BBM011,2 History of UK Finance

Paper money is first believed to have been used in China in the seventh century, but there is evidence that some forms of coinage date back to 700BC in Turkey. In ancient Egypt various precious metals were used as a form of exchange.

First evidence of fractional reserving. A balance sheet from the London branch of the Medici Bank, dated November 12, 1477, shows that a significant number of the bank’s debts corresponded to demand deposits.

Criminalisation of the poor lasted until the twentieth century

The Dutch East India Company officially became the world's first publicly traded company when it released shares of the company on the Amsterdam Stock Exchange. Stocks and bonds were issued to investors and each investor was entitled to a fixed percentage of East India Company's profits.

This has developed into the Lloyd's market we see today

Edmund Halley introduced the first set of actuarial tables

Gilts are bonds issued by the UK government. The first gilt issuance was in 1694 to King William III who needed to borrow 1.2 million pounds to fund a war against France. In conventional gilts, the government will pay the holder a coupon, or cash payment, every six months until maturity.

At Jonathan’s Coffee House, John Castaing begins issuing a list of stock and commodity prices called ‘The Course of the Exchange and other things’.

Equitable Life was founded and is the oldest mutual life assurance company in the UK

James Dodson, Richard Price and his nephew, William Morgan, who was actuary at Equitable from 1775-1830, played crucial roles in the design and successful implementation of this blueprint. The first rigorous valuation of the liabilities of a life office was undertaken by Morgan and his small team in the mid-1770s

Adam Smith's seminal work - still the foundation of the capitalist system

Income Tax was the first tax in British history to be levied directly on people's earnings. It was introduced in 1799 by the then Prime Minister William Pitt the Younger, as a temporary measure to cover the cost of the Napoleonic Wars.

The first regulated exchange comes into existence in London and the modern Stock Exchange is born.

Made it illegal for British ships to transport enslaved Africans to British colonies. This act did not free slaves already in the colonies.

This has become very common over the last 20 years and is incorrectly blamed for he credit crunch but actually dates back to 1822

Set the minimum age to work in a factory at nine years old, and limited working hours to eight hours a day for children aged 9–13, and 12 hours a day for children aged 13–18

Made it illegal to buy or own a person in most British colonies.

Initially this was a group of actuaries who wanted to develop a consistent set of professional standards

The Lloyd's insurance market ceased to be just a market and become a regulated entity

Pensions introduced in Germany. Retirement age of 65 was first deemed appropriate. This was based on a life expectancy of 66 so each person would have 1 years to sort out their affairs before death.

Karl Marx's seminal work which made the case for state implemented socialism

This is what really makes us a profession and obliges us to act in the public interest. Without charter status a profession is really a business club.

Women who lost their husbands in the First World War were granted the first State-funded, non-contributory pension (meaning that they did not have to pay a contribution towards it). They also received a dependents' allowance for any children under 16. The actual legislation dates back to 1901 though.

The beginning of the modern state pension was the Old-Age Pensions Act 1908, which provided 5 shillings (£0.25) a week for those over age 70 whose annual means did not exceed £31 10s

School leaving age raised to 14

For the first time women and non-property owning men were able to vote

Housing benefit is basically a system which pays the rent of those who cannot afford to pay it. It was formally introduced in 1982 but its roots go back to 1919

Tax exemption for pension contribution was introduced

Henry Ford, the legendary car maker, made Saturday and Sunday days off for his staff as early as 1926 and he was also keen to set down a 40-hour working week.

The end of the spiral of investors buying stuff they did not understand just because it was going up in price

3rd party insurance for driving vehicles on a road become compulsory

The pound left the gold standard in 1931 and a number of currencies of countries that historically had performed a large amount of their trade in sterling were pegged to sterling instead of to gold. The Bank of England took the decision to leave the gold standard abruptly and unilaterally

On June 5, 1933, the United States went off the gold standard, a monetary system in which currency is backed by gold, when Congress enacted a joint resolution nullifying the right of creditors to demand payment in gold.

Many years before the same thing happened in the UK

Alan Turing wrote the paper that is believed to have led to the invention of the computer

Keynes published 'The General Theory of Employment, Interest and Money

William Beveridge (1879-1963) was a social economist who in November 1942 published a report titled, 'Social Insurance and Allied Services' that would provide the blueprint for social policy in post-war Britain.

