I have been reading the Government’s Defined Ambition paper again. Many might ask “what’s the point?”.
The point is this; DC is broken and needs fixing, DB is broken and needs fixing, DA is the answer, but so far the consultation process has been pretty feeble and we as a nation are a long way from getting behind a DA solution.
At an intellectual level, the paper is stimulating, well written and is a great improvement on the previous effort last year which was little more than a brain dump.
But has the focus sharpened sufficiently for this to be much more than a marker? Is there really the political will to so radically reform pensions that defined benefit schemes can operate without guaranteed funding and a DC scheme provide certainty without reducing pension outcomes?
The paper properly dispenses with tinkering. It dismisses DC variants that simply insure that the price of the fund never falls. It also makes a clear distinction between the de-risking strategies being employed to limit liabilities in large DB schemes and a more radical solution that dispenses with employer guarantees altogether.
The same distinction is not being made by the Pensions Minister who has sounded distinctly off the pace of his own paper both in the introduction (which talks of the need for guaranteed solutions), and in a recent speech , where he held out the proposals of the Lloyds Banking Group to cap pensionable salary as “defined ambition”.
I am on reasonable terms with the LBG pension director and understand that she has shared with Steve Webb, her idea for defined ambition. It is a defined benefit scheme in which the only guarantee offered is an individual guaranteed annuity.
Let’s be absolutely clear about this. Guarantees are the problem, they are not the solution. The DWP may believe that the public wants guaranteed outcomes but the readers of the Mail and the Express keep buying the stories that these guarantees are ripping them off.
What we want is the cost-free guarantee, a promise that is effective and painless. It isn’t going to happen and this is why I wonder about the political will behind this paper.
When a politician wants something to happen, he makes it absolutely clear of his intentions. The War on Charges rhetoric that has accompanied the consultation on a charge cap suggests that it is a priority. By comparison, Webb’s woolly utterances on DA suggest he is putting down markers here for 2015.
So I’ll add a couple of thoughts to the debate without rasing the temperature much higher.
Firstly, the DB-lite stuff is about creating a carve out for a few very well established employers whose culture aligns them to DB. There are probably not more than 500 employers in the land (I take government schemes as a single entity), that have the appetite to operate such schemes. The political importance of these large employers shouldn’t be underestimated – without them we would not have the current confidence in auto-enrolment, they employ millions and they are part of Brand UK.
The DC heavy stuff is another matter. There is no doubt that the real argument is about collective decumulation and not about guaranteed accumulation. I don’t buy the Pension Builder Solution which is yet another variation on DC banking. I do buy the CDC section of the paper and the paper’s overall acceptance that if DA is to work , pensions need to go down as well as up.
We need collective decumulation because we desperately need to reverse the trend to universally underwritten individual annuities. Recent work by Legal & General suggests that only 27% of men reaching 65 can now be regarded as “standard lives”. While we may enjoy the thought that are likely to get an enhanced annuity, we need to be conscious that the cost of individual underwriting needs to be born by the entire pool and ultimately all we are doing is re-arranging deck chairs on the titanic.
CDC is the only DC variant that offers a long-term solution to the annuity issue. It cannot take away the cost of improved mortality, nor can it create the kind of market returns that would allow for annual income distributions in double digits. The fundamentals need to be addressed by the public in terms of their behaviour and expectation.
But CDC has been proven to give more income in retirement than the guaranteed annuity because it pools, because it allows a more appropriate investment strategy and because it does not have to pay the insurance premium to third parties.
When in May, a group of young Dutch pension experts called for Holland to switch to a Chilean model, it turned out they were interested only in the accumulation phase, they carved out collective decumulation which they insisted be maintained.
The paper’s endorsement of CDC gives us hope for the future. It is possible to think of NEST, NOW and People’s Pension as CDC arrangements, it is possible to consider the GPPs of the insurers offering a transfer option into a master trust set up specifically to decumulate on a collective basis.
That said, the cat is out of the bag and even if we do get collective decumulation, it may be sabotaged by less healthy participants being picked off by enhanced annuity brokers.
We need to get behind the concept of mutuality that underpins the Danish and Dutch systems (generally regarded respectively as the top and 2nd top DV systems in the world).
This will require a collective engagement with the issues surrounding the distribution of at retirement “product”. If the Mail and the Express can turn the debate from focussing on the “rip-off” to promoting the alternative, then we may get change.
But I suspect that we will have to see the continuation of this debate beyond 2015. The time to have had these discussion was at the start not the end of this parliamentary term. The damage to those who have bought annuities at the disastrously deflated QE rates , often without broking and without underwriting, cannot be overturned.
The paper is welcome but it is still only a discussion paper. We are too far away from a solution to the fundamental issue of DC (individual annuitisation) to celebrate.
There are many things to celebrate right now, and it would be churlish of me not to wish DA Godspeed, but I fear it is being discussed in an actuarial backwater, which is another opportunity lost.