton, a retired clinical psychologist. He concerns himself with liberal democracy (individual rights and freedoms protected). He seems unaware of pluralist and representative democracy. His message has two components. First, research can help us link many of the developments that are endangering democracy (detachment and distrust) to objective economic conditions such as inequality. True enough but subject to the caveats above of course. Second, he argues, with others, that psychologists should work to build “…moral capital; interlocking but not necessarily identical sets of values and norms” and that this capital would “…be the moral ingredients of citizenship”.

He is arguing for a core set of moral values and for psychologists to actively work to construct. This goes a little beyond psychological research methinks and is typical of the normative actions of Psychologists observable for some time. Why should Psychologists have a better handle on values than anyone else? These are the same Psychologists that are as biased as the alt-right (according to their own research) and prone to publish false research (according to their own analysis).

Asset Allocation and Bet Size

The most important decision any investor makes is the cash to risk assets ratio. In my blogs I have repeatedly asserted the validity of 70% cash v 30% risk assets. Most have regarded my allocation as overly conservative. A paper published in the Journal of Portfolio Management suggests it might even be aggressive. The Paper, Rational Decision Making under Uncertainty: Observed betting patterns on a biased coin by Victor Haghani and Richard Dewey, is worth a read. It is very accessible though the concepts will be alien to non-finance professionals. A link can be found on the Elm Funds website which is a very interesting source of information.

The thrust of the paper is that if you have a prospect with a positive expected value then you should invest (bet) a constant fraction of your investable wealth. They refer to the Kelly* formula which is 2xp-1, where p=the probability of winning. This assumes utility from playing the game takes a particular form but this is not critical to the argument. If you believe there is a 65% chance of your bet or investment paying off then you bet 2×0.65-1 which equals 0.3 or 30%. Of course, equity investment is a long way from a binary betting game but the principle is similar.

The logic of the approach is that if you bet too much you could run out of money and if you bet too little it is sub-optimal. The Kelly formula gives you some way of getting a handle on how much to bet. Many lifestyle funds use 50/50 as the asset allocation. This implies a 75% probability of positive returns. The logic is that in the long run this is true. It probably is but what if you get an unlucky run over the next few years? It makes sense if you are adding new cash to your portfolio each year so the invested value is growing. It may be too aggressive if you have a fixed wedge to invest for a finite number of years, as do most pensioners.

The other implication is that passive funds may actually be more risky than we realise. The funds match a market value weighted index. Nothing in the Kelly formula or this fine piece of simulation suggests investing more in larger companies. There may be other reasons for doing so, such a liquidity, but a case can be made for equal weight for each individual asset. Unless you have special knowledge about one asset that changes the probability of success there is no probability reason for anything other than equal weights. An index is weighted towards large cap stocks by construction and not their prospects.

So for a fixed lump sum investor, not being too aggressive makes sense. I stick with 70/30. Diversify as widely as possible so that individual asset risks do not overly impact the total portfolio. Where possible opt for equally weighted passive portfolios unless you are not well diversified or have better knowledge of some component assets.


Kelly, J.L., Jr. “A New Interpretation of Information Rate.” In The Kelly Capital Growth Investment Criterion, edited by L.C. MacLean, E.O. Thorp, and W.T. Ziemba, pp. 25-34. Singapore: World Scientific, 2012.

Risk Sharing and Social Care

Populations are ageing. Advances in medicine are keeping us alive longer. Unfortunately advances in health have not yet caught up. In part this is a legacy issue. Medicine has focused on treating illness rather than preventing it. This is changing and the pressure on ‘lifestyle’ choices is building. There is also increased research into the link between lifestyle choices and health. We know that obesity, alcohol, cigarettes, pollution, sugar, and salt, can all have detrimental health effects. Much of poor health today can be linked back to these. In a few generations we should see health catch up with progress in longevity. Meanwhile, we have a care crisis.

The logical solution to social care needs is risk sharing. Despite the evident link between lifestyle choice and health there is a large random element still. This is particularly true of dementia in its various forms. The link between lifestyle and dementia is not yet well understood. I had the opportunity to study the disease Alzheimer’s in a course on ‘Brain and Behaviour’ as part of an MSc in Psychology. I was surprised to discover that a confident diagnosis of Alzheimer’s can be made only post-mortem. This does not help in treatment. In fact there is no treatment for the disease as such, only the symptoms. Dementia needs labour intensive care. Moreover, dementia is quite undiscriminating. It can afflict anyone. This is why it is so amenable to risk sharing.

Risk sharing is the core principle of insurance. In a population of N, actuarially we can predict x% will get some form of dementia. The total cost of treatment for the population is £Y so we all contribute £Y/N and get treatment if we are unfortunate enough to be afflicted. The only issue is how should the risk sharing be organised. There are essentially two possibilities; the state or the private sector. The principle of public risk sharing has been accepted for medical needs, despite the lifestyle links, and takes the form of the NHS in the UK. For some reason this is not extended to the care needs arising from dementia even though the link to lifestyle is not yet established. This seems perverse. Someone who falls off a horse and is paralysed will get excellent free care from the NHS but someone that is afflicted by dementia must pay for their own care.

Social care is a legitimate risk for public risk sharing. Indeed it is more legitimate than care needs arising out of lifestyle choices because it is essentially random. The public actuaries should conduct the appropriate analysis and budget accordingly. Moreover there should be no hypothecated ‘care tax’. The blog For the want of a nail… deals with the issues arising from hypothecation. All social care should be funded out of general taxation. The structure of general taxation can be set to meet whatever ideology the democratic process concludes. Care should be, like medical services, provided on the basis of need and free at the point of use. This is what public risk sharing means.

Hypothecation takes us towards private risk sharing. Care is not provided on the basis of need but becomes contingent on contribution. This is the essential difference between pure public and private risk sharing. State pensions are linked to contribution as are some financial benefits. Private insurers pay out contingent on contribution. It is not pure risk sharing though this is part of the actuarial process. Care lends itself most to pure public risk sharing yet is excluded. The reason is fear of the cost. But this is a false fear. Public risk sharing for care is one of the most logical forms of public risk sharing because of its random nature. No one should object and I suspect will not if the state makes the effort to link risk of dementia to each of you



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