“The old is dying. But the new is miserable”. The FT demands pension reform.

the new miserable


In an important and I fear  under-read opinion piece, Martin Wolf  characterizes the UK’s shift from DB to DC workplace pensions in a pithy phrase

The old is dying. But the new is miserable.

His historical view is that provision of DB pensions by private corporations has become unacceptably expensive to corporate sponsors. This is factually true, but it has only become so because we have lost sight of the original vision which was to provide pensions for life from with the best endeavors of trustees and sponsors. Members of the original pension schemes were not given to expect any guarantee of indexation and implicit in the deal was that the scheme would pay out what it could afford.

A relation of mine explained this to me, he was at the time Chair of Trustees of the Unilever Pension Scheme which was trying hard not to over-distribute pension increases above its member’s expectations. What occurred in the eighties and nineties of the last century was a hardening of expectations into promises and promises into guarantees, and along the way people got used to the idea of a wage for life pension , with no downward review pension increases built in.

Another Chair of Trustees, Andy Cox, reminded me recently that up to a third of the cost of a DB scheme to its corporate sponsor is in the guarantee of pension increases. The cost of the triple lock on state pensions may be even higher.

Home truths about pensions

There are some important truths about pensions that people need to face up to. Firstly about this idea of a guaranteed wage for life with no downward reviews.

Few of us would sign a rental agreement for up to 50 years where there was no downward review on rents. Few employers would offer a job on the basis that the job would see guaranteed pay rises for as long as the jobholder was on the planet (and to his spouse if he/she wasn’t). But these features are baked into corporate DB pensions and the Local Government, Civil Service, Teacher’s .Fireman’s , NHS’ , Judges and MP’s schemes all retain these promises.

The promises are so binding that they have brought some companies down and will bring more. Not being able to meet future pension obligations is an insolvency event and it means that those enjoying DB pensions are putting the jobs of those who aren’t at risk. This aspect of the intergenerational transfer is rarely discussed, as is the burden on private industry, whose taxes partly pay for public sector pensions.

We can afford to meet these obligations and importantly it is probable that it will be more expensive in the long term to close the open private and  public sector schemes which rely on funds to pay their pension. This is graphically illustrated by this chart.

The first home truth about pensions is that we are where we are and continuing to close open pension schemes to future accrual is only going to beggar our neighbors.

The second home truth is that much of what has been promised was not originally expected and there is an argument that returning to the original “best endeavors”  approach may be the way out of the hole schemes like the USS are in.

Indeed, were we to make indexation conditional on the ability to pay, most funded DB schemes would become CDC over night. This would not mean they would close, it would just mean that they would be a lot more sustainable over time, because up to a third of their liability base would be based on the scheme’s ability to pay.

In practice, negotiating away promises like indexation is unlikely to happen and we are unlikely to see affordable DB offered as a workplace pension even by the Unilevers of this world.

But what of the miserable new?

The alternative to DB is not some brave new world of pension freedom but the misery of underfunded pension pots which buy pitifully small guaranteed pensions without indexation or offer a hit and miss drawdown strategy often doomed to fail by the high levels of adviser , fund and platform charges that eat into the sustainability of the income.

The only alternative to drawdown and annuity, for those who need the money in their pot is to cash out, which results in drawing down from a bank account. All three options are miserable, the fourth option – for those who don’t need a pension – is to manage the pot as a legacy for future generations. This is not what pensions received tax incentivisation for.

Pension freedoms are awesome in prospect but miserable in practice. Navigating them is like taking a fully laden oil tanker through the straits of Hormuz and many pensions are being robbed by pirates known as scammers.

This is why Martin Wolf writes that

Radical reform of British pension provision is urgent

I am an FT subscriber and for readers who are interested enough to want to read the full article, I am happy to pay for a link to be sent you that will allow the article to be read by you and two others. Mail me on henry@agewage.com for the link.

And what is the pension industry intending to do about all this?

There is sustained opposition amongst pension professionals to radical reform. I posted my article praising Wolf’s piece on twitter yesterday and it got a lot of friendly fire from people who I had thought would have seen sense in Martin Wolf’s  and Jo Cumbo’s arguments.

On the one hand , the idea that risk can be managed through solidarity between generations is deeply unpopular among pension experts.

Ros Altmann has recently commented  on this blog, arguing  that CDC is also the enemy of choice and that financial planning is the secret to a well heeled retirement.

I don’t believe you can devise a one-size-fits-all solution that would suit people and a collective DC approach with quasi-annuitisation that does not take account of individual needs seems to me to be a dangerous way forward. What is really needed is a system that encourages people to consider those questions above (and others relevant to their own situation) and only then can they be better equipped to choose the better path forward.

But the loudest cries against change are from those who cling on to the certainty of guarantees.

It is certainly true that CDC offers no guarantees and Victoria’s comments referred back to a tweet from me in which I tried to make it clear that CDC will have to be upfront with its public in explicitly denying any promise or guarantee of a certain wage.

Reading back through the various people chatting about this yesterday lunchtime, I see no-one within the pension establishment very much interested in radical reform. What I see is a continuing belief in the misery of DC and the attraction of guarantees (what Wolf sees as “the old system dying”.

I share a view with the FT and a few others, that CDC is the way forward because it is neither “the old dying” or the “miserable new”.

