Ros

I wouldn’t say my “postbag was full” , but my recent blog on the damage inflicted by pension consultants on the UK pension framework has raised a few heckles on social media. Having worked in pension consultancies for nearly twenty years (and as an IFA for ten years more, I am more than aware of their culture and when I say that the “primary objective of a pension consultancy is to maintain a perception of their omnipotence”, I stand on firm ground. Consultancies cannot afford to be seen to be wrong, nor to question their value, to do so would be to undermine their hegemony.

Baroness Ros Altmann is one of those who has commented on my blog and as a consultant to Government, she has good reason to defend herself. I was not thinking of her role when I wrote my blog and her long comment is as good as a blog in its own right. I am keeping my comments in green ink – there is more that unites than divides us.

ROS ALTMANN ON THE PENSION FRAMEWORK

Having watched and been part of the developments of UK pensions (DB, DC and State) for well over 40 years now, I must confess that I feel your criticism of consultants is rather unbalanced.

ROS ALTMANN ON DB

The successive tightening of DB rules, which turned a best efforts promise into a cast-iron guarantee was led much more by Government than the pensions industry. Forcing schemes to pay revaluations and partner pensions added significnatly to the costs of the young, immature schemes, which did not show up for many years and was partly driven by the desire to force employers to replace benefits that were otherwise going to be provided by the State.

Revaluation rates for GMPs were locked into ruinous increases after the 1995 Act, on top of which was the extraordinarily expensive requirement for mandatory inflation-linking from 1997, was another nail in the coffin at the same time as Government removed the dividend tax credits altogether.

Consultants did try to explain how dangerous this was, but were ignored.

My recollection of the 1990s is different and I suspect that the consultants you refer to were yourself and other economists who were advising Government. The mass of pension consultants involved with final salary schemes (as they were then), were happy to spend spend spend on discretionary increases and/or save save save on contributions – allowing employers to go on contribution holidays. These consultants “pivoted” when the harsh winds of the new century arrived and joined with the bankers in a call to “de-risk” these same schemes with LDI programs, which sucked the life out of them.

Other Countries’ DB liabilities are not typically inflation-linked and, just with the recent furore over schemes being allowed to change from rpi to cpi – and the eye-watering long-term costs just that small change would impost – it is clear that the inflation protection, on top of all the other baked-in requirements, have made DB schemes extraoridnarily expensive – indeed their value is still not yet recognised properly.

The value of DB schemes is experienced by pensioners , their voice is seldom heard. Consultants do not promote the fabulous value of pension increases, instead they promote pension increase exchanges which give jam today rather than protection tomorrow. The mantra is that the shape of the pension is wrong. PIEs are an example of clever consultants transferring value (and eating into the value chain). There are many other examples of  liability de-risking at the member’s expense, the commutation factors on tax-free cash spring to mind. Consultants live off the unrecognised value of DB schemes – exploiting rather than promoting it.

On top of the programme of QE since 2009, which I have tried to warn against for over ten years, the costs of pensions and their liabilities have soared by far more than any accompanying rise in asset values.

That resulted in consultants moving away from relying on asset growth (as should have been the ideal way forward for remaining open schemes and those who were still decades away from maturity even if closed).

This is the failure of nerve for which consultants should be held responsible. Consultants openly embraced mark to market valuations and crumpled. They made too little effort to push back against the extra liabilities imposed by regulators and led the charge to close DB schemes first to new entrants and then to future accrual. The “long-term view” of pensions was sacrificed for a rush to leveraged bond programs, the cost of which was born by sponsors as deficit contributions ballooned. 

So schemes have switched wholesale away from upside potential in assets like equities or others where there is an expected risk premium to deliver better returns, into supposedly ‘low risk’ bonds or sovereign debt, which cannot offer the long-term returns needed to meet the immutable past liabilities.

Most consultants have now effectively become annuity brokers, giving up on managing assets and focussing more on managing liabilities, which is a recipe for failure, but will be brilliant for insurers in my view.

Many consultants who led the charge to buy-out and buy-in , now sit within the insurer’s bulk annuity departments. Many more will follow. 

They will go on to use these hundreds of billions of pounds of DB assets to invest in growth-producing projects which could have helped employers afford their liabilities and not plough so much into their DB schemes in order to remove balance sheet risk, thereby also weakening the corporate resource of those firms.

I think “will go on” should be “could have gone on” as the opportunity cost you describe has been lost. Unless the insurers back annuities with purposeful assets, which I hope they do.