Beveridge had been drawn to the idea of remedying social inequality while working for the Toynbee Hall charitable organisation in East London. He saw that philanthropy was simply not sufficient in such circumstances and a coherent government plan would be the only sufficient action.

By the outbreak of war, Beveridge found himself working in Whitehall where he was commissioned to lead an inquiry into social services. His vision was to battle against what he called the five giants; idleness, ignorance, disease, squalor and want.

His 'cradle to the grave' social programme that amongst other proposals called for a free national health service alienated some politicians but it struck a chord with the public and this would influence Clement Atlee's Labour Government to implement these ideas.

Decimation caused by WWII was a main driver to changes to the welfare system. Also during the war children from inner cities were sent to farms and rural area to be safe from the bombing. Middle classes were faced with a realisation that the poor were living in a very different country and this would contribute to a move to introduce a more welfare based system

Probably the most respected Labour prime minister and credited with founding the Welfare State. Still an enormous hero to many on the left of politics.

National insurance is designed to appear to be a collective insurance system in which we all participate. In reality it is largely another form of tax although some contributory elements remain, such as eligibility for the basic state pension

Initially this benefit was only paid in respect of the second child onwards.

Coal nationalised along with many other industries at the time. Public ownership was deemed to be the right way to manage the major industries at the time.

A consequence of the Beveridge report - this is the most basic pillar of old age poverty prevention in the UK which survives to this day

National Health Service founded. Provided health care free at point of use for entire population without any means testing.

This was earned between 6 April 1961 and 5 April 1975. Qualification was based on payment of a number of fixed National Insurance payments ('stamps'). Graduated pension typically pays a small amount (£1 or so per week) to those entitled to it.

Developed by Fama at University of Chicago - started the move towards passive investment management

Concept invented in 1964, but introduced to financial world in 1977. Did not become widely used until early 2000's

A constant trend of improving health and lowering mortality rates occurred over this period. Before this much mortality improvement was in childhood mortality rates. Government ONS website is here

The American Institute of Certified Public Accountants developed, managed, and enacted the first set of accounting standards

From this point on increasing amounts of UK law would be set by Brussels - Solvency II and equalisation of pension ages and insurance premiums are examples of this

"Policyholders' Reasonable Expectations" was first introduced in the Insurance Companies Amendment Act 1973. This really came to the fore in the pension review

American Universities were driving forward the development of new methods of option pricing, using fair value methods

Child benefit replaced the old family allowance system

This is the American defined contribution system. Named after section 401(k) of the revenue code, it was passed to enable employees to not pay tax on deferred remuneration

SERPS ran from 6 April 1978 to 5 April 2002. As the name implies, the level of pension payable was related to earnings via the amount of National Insurance contributions. Qualification was based on band earnings above a Lower Earnings Limit (LEL) in each year. The LEL (£84 per week /£4368 pa in 2006/07) was usually set at the same level as the BSP (£84.25) and increased when BSP did.

Band earnings were those between the LEL and an Upper Earnings Limit (UEL) at which National Insurance contributions ceased to be payable by the employee (this was £645 per week/£2,795 per month in 2006/07, although the UEL now refers to a threshold where reduced NI payments are made, as opposed to payment ceasing). The UEL is also adjusted annually.

Guaranteed Minimum pension were introduced in 1978 to allow workers to contract out of the SERPS scheme proving that their employer scheme offered at least a minimum level of benefits

The reversal of the post war years of political movement towards socialism and the re-emergence of a free market economy. Top rates of tax were reduced from 98% to 40% and many of the old nationalised industries were privatised

Chile introduced a compulsory savings scheme of 13% of salary in an attempt to produce a simple solution to its own pensions crisis

Before this it had been argued that this was a victimless crime, which it clearly is not.

Stock market returns meant that companies did not need to put any money in DB pension for many years meaning they seemed like a very cheap form of benefit. In fact tax rules meant they could not put any more money in the schemes

The FTSE100 index was first introduced in on 3 January 1984

Before 1984 employers could erode the value of deferred pensions by allowing the increasing GMP to eat into the rest of the pension. This was called franking. Post 1984 this was banned and the value of the pension over and above the GMP (accrued post 1985) had to be maintained

Part of the wave of privatization that took place in the 80's under Margaret Thatcher's government.

