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
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 email@example.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.
Indeed, the risk transfer to the young is an issue but one that can be mitigated with excellent goverance (inc member nominated reps) and regulation. The alternative is individual DC where the risk is greater to the young from poor investment choices, and drawdown strategies.
— Josephine Cumbo (@JosephineCumbo) June 14, 2021
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.
And usually people are delighted if their income goes down in retirement… Makes for great headlines as well
— Veronica Humble (@veronica_humble) June 14, 2021
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.
It’s quite clear that without guarantees , members own the risk. We’re helped out by the tax-man, regulator, trustees, investment managers and with a bit of luck- a sponsoring employer.
— Henry Tapper (@henryhtapper) June 14, 2021
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!