Can you run a pension scheme with no end in sight?

The concept of infinity has puzzled philosophers for millennia and I’m not taking it on in a blog. It’s temporal counterpart  “eternity” has at least the boundary of time, though it’s still pretty mind-blowing to think of anything being eternal.

We can cope with this kind of talk when it comes to spiritual love , especially if we have faith in a timeless entity, but when it comes to earthly matters – such s pension schemes, we are wary of labels such as infinite and eternal. Life just isn’t like that.

Life just isn’t like that…

My guess is that though we know that some pension schemes will exist after we have died, it is hard to think that they can help retire people who have yet to be born, and those unborn children’s children. And yet there is no reason to suppose that those with retirement ages dating into the twenty second century will have fundamentally different needs to ours. They will have been children, will have worked and finally reached a point where they will want to wind down from work and enjoy the benefit of being paid for doing nothing. I see no reason why this should not be. Life is just like that- it has been since the Greeks started philosophizing about infinity and eternity.

I also think we have a tendency to think of our world as finite because of the existential threats we imagine for it. When I was a child it was the nuclear bomb, then the world running out of fuel, now it’s fuel running us out of our world. We cannot imagine humans on the planet in a happy state in 2,400. I wonder if Shakespeare thought the same 400 years ago?

Are pensions timeless?

Clearly not. A pension is a string of payments that are paid till someone dies

Are pension schemes timeless?

Perhaps, maybe there will still be a state pension scheme paying to our ancestors 400 years from now though we can expect it to have mutated many times to meet the changing needs of people as life expectancy and working capacity changes. Current thinking is that we are on a linear progression which will see people living to 200 sometime in my 400 year horizon, but there is no certainty of that.

The certainty is around the obsolescence of the human frame and its organs. We haven’t found a way of living without them! But our capacity to live on in the memories of others certain was a matter for Shakespeare.

Not marble nor the gilded monuments

Of princes shall outlive this powerful rhyme,

But you shall shine more bright in these contents

Than unswept stone besmeared with sluttish time.

We live on in what we bequeath later generations, we crave that kind of intergenerational transfer. So why are we so wary of bequeathing our children and their children our pension schemes?


The fear of the infinite

I posted on twitter whether we could consider an open pension scheme “infinite” and got some interesting responses

 

Norma explicitly linked my comment to schemes sponsored by private companies. Mike Harrison considered the matter from the perspective of public pensions

Considering that question of the “pool of new members drying up”, and Dan Skiman commented that a collective pension scheme does not have to be sponsored by an employer

For John Ralfe and I suspect many others, the idea of a pension scheme set up simply to meet the needs of those retiring is nonsense.

 

But I am not sure that John and Norma are right in thinking of collective pensions as necessarily linked to employers. There are many examples of self-perpetuating mutuals depending on the arrival of new savers or borrowers and indeed this is the basis of the provident movement.

There is co-existent with the desire to create something for future generations (the legacy instinct) a natural clubiness between people that creates mutual financial arrangements and very often these arrangements happen because the people clubbing together are excluded from the arrangements made by others for others. We should not forget that most company pensions excluded a large proportion of the workforce, it was only the most philanthropic that were open to all.


Can you run a pension scheme with no end in sight?

I think the answer is in the blog and especially in Mike Harrison’s comment that you can so long as you know there is an endless scheme of new entrants. Can an employer do so, I would agree with Norma that no employer can guarantee its long-term existence far enough to have made the pension promises that guaranteed defined benefit schemes made. Perhaps we were asking too much when demanding that those  promises moved from “we’ll do our best” (best endeavors) to “guarantee”.

But it looks like the best endeavor variety of collective pension may make a comeback and since all pension schemes (including the state pension) have to change the promise over time, maybe we will look back at employer guaranteed pensions as the anomaly.

My view is that we can and should be setting up pensions with the capacity to run for ever but that we should be ready to bequeath those schemes to the beneficiaries if we are no longer able to manage and sponsor them. So Royal Mail should be able to pass on its CDC scheme to whatever it becomes and that might include passing the assets to a member mutual.  Commercial master trusts are often member mutuals (Nest, Bluesky and People’s Pension for example) and could already exist without the sponsorship of participating employers.

It is perhaps time to start thinking of DC pension schemes for what they are looking to do in future (pay pensions) rather than for what they are right now, savings plans. So long as people want pensions, then arranging  pension collectively is a legitimate activity. So long as there is no dependency on a sponsor, why shouldn’t open pension schemes consider themselves to be infinite in their capacity and eternal in their time horizon?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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3 Responses to Can you run a pension scheme with no end in sight?

  1. ConKeating says:

    There is certainly no need for CDC schemes to be linked to any employer. I am working with several affinity groups (mainly of self-employed traders) who are interested in creating these schemes.
    An open scheme does not actually need a continual flow of new members. It may have years in which no new members join. The extent to which such gaps arise and can be easily accommodated is scheme specific.
    There is absolutely no issue with schemes being perpetually open. There are in fact some debt securities which are perpetual – I own (some of) one. We should also note that equity is usually issued sine die. The value of a perpetual is well known – it is the coupon payment (C) divided by the yield (r) — C/r. Not so long ago we had rather a lot in the UK isn the form of Consols.

  2. ConKeating says:

    Fired that comment off prematurely – fat finger!
    My perpetuity has a coupon of 4.25% and I bought it on a yield of 11.8% rather a long time ago at a price of 36% of its nominal (but never to be paid) value. If we want to use this as an analogy for an open pension scheme, then funding at this 36% level is adequate provided that funding earns the yield – note there is no need for any employer here.

  3. Eugen N says:

    For me a scheme which is open is a lot more riskier than a closed one. On a close scheme, you have only the investment return and life expectancy of a group that you know to content with.

    With an open scheme you have more risks, you need to adjust (increase) contributions or reduce the promises as you accrue new liabilities. So I do not think this question has too much weight on how you plan your scheme. Each cohort of people should be considered separately i.e. born in 1972, separate than born in 1973, to allow for clarity there are no money used from one generation to the other. You should also expect transfers out before retirement of around 50% – 60%.

    Up to 20% or so tend to be not very healthy at retirement, and they would not want others to benefit from their misfortune. Others may want to plan their retirement differently, and unless the scheme allows it, most likely a transfer out will be recommended. Some trade offs like high-low options before State pension should be offered, as well as benefits as 25% tax feee withdrawals (like a string of UPFLSs till age 75 etc) to increase tax efficiency. Who said this is simple?

    Using an equity allocation is good to produce return, but the risk increases as the liability is longer in the future. If you plan to get 3% per annum return over the long term, to provide a £10,000 pension in 10 years you would need now a contribution of £7,440. For £10,000 in 20 years, you will need £5,537 contribution now. But if you get only 2.5% per annum return, you will be 5% short in 10 years, but 9.3% short in 20 years of your target. The longer you do not achieve your targeted investment return, even by a small difference, the bigger the problem you have.

    It is very important to get your assumptions right, and if not, to be able to slash forecasted pensions by 5% or 10% or even 20%. Added to that is important to be able to make life expectancy assumptions right, when there is also a high possibility of another push in life expectancy due to new medical treatments.

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