Has the hardest nastiest problem in finance just got a little easier?

nastiest 3

I enjoyed reading this serious and sensible argument by Steven Lowe of “Just”.  I suspect that most financial advisers reading it will conclude, as I do, that planning an income for the final years of someone’s life is so fraught that (if income is needed) it had best be provided by an annuity. This is the conclusion that all the workplace pension providers have come to. Every “guided pathway” on the market leads to the deferred purchase of an annuity – usually at 75.

But Steve’s article makes the point that if you make it to 65, you are likely to live well beyond average life expectancy

While facts in the newspapers may make it tempting for clients to target fixate, the reality is that life expectancy is transitory. A 65 year old man may be expected to live to 84 but those who make it will be expected to live to nearly 92.

Steve is writing to financial advisers whose clients are wealthy enough to have taken themselves out of the common way of financial planning (trust in my pension or hit and hope) and instead employed the services of an expert. Almost by definition, this self-selecting groups of clients will live longer.

What Steve doesn’t say, but has to be said, is that by staying in a pool of people who are likely to live a lot shorter, the wealthy are doing those poorer people in the pool a favour. They are effectively cleansing the pool of much of its longevity risk and taking that risk upon themselves (the hardest nastiest problem in finance).

Has anyone considered the impact of the wealth industry on pensions?

If occupational pensions lose their 10% longest living clients through CETVs to self-managed drawdown, then they are managing a different set of liabilities to those people hanging around and scooping the pool. This is particularly the case with defined benefit schemes which could become in twenty or thirty years time a means of supporting a few very old people (typically the spouses of the men who built up the pensions).

The wealth industry depletes the liability pool, probably faster than it depletes the asset pool, those transferring out of occupational schemes on high incomes carry those schemes biggest liabilities not just because of the size of their pensions, but the duration over which that pension is paid.

A lot is made of the problem of allowing people to select against their pension by taking a transfer value because they anticipate dying quick, not much is made of this opposite- beneficial – situation, where the rich select against themselves.

But we get that the richer we are the less we need income in retirement!

A great capital reservoir is a great thing to a capitalist, he or she can use a drawdown pot to fund all kinds of ventures, from deposits on dependent’s houses to small businesses set up to diminish the tedium of retirement. The agility of liquid capital – what pension freedoms is about – is precisely what an entrepreneur prefers. The rest of us “wage slaves” are about the maintenance of a wage for life which ensures there is bread on the table.

When Merryn Somerset Webb said in the FT that if she had a DB pension she would cash it out, she was saying more about her life aspirations than her financial skills. She is a woman with high self-confidence- Ros Altmann is another (again someone advocating transferring income to wealth last year.

The difficulty with these messages is that while they play well with core FT readers, they can (and are) lifted out of the context of the intended readership and used in advertising by the mass market transfer houses about  which this blog has spoken at length.

While shifting the wealthy out of DB schemes, is probably good news for those schemes, shifting the average Joe (of which I’m one) is not good news to anyone.

Typically people like me underestimate our life-expectancy by 8 years and writing with a new years eve hangover , I feel like living till 60 will be a challenge! But the reality is we do not know. We certainly don’t know about our spouses and even if we thought we knew, we might not now be so sure. Here is the Christmas circular from one of my friends. He doesn’t say he was given no chance of being on the planet past the end of 2015.

Health-wise, it’s all been good, my tumors have had a quiet year with no growth. so my wonder drug is still doing a great job! So well, in fact, that my oncologist only wants to scan and see me 3 times a year, not 4.

We just don’t know!

nastiest 1

Nobody can accurately predict their income needs for thirty years, there are too many variables and that is why increasingly we are looking for the break clauses that might allow us cash out an annuity or take a CETV while a pension in in payment.

My hard-core actuarial chums grind their teeth when I write such heresy but it is a fact of human nature that people are much more likely to enter a building if they know they can get out of it again! The truth is that most of us don’t need EXIT doors and won’t use them, but I would not have been dancing last night in a bar where I didn’t see the bright green light!

What I’ve argued in this article is that by giving people the freedom to leave defined benefit schemes, we allow the wealthy to do what they do best, which is to put capital to best use. By allowing ordinary people like me to have property rights over our pensions, we give us all the EXIT option – albeit one that we are unlikely to take. Auto-enrolment tells us a lot of things – but it shouts loudest that once “in” most people stay “in”.

What does this mean for CDC?

My first “guess” is this. Despite having no empirical data to prove I am right , I suspect that most wealthy people will want nothing to do with CDC – they are wealthy because they like to invest their money as they like.

nastiest 2

Most of us will not be millionaires


My second guess is that the 87% of postal workers who would rather go out on strike than be stuck in a cash balance or DC plan – voted because they wanted a pension – a wage for life.

As Con Keating’s masterful blog yesterday demonstrated, when you stop guaranteeing pensions , you can release sufficient upside from patient capital, to provide better pensions (pound for pound) than any other kind of pension scheme.

CDC has the opportunity to take a vast pool of people with relatively low life expectancy,  and allow the rich to self-select against themselves. By managing the pool on the basis of “equity” not “liability”, the pool can pay more – a function of the duration of investable capital.

Of course CDC could also screw up and become a series of Ponzi Schemes run for the benefits of mendacious actuaries but this seems a very low level risk. Far more likely is that CDC could be the way for the FAMR problem – the great unadvised- to find a solution to the hardest, nastiest problem in finance.

  • global aging
    Could we make them softer?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in actuaries, annuity, CDC, pensions and tagged , , , , , . Bookmark the permalink.

Leave a Reply