Introduced by Nigel Lawson - this was the computerisation of the stock exchange

Target pension was reduced from 25% to 20% for the SERPS scheme

SSAP 24 was the accounting standard for pensions that allowed actuaries to smooth volatile asset values when assessing the cost of pension schemes. A fall in asset values could be gradually fed through the P&L into the balance sheet

The ability to just save directly in your own pension was first introduced in the UK. Before this there were just workplace schemes and the state scheme. It was part of the Thatcherite personal responsibility revolution

From 1 August 1990, all UK accounting standards were issued by the Accounting Standards Board (ASB).

Many defined benefit scheme members were persuaded to opt out of the occupational pension scheme and invest in personal pension instead. This was deemed to be such egregious and bad advice that the government forced the advisors to re-imburse the members of the value of their lost employer contributions. This was called the pension review

Now the revaluation had to apply to the whole of the deferred pension, not just the post 1985 accrual.

Sir Adrian Cadbury introduced his code of best practice for corporate governance including the role of chairmen and non-exec directors

Similar to a stocks and shares ISA, introduced by John Major. Replaced by ISA's as PEP's and TESSA's were felt to be an over-complicated solution to the savings problem

The 'minimum funding requirement' was how pension schemes had to demonstrate they were fully funded. It was highly controversial as it allowed actuaries to take advance credit for the performance of assets such as equities which were not a match for the liabilities but which were expected to outperform bonds over the long term.

Pensions in payment had to increase by inflation capped at 5%. This is called Limited Price Indexation

The financial Services Authority was set up to bring various regulators under one roof. It was disbanded 10 years later as it took the blame for the credit crunch

An era of wider non-financial societal reforms began but major legislation such as the minimum wage were introduced

A shift back to a more welfare based society begins

It first become the norm for office workers to have their own computer at their desk. This led to the wide-spread use of stochastic reserving and asset liability modelling techniques. Before this time actuaries worked using the principles of prudence and putting safe margins in their assumptions

Actuaries moved away from discounted cashflow valuation towards fair (i.e. market) value techniques.

Individual savings accounts introduced on 6 April 1999. You can now save £20,000 per year in one. The choice of exempt-exempt-taxed and taxed-exempt-exempt was now born.

EL came to the brink of collapse in 2000 after it could not afford to pay guarantees on pensions annuities, and was forced to put itself up for sale and close to new business.

Example of accounting standards driving change was the replacement of intrinsic value stock option accounting with fair value or black Scholes value stock option accounting

FRS17 was the accounting standard that replaced SSAP 24 which forced companies to account for pension on a fair-value or market price basis.

Paul Minors was asked to investigate institutional investment in the UK. He produced a report which become the template for institutional investment advice in the pension sector. Advice moved from picking the right fund manager to having the right equity bond split.

This was really a rebranded PP. It never really got off the ground and so the principle of opt-in effectively died and was replaced by auto-enrolment and the principle of opt-out

This was established in order to find a new way forward in the post DB age

S2P was introduced on 6 April 2002. As with SERPS, the level of pension payable is related to the recipient's earnings via their National Insurance contributions. Qualification is based on earnings at, or above, the LEL, but no band earning calculation is made until earnings reach a higher base (£12,500 pa in 2006/07) called the Lower Earnings Threshold (LET). Earnings below the LET (but above the LEL) are credited up to the LET. Unlike the Basic State Pension, participation in the Additional Pension schemes is voluntary. Those who do not wish to participate can contract out. This option was introduced with SERPS in 1978 and is only available to those who have made alternative pension arrangements through Personal or Occupational schemes. Further changes to be introduced in 2012 would see S2P change from an "earnings related" to a "flat rate" pension, and individuals lost the right to contract out.

Not untypical for lenders to offer home buyers loans to value ratios of 105%. When borrowers failed to repay even quite early on, the banks started to realise they were in trouble.

Pension Credit is a principal means tested element of the UK welfare system for people of pension age. It is intended to supplement the UK State Pension, or to replace it (for example, if the claimant did not meet the conditions to claim a State Pension). It was introduced in the UK in 2003 by Gordon Brown, then Chancellor of the Exchequer. It has been subject to a number of changes over its existence, but has the core aim of lifting retired people of limited means out of poverty.