Consultants were encouraged on this path by regulators who, instead of professionalising the investment approach of DB schemes and pushing for a little more flexibility, decided to focus on the supposed removal of risk.

I agree with this, but isn’t the head of tPR’s policy team a pension consultant. Isn’t the head of PWC’s corporate consulting team a former banker who also headed tPR’s DB  function. Who was the tail and who the dog? Britain’s highest paid pensions CEO is the former CEO of tPR, the regulator’s are springboards for career advancement , there are few true regulators – you had one advising you.

But removing the risk has also removed returns that would have helped reduce liabilities and deficits, because low-risk investments cannot keep up with the rising costs of inflation-linked liabilities, even if demographics improve. And as gilt yields rise, the asset base will fall whereas using those assets to invest in growth projects would have helped fix deficits.

ROS ALTMANN ON DC
On the DC side, the idea of locking into annuities at current yields, especially if inflation-linked, is again not in my view a sensible way to move forward. And locking into fixed pensions at low rates will take away the potential upside, so we need carefully managed approaches that encourage people to leave their pensions invested for as long as possible, use their other assets to draw on first and ensure that their money is being put to good use and build up more in pensions if they keep working longer, rather than ending their pension at age 55 or 60 as is so often the case right now.

I agree with this and applaud your recent blogs. The cult of early access has become so embedded that even the proposed raise of the minimum retirement age to 57 is being complained of as an infringement on pension freedom (despite it being part of the deal).

CDC is also an opportunity for consultants, who will need to carefully assess realistic return, interest rate and mortality assumptions relevant to each scheme, depending on its workforce characteristics,

CDC appears to offer consultants very few opportunities and a huge threat from consolidation. Provided they are allowed to operate at scale , they will take the complexity out of DC and become part of the consolidation we need to see around a handful of large DC schemes. My fear with regards DC is that “consultancy creep” means we end up with hundreds of sub-scale CDC schemes all tailored to the needs of employers. This tailoring is a total fiction dreamt up by consultants which manifests itself currently in scheme specific defaults which consultants sell to non-plussed employers who feel they ought to be doing more for staff than DC does.  Consultancies are (as yet) showing no interest in converting their own master trusts to CDC , nor much enthusiasm for Government’s plans to consolidate DC around large schemes. Homogeneity and standardization are not “virtues” in the consultancy psalter.

…but I do fear that there will be a danger of those allowed to transfer money out being able to select against remaining members because there seemed too little support for the concept of ‘risk margins’ being built into transfer values, to reflect potential future market weakness or unanticipated cost increases which will fall entirely on remaining members.

I agree that transfer values from CDC will be a matter of great contention. It is telling that we are paying more attention on how to get out of CDC than how to get into it. BAU for most people is to join a scheme and stay in it.

ROS ALTMANN ON DB TRANSFER VALUES

Indeed, I have also called for reductions in transfer values from DB schemes to reflect current deficits, rather than future projections of full funding which have most frequently been used by consultants.

The consultants have been using DB transfer values as a means of getting short term value onto employer’s balance sheets. They have done this irresponsibly and have failed to manage the implications for members. When BSPS hiked CETVs by 70% to reflect lower discount rates , no effort was made to explain what was going on to members. We all know what followed. Many who took CETVs at lower rates are now pursuing claims based on the true value of their benefits while those who took the higher values are claiming those were mis-sold to them. Meanwhile, the architects of the chaos, the consultants who advised the trustees , are not held to account.

So there is a combination of faults leading us to our current position, and I still think consultants could be part of the solution, rather than being the underlying problem. In DC, of course, the role of ‘consultant’ extends to expert financial advisers and pension providers who can reach out to customers and help them understand the benefits of their pensions and investing for the long-term. Guidance is a good start, workplace financial advice should be part of an employee benefit program and mid-life MOTs could be adapted for regular 5 or 10 year financial ‘healthchecks’ to assess what path each worker may be on toward their later life income needs or goals.

I agree with this, but we only need these workplace education programs because we have allowed pensions to become so complex. As with “de-risking”, consultants see opportunities to make money from clearing up the mess they helped to create. If they were to support consolidation of DC and DB schemes and the use of CDC rather than the pursual of investment pathways, I would be less critical. But I continue to see consultants miring pensions with unwanted complexity to their own ends and to support their supposed omnipotence. We cannot do without consultants can we?

Lots still to do, but the pension opportunity is enormous, if the industry adapts its thinking to harness the power of these vast assets in the interest of those who it needs to serve.

Henry, thank you for all you are doing to highlight important issues.

Ros