There’s a very good BBC Martin Lewis Podcast on borrowing ; http://www.bbc.co.uk/programmes/p04qhdsg
We’ve always thought as Lewis as anti-debt (an advocate of “debt-free” living). The Podcast gives as an example a man who has moved to the country with his family who finds the only way he can get his kids to school and take the job he’s been offered is to buy a car. This will mean he’s taking on a personal loan while he’s still on probation.
Should he back himself, get into debt and risk personal bankruptcy?
Should he spend some time on benefits and wait for another job to come along?
Lewis points out that the loan (at an APR of 20%) is not necessarily “bad debt”. He gets angry that people will assume that this person hasn’t got a right to risk bankruptcy to get the right school and the right job.
The questions are what is the worst that can happen? (personal bankruptcy), how would this happen? (failing probation) and will this person back himself to do the job properly?
The only person who can answer those questions is the man, he must show leadership. He must assess his personal covenant and act accordingly. Martin Lewis cannot be the judge. Listen to the podcast.
There is a profession of people who assess the risks the man is considering, that of investing against sitting on your hands. These people are called Covenant Assessors and for the most part, they are looking at the worst case scenario (value at risk), the probability of something going wrong and will deliver a judgement on whether risk can be taken.
The problem with this approach is that it is anti-entrepreneurial. Since the risks of suggesting an entrepreneurial decision is taken revert to the Assessor and there is relatively little risk in advising someone not to take risk, the bias of Covenant Assessors is to take no risk.
Trustees (especially independent trustees) of Pension Schemes like to hire covenant assessors (ultimately at the expense of those being assessed) to help them take decisions. But they also like them, because the guidance from the Assessment is likely to be to avoid risk (the Assessor’s bias). Actually the trustees (especially the independent trustees) are also rewarded for not taking risk. There is a regulatory bias against entrepreneurial trusteeship. It becomes evident in
- Higher PPF levies for schemes investing more in growth assets
- Support from the Pensions Regulator in the approval of recovery plans
- Herd approval, conferences, articles and networking reinforce de-risking.
Infact, the bias towards a debt (or deficit) free world is inbuilt into the DB management system so that trustees have to step away to see the wider picture.
Take, as a case study, the Royal Mail, where the trustees have a deficit-free scheme and keep it so provided they stay almost entirely invested in bonds and either cease accruing further benefits for posties or get the Royal Mail to fund the scheme at 50% of salary.
The alternative for the trustees would be to take on more risk by investing in growth assets, but this is like the man borrowing while on probation. Should they be gaming the Royal Mail’s bankruptcy (and the scheme possibly going into the PPF) or should they be sitting on their hands waiting for something better to come along.
I haven’t read what the covenant assessors have said, but I’d be surprised if they weren’t saying that the Royal Mail is in no fit state to pay 50% of salary a year into the scheme, nor that the scheme should any risks of demanding deficit contributions from the Royal Mail by investing for growth.
Like Martin Lewis, I get angry that entrenched bias’ are driving decision making.
In a recent article in Professional Pensions, Goldman Sachs told DB Trustees that they were focussing too much on hedging and not enough on risk http://tinyurl.com/jdceaf4.
They see the bigger picture. They see the impact on the Royal Mail if they have postmen out on strike, of postmen leaving to work for higher wages with competitors.
They see the man who is frightened into not buying a car, to get the job, to make the move to the country a success. They see him not getting a job, losing job-seeker allowance and the misery of an unemployed Dad without friends or his usual neighbourhood.
The inherent bias in the pension system is mirrored by the prejudice that Lewis is sees in our attitude to credit.
Both bias’ stem from an over-emphasis on risk-free behaviours and an under-valuing of the entrepreneurial risk taking that drives growth not just in pension schemes, but in small and large companies – even in the development of families and individuals.
Of course it is always better to be in credit than in debt, but there is (as Lewis points out) good and bad debt. The line between good and bad debt cannot be drawn simply by looking at APR. Sometimes those with bad credit histories and with little security need to borrow to get back on their feet. As Lewis points out, sometimes that means us backing them to take on risk.
As with Martin Lewis, so with Goldman Sachs, individuals and trustees must see the bigger picture. Professional Pensions is running another story this week
So long as we hand over the running of DB schemes to those who are inherently biased towards a risk-free approach, so long will see schemes like the Royal Mail grounded on the rocks of a risk-free investment strategy.
We must start backing employers. We must stop imposing on employers ever higher demands, we must move to an “integrated risk framework” where the balance of risk is set in favour of risk elimination. We must see the bigger picture.
Sometimes we must invest , even when we are in deficit or on probation, we can invest to make a covenant stronger!