State benefit paid through the tax system to people working more than 16 hours a week on below a certain pay level

State benefit paid through the tax system to people with children on below a certain pay level

This was in response to employers trying to rescue underfunded pension schemes

Individual Capital Assessment introduced into the insurance industry. This was the first time it became necessary to really did proper risk based reserving

Compare the market was founded in 2006 and the new age of internet sales started

In 2006 the FSA introduced the concept of 'Treat customers fairly' stating that: "All firms must be able to show consistently that fair treatment of customers is at the heart of their business model. Above all, customers expect financial services and products that meet their needs from firms they trust."

Pensions simplification. Many complicated contribution limits were replaced with high level maximums which did not impact most savers

Northern Rock, RBS and several other banks collapse. Blamed on the investment in MBS, CDO and CDO squareds. All assets which were not fully understood and collapsed in value due to a relatively small change in underlying house prices and repayment rates.

Post credit crunch the banks became very careful about lending to homebuyers. This led to the 'rent trap' and many younger people being unable to save for their 10% deposit while paying their rent.

Post credit crunch the FSA was split into the regulation of small advisors for compliance matters - this is the Financial Conduct Authority, which is based at Canary Wharf, and the PRA based at the BoE

The Prudential Regulatory Authority which is based at the BoE is responsible for ensuring the stability of the overall financial system

Based on the merger of the English Institute of Actuaries and the Scottish Faculty of Actuaries

Guaranteed that BSP would increase in line with inflation, earnings or 2.5% whichever was highest

The State pension age for women was increased from 60 to 65 (inline with men) and this increase is still being phased in

Much about rebranding the conservative party, but along with George Osborne the chancellor policies like capping benefits at £26,000 per year (initially) were introduced which were popular with the public.

One coalition policy that came from the liberal democrat manifesto was increasing the personal allowance to £10,000 per year. This has become seminal since and several parties have adopted this as a flagship issue

This is now replaced by the money helper web site

This brought together six benefits under one roof. It meant that everyone had a basic benefit amount that was then reduced as their income increased by 76p for each extra £1 that they earned.

10 years after the pension commission auto-enrolment was finally introduced. It started with low contribution but built up to a total of 8% (3% employer, 5% employee)

Help to buy is a government scheme which lends first time buyers 5% of the house's value on top of the 90% that the banks would lend

From this time you were allowed to take your whole pension at once without having to buy an annuity

The EEA wide insurance reserving regulation package was finally introduced. It formalised risk based reserving and brought in the concept of the 1 in 200 insolvency risk over a 1 year time horizon (more complicated than that)

Flood re was a government backed scheme to enable insurers to continue to offer insurance to householders in high flood risk areas where direct commercial pricing would have been unaffordable

Leave won by 52% to 48% and the long process of leaving the EU began. For actuaries issues like will Solvency II survive are important but most actuaries feel so much effort has been put into it that they might as well keep it.

Will workplaces ever be the same. Is the concept of the 35 hour week dead. How will people be remunerated if we don't know how many hours they work

Large change to insurance accounting. Pulled many resources into reporting - but things a resettling down as of 2023. Video

Invasion of Ukraine has economic impacts for the UK and the whole world.

Multiple factors including large amount of money spent on furlough during pandemic could now be spent. Also war in Ukraine reduced supply of basic food stuffs pushing up the price.

BoE base rates rise from 0.1% to 5.25% between early 2022 and mid 2023. Graph

Impact of Ukraine War on oil supply mitigated and demand push following pandemic dissipated.

Promise of no new taxes on working people? £22bn black hole. Budget at end of October???

Illustrative Solution

There are many examples of the state reacting to market demographic and other events.