Veronica is probably right in saying you won’t get  support for non-guaranteed pensions but when we start to see comparisons between the pensions people are being paid from CDC schemes and the annuities and drawdown pensions which others have purchased, popular support will grow.

It is a shame if we have to wait another ten years to be proved right. But I intend that we won’t have to make that wait!

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 “The old is dying. But the new is miserable”. The FT demands pension reform.

  1. John Mather says:

    Surely the message is clear collectives work through the tax system on a pay as you go basis.

    Private provision tops up the State 30% of NAW

    DB only really worked when leavers could be used to subsidise those who reached maturity and then retirees helpfully died three years later. Longevity has screwed that model while morbidity has burdened the care service beyond redemption

    If the U.K. was more productive the State scheme could have the ambition to deliver a living wage. Brexit has crushed that ambition at birth

  2. So sorry Henry but the explanations of past problems and future solutions here are far too simplistic. DB works for the member, but not for an employer in the private sector. DB requires guarantees to be made today which will only be honoured decades into the future. But average corporate life is around 10-15 years, so I’m afraid DB cannot be relied on. I totally agree that indexation has proved a costly error, but that stems back to the days when DB schemes were immature, could benefit from leavers’ contributions that stayed in the fund and not many pensions were in payment, so actuarial advisers could forecast that the schemes were in surplus. In order not to be taxed on these so-called ‘surpluses’ (Government decision that I believe was really wrong) trustees were encouraged to promise better and better pension terms, including spouse cover and annual inflation uplifts (no other country has DB schemes that were as expensive as ours). They were not surprluses, however, they were buffers against bad markets and risk margins against future unforeseen changes. But sadly those funds were dissipated and distributed to the older members and left younger members more at risk. Having Member Nominated Trustees or independent advisers did not stop the older members benefitting prematurely at the expense of younger members’ future pensions. The concept of DB which is legally enshrined in law and can never be reduced regardless of scheme funding does not fit with 21st century capitalism. Jobs for life are gone for most people. Companies that can be relied on to be around in 60 years’ time are just about non-existent. Public sector pensions could be underpinned by taxpayers, but the costs of the guarantees have soared and most people don’t realise just how extraordinarily generous a typical unfunded DB scheme really is.
    And then we have had QE – a massive policy error in my view, which may have been worth trying as an experiment in pro-growth policy in 2009, but has now become the Government’s and financial markets’ best way of making money. The artificial distortion of long-term yields what were supposed to be ‘risk free’ assets has led to huge rises in liabilities (much greater than the rise in assets) and has dramatically increased the cost of DB promises from perhaps around 25% of salary, to nearer 50% of salary – but none of this is transparent.
    CDC does not guarantee any future pension, and is bound to see the oldest members benefitting at the expense of the young. Pension increases may not be formally ‘guaranteed’ but most advisers would be loathe to cut pensions, even if investments were doing poorly. And if those transferring out of CDC are given the apparent full value of their share of investments at today’s prices, then again there is no buffer against bad markets in future, nor any risk margins to protect against future unanticipated increases in pension costs (this was the mistake made in DB in the 1980s) Ministers rrefused my efforts to insert such risk margins into CDC legislation, and therefore allows members to select against the CDC scheme, which is bound to pose problems for the long-term. Of course today’s advisers will not be around by then, but if we want to set up a private pension system that is sustainable, then it cannot rely on one-size-fits-all assumptions in my view. Pensions should be personal, with individuals taking responsibilty and interset in how their money can work for them. ‘Experts’ don’t know and can’t know what is actually best for each individual, but they can help them understand how to use their funds – in most cases the best advice is not to take the money out when still relatively young (i.e. in your 50s or 60s) unless you are seriously unwell and have shorter life expectancy. Encouraging people to think of pensions as money for their 80s and 90s, rather than 50s and 60s, and perhaps a little extra before that to top up less than full-time earnings, would be a more sustainable solution (and also more helpful for the long-term) than perpetuating the idea that people can save enough to build up funds that will pay good pensions for 30+ years in later life. Employers can’t underwrite this and pension policies which fail to take account of each individual’s health, other savings, working status or which allow transfers to select against remaining members, are likely to prove unsustainable or unfair between generations.
    People are not incapable of making their own choices as to how to top up their state pensions, but they do need help and ideally advice. Which is an individual need, not a collective one in my view.
    Yes, CDC should be more sustainable than DB, but individual DC is more socially equitable.

  3. Bob Compton says:

    There is much I agree with in Roz’s comments on the history of DB, and I can share her concerns for the potential of intergenerational unfairness if CDC Schemes are poorly structured. I would recommend Roz read many of the articles penned by Con Keating, on operating CDC based on member share of funds determining member pot and pension.

    If one can’t use modern sophisticated computer programs to manage member share, on a daily, hourly or minute by minute basis, then what will be the middle ground that Martin Wolf is seeking? I would suggest it could be the use of CDC pension pots by cohorts based on age. This is where on deciding to convert all or part of your DC pot when a “wage for life” is wanted to be set in place, rather than purchasing an overly expensive annuity (in part due to QE), transferring ones pot into an age cohort CDC pension can be a solution. However each cohort pension member will have to accept that should they die younger than the oldest surviving pensioner they will have subsidised the the oldest. This is the basis of true insurance and pooling of risk, but provides a degree of certainty as pensioners age..

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