Pensions are at a crossroads. For 30 years they have been travelling in the direction of the financial services and we could continue that direction of travel. We could turn left and go Dutch or turn right and adopt the American system of self-reliance. Finally we could turn back. Here’s Auden’s advice to the traveller in his great poem The Watershed.
Go home, now, stranger, proud of your young stock,
Stranger, turn back again, frustrate and vexed:
For Britain , the future of our pensions future may not be the Dutch or American model, nor a continuation of the personal pension model we have pursuing for over quarter of a century. Our future may be, like Auden’s stranger, in our past.
This is not a romantic or nostalgic regression, it’s a recognition that we have been travelling down a wrong road for some time and must now retrace some steps.
Fortunately it does not mean unwinding what has been done, we can take a shortcut to the past and that process starts with the current reading of the Pension Schemes Bill.
Auden’s view of the world was not wholly derelict
Who stands, the crux left of the watershed,
On the wet road between the chafing grass
Below him sees dismantled washing-floors,
Snatches of tramline running to a wood,
An industry already comatose,
Yet sparsely living….
Those lines do it for me. The spirit of optimism that surrounded the provision of pensions when I came into financial services over 30 years ago is “yet sparsely living”.
But the contract between Government , employer , trustee and employee to use joint best endeavours to achieve a replacement ratio of 2/3 final salary has almost been broken.
Almost but not quite- “yet sparsely living”.
Dutch or American – who’s interests are being served?
The New York Times published a good article over the weekend. I urge you read it on this link. Its author, Mary Williams Walsh clearly admires the “no smoke, no mirrors” approach of the Dutch system. The article doesn’t pass by the conflicts between older and younger people in the Netherlands and it properly reports the shock felt by pensioners when pensions were cut by up to 2% post the financial meltdown.
The Dutch debates are being conducted at a societal level, moderated by the Regulator, the Dutch Central Bank and participated in by those in and out of Government. This debate is not being led by the Financial Services industry who are subordinated to the role of delivering on strategic decisions taken by those who pay and receive the benefits.
By contrast, the debate in the USA is led by the financial services companies who appear both the architects and beneficiaries of the 401k system, American public pensions are in such a poor state that whole Cities such as Stockton and Detroit have declared themselves bankrupt as they cannot service their pension debt.
The implication of the article is that where the debate over retirement funding is left to those with separate agendas, the delivery on promises is jeopardised.
Why there is so much opposition to a change in direction
In Britain, as in the US, delivery on expectations from DC plans has fallen way short. This can be blamed on heroic assumptions on asset management growth and a rash bet that inflation and interest rates wouldn’t fall. But the one constant is that the profits of financial services industry have remained steady. An annual management charge may reduce nominal revenues when markets fall but (like dividends) the underlying profit streams remain constant. In the new era of semi-compulsory universal contributions, the financial services has everything to gain by a maintenance of the status quo.
Which is why any talk of turning left towards the Netherlands or turning back towards the promises that our pre-87 defined benefit made, is met with staunch opposition by those with a charge on the assets. For them, the direction of travel at the crossroads must be straight on.
Why we need to go back to go forward.
The lesson from the Netherlands is that by embedding the issues surrounding retirement funding into the national political debate, pensions can break free from the servitude to the external interests that have been so destructive to value in the US (and to a lesser degree in the UK).
The Netherlands has been for some time at or near the top of global pension rankings compiled by Mercer, the consulting firm, and the Australian Center for Financial Studies. Denmark (a next door neighbour in geographical and pension terms) is top.
But the Netherlands is not Britain (nor Denmark). We have unique circumstances, a strong workplace pension accumulation culture, an efficient DC accumulation apparatus and a contribution system that is both voluntary and inclusive. We have no need to change these things.
But we must change other parts of the system.
20 years ago, Frank Field and Tony Blair were talking about private pensions as Britain’s economic miracle. They were talking about a system that was being dismantle around them.
The high-watermark for UK private pensions was the mid-eighties. The successive reforms that moved our pension system from market leader to market average was the imposition of unnecessary and unwanted guarantees on the benefits offered. At a time of high inflation , high wage growth and high asset returns, these guarantees had little initial impact on funding. But when interest rates fell and market returns dried up, the cost of the guarantees emerged.
Not only did they impact corporate cash flows (as surpluses turned into deficits) but they impacted balance sheets which were forced to disclose deficits to interested parties. From miracle to millstone in a decade, pensions were destroyed by pension guarantees.
We need to go back to rediscover the miracle, not forward into a system of guarantees, reserving, banking instruments and gilt plus income streams.
I believe we can do so without throwing away a system of DC workplace pensions which is accumulating the funds necessary to pay people proper pensions.
Pensions cannot serve two masters
For many years, the pension industry has purported to serve the interests of its members. But increasingly it has been serving its own interests. This conflict, supposedly managed by trustees, is often not managed at all.
One only has to go to a major pensions conference, such as the impending NAPF benefits conference, to see that the agenda is now controlled by the providers of services (whether administrative, consultative or administrative) that should be called upon when needed.
Employers, who stand in the place of trustees in the choice and governance of workplace pension schemes have been exposed as some of the worst buyers the OFT have seen, they are totally reliant on providers and advisers for the decisions they take.
Stronger rules are the only answer
We do not see more rules as the answer, we see stronger rules as the answer. The enforcement of the RDR, the ban on consultancy charging, the charge cap and ancillary measures and the proper measurement and control of fund management costs are the inevitable consequence of the “financial services takeover” that has happened to the pensions industry.
But the long-term solution is to return to a system where independent fiduciaries maintain the balance of power. The Pension Industry can only serve one master, the beneficiary of the scheme or plan. Trustees, governance committees and IGCs may act as agents for those beneficiaries but it is the beneficiary who matters.
We need strong regulation to put the beneficiary and his or her agent back in charge so that the conflicts mentioned in this article , do not return.