Market

One example is the oil price shock of the early seventies

In this case the OPEC countries restricted the supply of oil onto the global markets and the price of oil went up

This forces the prices of many other goods up as well and so there was a lot of inflation

inflation eroded the value of people's savings and the value of pensions which are paid many years into the future and can be devastated by high levels of year on year inflation

government reacted to this particular threat by passing laws which required pensions to be increased in payment in line with prices capped at 5% (at least for a portion of them)

and also for the revaluation of pension in deferment to be inline with inflation (also capped at 5%)

Companies that opted out of the SERPS also had to provide a guaranteed minimum pension which increased in line with inflation or some other fixed equivalent amount

the excess pension over and above the GMP was also required to increase as well and could not be 'franked' so that its value was eaten away by increases in the GMP

Demographic

Between 1970 and 2018 mortality has got lighter and lighter every year, this means that annuities get more expensive every year.

Increasingly the requirement to purchase an annuity at age 65 become very unpopular as they become perceived to be less and less good value for money.

In successive stages governments have removed this requirement, initially replacing it with an option to draw down a portion of the pension and then eventually allowing people to take out the whole of their pension all at once.

Other events

Example 1

Lloyd's market has been writing insurance through the names system since 1688

In the early 1990's Hurricane Andrew exposed the LMX spiral which nearly brought the whole of the Lloyd's market down and bankrupted several names

The government responded to this by allowing limited liability corporate names into the market so that the insurance world was not underpinned by risk of bankruptcy.

Subsequently new unlimited liability names were banned from the market and now very few remain

Example 2

The unacceptable death toll from car accidents resulted in the introduction of compulsory seat belts in the front of cars in the 1980's. Many years later this was extended to compulsory seat belt wearing in the back seats as well.

It illustrates one of the many ways that the law and the insurance industry interact

Other Issues

There are many examples that would work in this question from around the world.

For example in India life assurance pricing is fixed by the state. This has all sorts of knock-on effects such as deliberately not advertising is poorer areas where the fixed prices are uneconomic given the higher levels of mortality.

i) A collapse in the stock market is only a problem for pension schemes if they have not been invested in matching assets. For those pension schemes that have matched their cashflows in bonds they should not be affected.

However there if the stock market collapses then there may be a knock-on effect on corporate bond prices as default risks may be perceived to increase. Given how pension scheme valuations are performed this may not affect the funding position, but this is only because the AA-corporate bond discount rate is used for the liability valuation.

Pension schemes that are heavily invested in equities should have a strong corporate covenant or they should not be heavily invested in equities

These factors taken together should in theory mean that the government does not need to take action

However in reality many schemes will still be in trouble and their sponsoring employers will be in trouble as well

One solution is to set up a 'pension protection fund' or equivalent. This would involve requiring all pension schemes to make a contribution and then funding a safety net scheme which could pay out benefits to those schemes which had to close to due sponsor default

Another solution would be to nationalise the companies that were in default and so have the tax payer underwriting the pension bill. Partial solutions would be to just nationalise the pension schemes that were in trouble by taking the assets and the liabilities over at the same time.

Clearly this would involve all sorts of moral hazard and anti-selection risk as companies may deliberately under fund in order to get the greatest benefit from the state taking over the pension liabilities.

Alternatively the government could take the view that the matter should just be left to the market and if companies that sponsor pension schemes fail then it would simply be accepted that members would lose a part of their pension

ii) Insurance companies collapsing should be possible to prevent or at least reduce in severity by a proper reserving regime.

something like solvency II will reduce the chance of companies getting into trouble and also will drive a process of consolidation should they still become unable to write further business before becoming truly insolvent.

Compulsory stop loss reinsurance would also act to reduce the possibility of mass company insolvencies but this would be expensive and unpopular.

The Lloyd's market acts as a great risk diversifier and as such would help mitigate against the wider consequences of such events

The uninsurability of homes could be dealt with by the government offering direct insurance at a subsidised price

It could be made compulsory for insurance companies to offer insurance at a subsidised price

A system like flood-re could be set up which meant the government underwriting insurance companies to offer insurance at an uneconomical price

The problem could be left to the market and it be accepted that insurance would be very expensive and that this would make the house much cheaper to buy (in effect subsidising the insurance)

iii) This would require an uplift in the basic state pension, or possibly an uplift in the level of top-up benefits for people who had not accrued a full basic state pension

It is possible the government cold also introduce compulsory saving as in Chile or auto-enrolment as in the UK

The government could also introduce compulsory pension provision from employers

Possibly even the government could just print the money to increase pensions but then there would be a risk of inflation