The work done by Iain Clacher and Con Keating on creating a consistent framework for a fair , sufficient and sustainable way of returning to funded pension provision is too important to sit on an academic bookshelf.
We have DC pots that rarely turn into pension and DB pensions that too often turn into DC pots. For most people, the only wage they will see in retirement is the state pension. The state pension is not sufficient for most people to live on and most people are not financially sophisticated enough to solve the nastiest hardest problem in finance – the conversion of a pension pot into a wage for life.
The FT run a simple headline this morning.
Despite the scorn poured on CDC by its critics, there has been no alternative put forward other than the wholesale adoption of advice by a population who show no sign of wanting to pay for it. The “poll” in question was conducted by LV= from a sample of 4,000 UK adults.
Just over a third, 34 per cent, of those who took part in the survey, commissioned by LV=, a pension provider, said they did not know how to ensure their money lasted through their retirement.
Even were there sufficient advisers, the cost of advice – when added to the management costs of self-invested-personal- pensions , makes SIPPs an impractical way to deliver pensions. As Con Keating put it yesterday , they are just too much hard work.
Meanwhile, DB is ensnared in its complexities. It’s not just the fundamental problem of the sponsor’s guarantee, it’s the flotsam of GMPs and the jetsam of McLeod that mean DB benefits are now so hard to measure, we cannot even get defined benefits onto a pensions dashboard.
Simplicity is difficult but essential
There is no doubt that the Contractual Accrual Rate that is at the heart of Keating and Clacher’s work is difficult for pension professionals to take on board. It is difficult because it goes back to the first principles of what a funded pension scheme is trying to do. We have become so used to the complexities of actuarial valuations of DB schemes that the notion that a DB plan needs only to achieve a percentage rate of growth to meet the target benefits it sets itself is hard to take on board.
But what is hard for experts , is easy for the general public. We understand that what comes out of a pension scheme is based on what goes in and the growth on the money while it is invested. Why this is hard for most experts is that we have lost confidence in the long term assumptions of growth in the economy and instead become paralyzed by fear of the next financial crisis, pandemic or by the impact of the next disaster (probably climate change). There was a moment in yesterday’s talk when a question came in asking
“what would happen if there was no growth, could CDC survive?”
Con Keating’s answer was “yes”. The simplicity of that answer included the inevitable conclusion that if there is no growth in the economy , or in asset valuations and in fund unit prices, then we will have lower pensions and a lower standard of living in retirement. By implication, if the world screws up, we will be poorer and will have to cut our cloth accordingly.
But we do not plan to fail, we plan to make the most of what we have. The plans laid out were based on a contractual accrual rate being established for each CDC plan and detailed by certain rules around tolerances where the CAR was not met or where it was exceeded.
These rules were set out in these slides.
They are simple rules that we can all understand. But they come from deep financial analysis and are simple as Einstein’s equations are simple – because simple is effective.
And at the heart of this is an important statement that “the membership of pension schemes is heterogeneous”. People’s experience in retirement differs, some live longer, some live healthier, some have low financial expectation, some high. Consumption patterns differ and there is no way of predicting who will need what with great certainty.
Therefore, as with any collective, there needs to be risk-sharing both within a cohort (the acceptance that those who live longest will benefit most from the pension payable) and between generations. There must be an acceptance that if the CAR is not met over time , younger generations will suffer and that if the CAR is exceeded the young will benefit.
This is common sense and it appealed to those in the audience. There was a substantial shift in the “before” and “after” polls away from skepticism and ignorance towards approval for CDC and an understanding of how it might work.
This was because Con Keating kept things simple, answered questions with straightforwardly and did not pretend that there was any certainty about the future. His insistence that we cannot insure against failure through creating buffers (reserves) was explained in terms of the CAR framework that accepted that from time to time – CDC will deliver financial reversals which will be deeply unpopular.
It is not nice being told you are not getting your expected pay increase and even less nice being told that you will be getting a pay-cut . However that is the bargain you enter into with CDC and the critical thing is that it is not a bargain that is imposed upon you. An opt-out into pension freedoms needs to be available.
There are – as John Ralfe points out – no magic beans. However, in a collective approach, there need be no DDT either. There is no need in CDC to de-risk and drop anchor on the future.
I hope in this interpretation of what was said at yesterday’s session, I have properly represented what Con Keating said. It was a compelling talk , if difficult. It was difficult because it dealt with fundamentals and because it challenged what has become received wisdom.
But what was said is backed up by research which has been distributed and will be distributed on this blog shortly. Thank you to Z/Yen and Chair Michael Mainelli and thanks especially to Con and Iain for their unpaid work getting us to a point where we understand how a collective system can work sustainably and fairly to improve the sufficiency of retirement income for those facing the longest holiday of their lives.
You can read Con Keating and Iain Clacher’s arguments in more detail by downloading their paper, available on this link.
And you can now see the presentation live (as recommended by Adrian Boulding in the comments to this blog).