On the day of a mallowstreet debate on the subject, here are some thoughts on how mark to market practice has impacted on the structure of DC provision.
I’ll start with a comment appearing on Citywire from Dawid Konotey-Ahulu – (it relates to the debate on the discount rate for public sector pensions).
‘It’s a continuation of the broad theme from some circles that marking liabilities to market is ultimately a bit pointless and that it makes much more sense to look at ongoing cost. Of course, in reality the two are inextricably linked. It is only by controlling the mark-to-market liability that one is able to manage the annual costs. You can’t have one without the other.’
Current DC practice takes mark to market pensions accounting to an extreme. It was not always so and hopefully it will not be so in future. (like Dawid, I am no purist!)
We accumulate a DC pot in a liability-free environment until the day we annuitise our pot. The amount of annuity we get depends on the spot price of out pot, the spot price of the gilts that back our annuity and the generosity of the annuity provider in its assumptions and margins. Some get lucky, some don’t.
Until quite recently, the concept of “smoothing” the market volatility to take out luck was the “norm”. Insurers operated with-profits policies that aimed to provide a degree of certainty around the accumulated “pot” and used the mutual interests of policyholders and its reserves to provide “with-profits” annuities.
The demise of the Equitable Life and the subsequent collapse of with-profits provision, was caused by a combination of “over-promising” by the insurers, a tougher market environment and a requirement for the insurers to report their solvency on a “mark to market” basis. EU Solvency II is the latest incarnation of mark to market purism.
Returning to Dawid’s comments, I believe that the current state of DC represents an over-reaction to the breakdown of with-profits. While it appeals to the purist evangelists of a mark to market approach, it ill-serves the coming generations of upcoming pensioners who will rely to a much greater degree on DC to provide their retirement income. A mixture of mark to market discipline and of smoothing will be required for the “bunnies”.
It remains to be seen how the pendulum will swing back to equilibrium. At present, the DC affluent can protect themselves through the use of phased retirement and income drawdown. Those with small DC pots are least protected from market vagaries.
However, as many of the collective DC arrangements we operate inch towards maturity – opportunities will arise to redress the current imbalance. Nowhere will the opportunity be greater than with NEST which will have the covenant and scale to demonstrate leadership in the development of DC in the 21st Century.
- Equitable Life investors offered £1.5bn compensation (guardian.co.uk)
- EU warned over pension issues (lv.com)
- Annuities: your choices (bbc.co.uk)
- The £1.5bn Equitable Life victory: Triumph for Mail’s campaign as up to a million victims will get payouts three times as big as they expected (dailymail.co.uk)
- Steve Schwarzman Blasts Mark-To-Market Accounting And The Idiots Who Like “Something Called Transparency” (businessinsider.com)
- Prudential UK Enters Into Buy-in Agreement With GlaxoSmithKline (prnewswire.com)
- The Wrong Kind of Annuity (fool.com)
- Equitable Life’s policyholders will get £1.5bn. But is that fair when the axe is falling elsewhere? (guardian.co.uk)
- Equitable clients set to win £1.5bn (guardian.co.uk)
- Equitable Life: ‘Our fight goes on’ (telegraph.co.uk)