Cash and Carry

collaboration

 

My Mum and Dad used to buy the ice-cream and cakes for the Methodist Fete at the cash and carry in Poole. They used to go down each summer in the Methodist Minibus and they would take me and other members of the church.

The 30 Axel buckling miles back to Shaftesbury from Poole brought the Fete provisions but also huge tins of backed beans and industrial quantities of toilet rolls (not to mention the odd crate of beer – not very Methodist that).

The Cash and Carry needed a card, you needed to be a wholesaler to get the card and everyone knew that it was the Tappers who could get you cheap stuff- it became quite a thing.

Which is why I value collective pensions.

Cash and Carry is a great descriptor of how all this could work.

There are two models, one that targets payments to be paid so long as you live and one that targets payments that meet the immediate needs of the beneficiary with less of an eye on the distant future.

The one that aims to provide longevity protection  we call CDC and the  one that pays out up front we call collective drawdown. With collective drawdown there is a general acceptance that at some point in the future , the remaining income will buy an annuity which will be “enough”.

Thinking of this as “cash and carry” is quite useful. For these are collective arrangements where services- asset management, payroll and record keeping are provided in bulk. The goods-cash- are consumed by individuals but this is Lidl (minus) not Waitrose. Infact it is Booker (if you follow these things).

The “carry” is a bit of a verbal joke- we all used to leave the warehouse with pallet loads of stuff – that was the “carry”, but in financial jargon – “carry” is a term meaning to defer. While you are taking your cash to spend on the bills, you are leaving money invested for the future, in one well-managed pot.

The modelling that my actuarial colleagues are carrying out is all about “when the money runs out”. In very simple term- every extra 1% return you can get , gives you another 5 years. So a 65 year old who at a lower rate of return might be safe to 80 (at a given drawdown rate) might be safe to 85, if returns are 1% better (which gives you an idea why charges matter!)

The second thing that my colleagues are modelling is the shape of the payments. We are fascinated by how people spend in retirement. This is often referred to by economists as “consumption”. People tend to spend heavily in the early years and less as they become less active. Unfortunately, people who become too inactive start needing care and that can more than cancel the savings from reduced spending. So modelling the cash payments people might need in later life is not just important, it is extremely different as we have no idea of what our individual spending pattern will look like.

How do we bring some certainty into this uncertain world? Well we can have some experience of how assets behave, we know for instance that if you are simply looking to pay pensioners, you shouldn’t be looking for a return of more than 1% above inflation, if you have a mix of pensions to pay and cash to carry then you can expect to get some more return – say 2% above inflation (by investing in longer term strategies ) and we know that you weren’t taking cash and simply “carrying” , 3% above inflation is a reasonable assumption – over time.

We know that some assets will provide immediate certainty (cash) and little investment return and some assets will provide investment return but little immediate certainty. The trick is managing the mix, having confidence in your assumptions and having the balls to ride out the bad times in the hope that things will come right in the end. Which more or less sums up the funding philosophy of defined benefit pension schemes before the era where everything had to be guaranteed.

There are two ways you can increase the degree of certainty (other than by investing in low return assets).

The first is collective insurance – where people accept their will be winners and losers and accept that if their circumstances mean they don’t need extra help to pay care bills or to manage extreme old age, they will get less from the big pot than those who do. This is called “risk pooling” and is the basis of mutuals.

The second is a simple levy which is paid by everyone according to a formula. It might be a flat amount (a fiver a week) or it might be a percentage of your holdings in the big fat pot- (say 1%). This levy builds up a fund that you have a right to draw from in times of hardship.

Whether the payments are from pooling or from levies, the outcomes should be much the same and the difference is mainly presentational some people like to see the transparency of levies (hypothecation) and others see the mutual insurance model as more flexible and worth the loss of transparency.

But underpinning all this is the same idea as my Mum and Dad had, that if you get a great big bus and fill it with cheaply purchased and self-carried groceries, you can make your money go further.

In financial terms, we should be thinking about cash and carry facilities for those who don’t want or can’t afford the individual attention and pristine information you get from a Waitrose or M&S.

In my view, there is space for individual approaches and collective approaches and people can work out for themselves the relative values of a cheap and cheerful collective approach and a more tailored and more expensive approach (involving individual drawdown and annuity products).

The great leap forward is that we now have a way to discuss these issues in more than theoretical terms. I expect to see some of the ideas discussed in this blog, available to me in 2015. I will be 54 then and I’m already anticipating how I will be adjusting the investment of my DC pot in readiness for me putting my feet up in 2016 and taking the longest holiday of my life (and if you believe that you’ll believe anything!)

This article was first published in http://www.pensionplaypen.com/topthinking

 

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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