Why we need to say “NO” to pension guarantees!

English: Jarvis Cocker performing on the main ...

On Monday the Institute and Faculty of Actuaries delivered a paper stating that it would be able to deliver a system of lock-in guarantees at a price of less than 1% pa of the fund that could be used by retirement savings plans in the UK. This was a paper requested by the DWP as part of their Defined Ambition research.

I like the idea of Defined Ambition , I like the Institute and I like Steve Webb and the DWP but I do not want to see any more guarantees clogging up UK pensions. Imagine putting three anti-virus systems on your PC and think what this would do for performance. Then carry that thought to your pension fund.

Clearly, the results of the paper were knocking around for a bit as within 48 hours, NEST were getting excited about the possibility that they could further choke investment growth on their member’s funds by adopting a system of lock-in guarantees.

Let’s be clear, guarantees do not grow on trees. They are supplied by Banks who use the Capital Markets and complex financial instruments (derivatives) , the costs of which are passed on with a loading to pay bank salaries;-  like I said – not cheap. Or guarantees are provided by insurers who need to reserve for every conceivable risk under the stringent codes of the EU solvency regulations -not cheap. Or they are provided by the Government but this means sacrificing any exposure to growth in the nation’s economy and investing in the currently depressed gilt market – not cheap.

There would have to be a very good reason to adopt a system of pension guarantees of this kind and one wonders at the motivation behind the initiative. Having wondered a great deal, I have concluded that there are three motivations – all well-meaning and all misguided.

The first is what could be called – misdirected paternalism

The second is regulatory and I’ll call it – solvency creep

The third is commercial and results from the understandable desire of banks and insurers to make a turn.

While the third is self-explanatory, I think I had better explain what I mean by “misguided paternalism” and solvency creep.

The DWP, NEST and other bigwigs have got it into their heads that the people who are to use NEST, the great pension unwashed, are simple people who cannot take the slings and arrows of market conditions and will jump ship at the first sight of choppy investment waters. Consequently NEST has adopted a tranquillised investment strategy for those joining it which smooths market returns through a cautious diversified investment strategy. They have generally been applauded for this by people who have no idea of the behaviour of the people who are likely to use NEST- eg academics  and pension strategists.

I would like to play the behavioural psychologist here, I spend a lot of time with NEST’s potential customers, in bars, in bookies, in dodgy clubs and in football grounds.  I do not do this in the interest of academic research but in the interests of having a good time.

What I notice is that NEST’s customers are very interested in taking risks. They are constantly betting or doing things that will probably harm them in some sense or other. They do so  because it is more interesting than reading the Financial Times

They”drink and dance and screw, because there’s nothing else to do”.

When asked how they intend to have a good time in retirement, they are prone to referring to the National Lottery

“mister one day when my numbers come in , I ain’t ever going to drive a used car again”

So it is wrong to say that the pensions unwashed are risk averse. They are however averse to insurance salesmen and bankers and to DWP potentates who say they can’t afford to take risk. Sorry, they know they can afford to take risk because they understand moral hazard and would rather one chance in a thousand of being rich than a 90% chance of being marginally less poor.

Which is why the DWP’s paternalism is patronising and misguided and laughably wrong.

The second fallacious motivation surrounds the heresy of “pensions solvency”. The only time that a pension needs to be solvent is at the final payment due. This has been drummed into me by my friend Con Keating and Con I do agree.

However, there has emerged, partly because of the lazy practices of those running funded pensions and partly because of the Government’s insistence that everything needed to be guaranteed, an army of accountants who insist that pension funds need to be able to wind themselves up at a moment’s notice and must be funded accordingly.

This is like going to a rave and being told that you must be ready to leave whenever your taxi arrives. The net result is that rather than dancing around and getting into the music, you mince around at the door and spend the whole evening looking at the taxi rank. It is bad enough that the accountants have ruined DB plans, but now they want to do the same to DC too!

Look Mr Accountant, the members of NEST have got better things to do than look at their pension account balances every quarter to check they are still on track for the growth projections laid down in the Statutory Money Purchase Illustration. They would much rather do the Jarvis Cocker things mentioned above (and so would I). And they really do not want to pay you to be looking out for them and nannying them home, they are responsible adults (even if they haven’t done much about pension planning).

So let’s say “NO” to pension guarantees because the well-meaning paternalism is air-brained, because the accountants are clueless, because the main beneficiaries will be insurers and bankers and because we’d like to have proper pensions.

Does that sound fair enough?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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15 Responses to Why we need to say “NO” to pension guarantees!

  1. Andy Heath says:

    Thoughtfully and cogently argued, Henry.
    (Though, personally, I think paternalism is always misdirected.)

  2. Mike Atkin says:

    Henry – I’m getting bloody fed up of agreeing with you 🙂 – anyway as part of my portfolio diversification I’ve brought a few lucky dips and scratchcards. Ill let you know after the weekend how we have performed – is there a suitable benchmark I can refer to?

  3. henry tapper says:

    I would imagine your strategy will be suitably non-correlated with most of the major indices and would suggest you benchmark yourself against my betfair account which will probably demonstrate similar performance and volatility

  4. Richard Barnes says:

    Personally, I think there’s nothing wrong with a guarantee that is clearly priced and optional. Those who are more risk averse can choose to pay for it. Those who aren’t, need not. Wouldn’t that work?

  5. Nigel Heaton says:

    Henry, my respect for you has increased hugely now you are quoting Bruce Springsteen lyrics from his more obscure album tracks (“mister one day when my numbers come in , I ain’t ever going to drive a used car again”)

  6. henry tapper says:

    Richard, your suggestion is spot on; the issue is what fund is the default (Auto-enrolment is all about defaulting). If people default into a guaranteed fund (bad) if people have the option to choose a guaranteed fund (good-provided they know there is a cost attaching).

    I don’t think we should be defaulting people into sub-optimal investment strategies for the sake of keeping opt-out rates low. That’s a variant of “seal culling”.

    • Richard Barnes says:

      Agree completely Henry and you’ve put your finger on the heart of the problem for fund-based occupational DC pensions, which is that relatively unsophisticated investors are expected either to take a potentially unsuitable default fund or exercise a choice on their investment, generally without advice.

      • henry tapper says:


        In my ideal world, everyone would chose the best pension plan and do their own research and arrive on the best default or take advice from someone clever and get something which was bespoke.

        My tailor thinks the same way about my suits except I go to M & S because I can’t afford the time and money he requires from me.

        The problem with default options is when we trust them and they turn out be rubbish. Which is what I think will happen with the guarantee’d approach being floated.

        If you are prepared to sacrifice growth potential for certainty of outcome, perhaps the guaranteed option is for you though I’m still unsure that many people have that luxury.
        Guaranteed poverty or potential to have a decent income (with the downside of slightly greater poverty)

        Defined benefits would love to lock down their uncertainty by buying guarantees (buy-out) but the cost is too high for the company. Similar trade-off ; guaranteed pension and redundancies/business closure v future jobs and ongoing pension defecits.

        If you believe we are in for a 20 year Japanese style slump then you will probably be opting for a bond based approach to pension funding from the start of the lifecycle but I don’t think that is a “default position”

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