What price certainty?

















The cost of certainty changes in proportion to the amount of certainty. The more flexible your guarantee, the more it’s going to cost you.

I can buy a ticket to Leeds on the train but to be certain I use it , I need to pay three times as much as I would if I gambled on making a particular train.

The longer ahead I plan to travel, the cheaper my ticket but the greater the chance that something will come up that will make my ticket worthless.

This puts me in mind of my retirement planning. I am certain I will need money in retirement but not certain of how much, when and what I’ll have built up for myself in the years before I stop working. To plan for certainty in all events I need to insure against all likely disasters, falls in stock markets, increases in the cost of annuities and of course the possibility that my income between now and “then” may fall away due to ill-health or redundancy.

Which is why the defined benefit scheme which can give you certainty whatever your circumstance is both so valuable and so expensive to provide.

Provided that the body that promises you a pension is still around to pay it, there is no particular reason it should put money aside for you. After all, it plans to be around a lot longer than you and the promise it has made to you is based upon a stream of future income flows generated from its production. In Germany, the only variable that really needs worrying about is the capacity of the employer to keep trading, it’s assumed that all else will follow.

This system of “book reserving” where the promise to pay you a pension is just a note in the accounts doess not suit us over here. There is too much uncertainty for us surrounding that promise being forgotten or written off as a result of the failure of the organisation to remain solvent.

Similarly, we are not too impressed when we look at the Dutch pension system and find that the promise to pay pensions at certain levels is based on a large group of people co-operating and revaluing the level of income paid on the basis of “agreed fair shares!”.

We want our cake but we want to be 100% sure of eating it too. The cost of insuring that we get on the train, get our pension or whatever future event we imagine to be ours by right needs to be paid for.

If it isn’t paid for by us, it needs to b e paid for by others – either those richer than ourselves (wealth redistribution) or those with longer time horizons (inter-generational wealth distribution). Either way, we rob Peter to pay Paul. As Paul tends to be in charge in the year’s preceding his retirement, it is not surprising that Paul has been robbing Peter for some time.

Peter’s only hope has been that he will be helped out by the markets, this has been happening for some time but has stopped happening. When the markets refuse to help out then the cost of certainty becomes critical. Who will pay for the current generations in occupational schemes enjoying healthy retirement why the likes of us? Who will pay for our retirements? Why -our children- see photo above!

Well not quite. My generation – eg the generation within twenty years of retirement are the first to discover that pensions are not a one way  street- they don’t just grow and grow but they can fall and fall. While we pay taxes to keep the elderly state employees in a good state and have depressed wages so that companies can meet their obligations to their defined benefit pensioners, we have no one to take care of us and find our pensions subject to market conditions we have no control of, no way of predicting and little capacity to insuring against.

Those in the private sector feel resentful that those who continue to enjoy certainty are employed by them  but also make the rules that subject them to the vicissitudes from which the public sector are protected.

It is not surprising that the price of certainty is a matter of great debate. If we were able to quantify the price of certainty int he way we can by comparing a fully flexible with a completely inflexible travel ticket, then we could build that cost into a total reward system. We could tell those with defined benefit pension schemes what they have to lose in other benefits for the privilege of certainty.

But this we cannot do. We can’t work out the price of certainty because it is based on a subjective “feel good” factor that cannot be determined. Successive Governments have argued that we do not need certainty and that is has little or no value. When the conservatives introduced contracting out of SERPS, they gave those who chose to forsake their defined benefit (SERPS) compensation that added up to 1% of their “relevent” earnings (this was added to the contracting out rebate that went to a personal pensions).

This was an early attempt at valuing the cost of uncertainty and in retrospect a very mean one.

Going back to the Germans and the Dutch, they have concluded that guarantees can be given by companies and by groups of like minded people without the need for funding, for vigorous regulation or for expensive reserving (thing Solvency II). This view of  communal agreements is based on an optimistic assessment of communal behaviour (and not our post-Maxwell paranoia).

I’ll finish with my view that the price of certainty is linked to the degree we trust those who govern us, those who employ us and those with whom we reach retirement. The more trust there is , the less the cost of certainty. The less trust , the greater the cost.

Until we can return to a degree of trust, the cost of pensions will continue to escalate and the likelihood of our achieving our required post work incomes (on our own) reduce.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to What price certainty?

  1. Pingback: Sorting the pensions of the “squeezed middle”. « Henrytapper's Blog

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