In the latest in a long series of rebuttals, Con Keating lets fly with an acerbic missive. John’s blog can be read here.
Hazard Warning: Recrudescent Ralfe Syndrome
The Times Business Section this morning was the scene of the latest outbreak of this pensions pathogen. Some minor mutations on previous outbreaks are evident, including that the prime carriers are now completely deluded as to what is and isn’t reality.
The commentary opens, misleadingly, by stating long-superseded, and now inapplicable, quotations as to the difficulty of completing the enabling CDC legislation. Royal Mail and the DWP are engaged on this task, and the next development we may expect is a DWP paper, on which they are already working, outlining its proposals for CDC. In fact, the required changes for CDC are modest and may be implemented by a simple and brief statutory instrument.
But the creation of an atmosphere of uncertainty, of great apprehension and dread, along with the promotion of remote possibilities to probabilities, is a symptom of the syndrome. Experimentation and innovation are then much simpler to depict as irresponsible and dangerous. It paves the way for millennium bug hysteria at its most extreme. We would do well to remember that if we make precautionary provision against every possible future event then we may well be unable to feed or clothe ourselves adequately today, let alone save for pensions. The comment asserts that: “The department is right to be cautious. Legislation for an entirely new, untested type of pension must be absolutely watertight to avoid creating new problems.” This is a clear misapplication of the precautionary principle. It runs counter to the calls from the FCA, Pensions Regulator and DWP for innovation in the DC space. Make no mistake, CDC is a form of DC; it completes that proposition by offering integral decumulation options. My central objection to the application of the precautionary principle is that it is unscientific, in both meanings of that word.
Sophistry is present: “CDC fans do a lot of arm-waving when asked to explain CDC — they must go beyond theory and produce practical details showing all the nuts-and bolts (Sic).” The advocates of CDC have produced numerous explanations and descriptions of the operations of CDC schemes, but with the enabling legislation not completed, it is not possible to describe the nuts and bolts of any particular scheme, as the author well knows. Indeed, it is likely that the specifics of different designs of CDC will differ considerably. Or is this simply a case of wilful or feigned ignorance?
The commentary contains its share of untruths: “Lobbyists claim that it can deliver average pensions, say, 10 per cent higher than defined-contribution schemes by smoothing fluctuating investment returns via “intergenerational” risk-sharing. We don’t.
This is related to the following paragraph: “But this higher average pension is simply because CDC takes higher investment risk, holding a higher proportion of equities and a smaller proportion of bonds. If an individual defined contribution saver was happy with the same investment risk, they also would, on average, get the same higher pension.” In fact, the disjointed nature of DC pensions, separation of saving and decumulation, means that scheme members are in fact taking very considerable risk – broadly speaking equivalent to holding only equities for their entire lifetime. One confirmation of this is the PPI multi-year study conducted for the TUC where a 60/40 equity/debt savings fund was converted to a life annuity at retirement, at the rates then prevailing. The savings funds exhibited a volatility of 11%, but the pensions a volatility of 18% – a level commonly associated over the long term to equities. By contrast, CDC schemes may hold all equity portfolios perpetually and through risk-sharing lower the volatility or risk experienced by pensioners to levels far below that currently experienced.
Of course, no pensions critique is complete without some wild scaremongering over intergenerational issues, whatever they might be. CDC schemes pool and share risks among existing members, equitably. They are in no way dependent upon inflows of new members; there is no subsidy of prior deficits from new contributions. There are no intra-generational issues, let alone inter-generational.
In this mode, the comment poses a question: “CDC fans should explain what happens when there are no new members and the youngest generation is left holding the parcel?” My answer to this is rather little of note; pensions continue to be paid to members in accordance with scheme rules, and the net asset value of their equitable interest is as likely to be above the promised pension value as it is below.
The author obviously felt that this intergenerational meme had impact for scaremongering purposes. “By definition, the first, oldest CDC generation, has taken no risk for an older generation, but the youngest generation takes risk twice, for itself, and the penultimate generation. End-to end the oldest generation gains at the expense of the youngest.” It shows a profound ignorance of the difference between (cross) subsidy and risk-sharing, where the latter is a compensated activity. End-to-end there is no gain to any member relative to another. There is no double exposure to risk.
The comment asserts, without foundation that: “The annual contribution is the same for all members, regardless of age, building-in a huge structural cross-subsidy from younger to older Royal Mail employees, which again must be properly explained.” The first thing to understand is that age-related contributions are perfectly feasible and may be utilised. I personally favour the age independence formulation incorrectly criticised above. This formulation is a form of ex ante risk-sharing among members. It represents a form of insurance of most value to the young. As insurance, it works both ways when investment returns are high the young support the old, when they can most afford to do so. And when investment returns are low, the old support the young, when the effects of low rates are most deleterious to their long-term savings. In addition, any residual bias there may be is offset by the fact that the young expect to grow old. This has been covered in numerous blogs, articles and published consultation submissions. Wilful ignorance on display?
Then comes a risible suggestion: “If the government does allow CDC, Britain should use well-established Dutch rules (where CDC is standard) to maximise fairness between generations.” We might debate whether CDC is standard in the Netherlands, rather than just a change of nomenclature, a rebranding of a flawed DB model. But the most telling point is that none of the Dutch pensions experts present at the recent CASS/NetSpar workshop, convened to share experience with DC plans, advocated the introduction of Dutch style schemes or regulation. Indeed, most of their advice was precisely to avoid the methods proposed by John Ralfe. And the very next sentence in his commentary, itself actually supports this: “Under these rules the Royal Mail CDC annual contributions could only support “target pensions” of just half the present DB pension.”
“If CDC stands any chance of working, we need both proper regulation and realistic
expectations of what it may deliver in practice, not the overblown claims of Royal Mail.”
Indeed, we will need proper regulation, but that need be little more than authorisation of particular schemes based upon their rules. Realistic expectations are the prime concern of scheme trustees in the contribution pricing/award setting process. As for Royal Mail’s claims being “overblown”; well, the market does not agree with that assessment, but hardly surprising as the quantitative elements of this commentary are all highly questionable.
As we have, as yet, no cure for the syndrome, perhaps we should introduce a quarantine and isolation procedure for its most virulent carriers.
— John Ralfe (@JohnRalfe1) June 11, 2018