This blog is about the communication of “risk” by pension experts to ordinary people and it follows from comments I’ve made over the weekend on the lack of communication of risks within DC schemes, especially schemes that “de-risk” their default fund for those in their fifties and sixties.
A risk shared is a risk halved
Risk is inherent in any plan designed to provide benefits years and decades away. But the “pensioner risk” is pretty consistent, a good outcome – where risks taken have paid off, lead to good outcomes and the reverse is true. Obviously “pensioner risk” is highest when the pensioner has to take all the risk (DC) and less in shared risk plans (CDC) and less still in corporately and then state funded DB. The better the promise of help (the covenant) from third parties, the lower the risk of bad outcomes, though even the state can go back on a promise, as we saw with the triple lock this year.
My beef is that we do not think of pensioner risk consistently. Members of DB schemes are on easy street, the worst that can happen is that they get some of their pension clipped if their employer fails and their scheme goes into the PPF.
By comparison, the members of DC schemes can see their future benefits slashed by circumstances beyond their control, when they are tied to the stake of an inappropriate de-risking strategy. This is deemed an acceptable risk to have been taken because the people who measure risk in terms of “matching assets and liabilities” saw de-risking in the member’s interests. This is so very wrong, 90% of DC savers are not exposed to interest rate or inflation rate risk and do not need to be in bonds and long dated gilts when interest rates and inflation are on the floor. And yet – unaccountably – millions of DC pots are “de-risked” into such instruments and pots damaged beyond repair.
And now we come to the treatment of risk in “risk-sharing” pensions by which we can mean any attempt to pay an income to life which does not rely on a purchased guarantee. I do not see purchasing a guarantee from an insurance company as “risk sharing”, it is a risk transfer paid for by a premium which is born in a reduced income over the period of the annuity (usually the rest of your life).
What really gets my goat!
In risk-sharing , pensioner risk is born within a specific group who self- insure the risk of dying by pooling their experiences; those who die soonest subsidise those who live longest. Similarly, there is a degree of cross subsidisation in the investment policy , where some members of the pool may see their investment gains being used to pay pensions to those who haven’t had the same investment success. This is justified on the basis that these things even themselves out over time – which they do.
These risk-sharing arrangements needn’t de-risk so long as there are new people arriving in the pool to replace those who leave it.
But because there is no “de-risking” going on – because these risk-sharing arrangements can invest into the future in assets designed to grow over time. these arrangements are singled out for being “risky”. The people throwing stones at risk-sharing arrangements are almost always those who have lived on DB easy street where there is an employer to bail you out if things go wrong .
So we are told that members entering into a CDC pension will have to face a risky future in retirement with every chance that pensions will not receive full indexation and some chance that pensions may from time to time fall. We are told that communication of this risk is vital to the success of CDC and great swathes of Pension Schemes Act 2021 and TPR’s CDC code are given over to communicating this.
But this risk is as nothing to the risks of those who are in DC schemes. Where are the comparable risk warnings to people in default funds that “de-risking might result in your fund falling in real terms 25-30% (up to 40% if you allow for inflation)? Where is that warning? Is is any guidance from TPR or in the FCA’s rulebook? I haven’t spotted it.
It strikes me that there is no consistent way of assessing, communicating and mitigating risks across the spectrum of workplace pensions we have in this country. Risk is perceived from the perspective of people in the easy street of DB.
We all know that we have to have rules that warn people about things going wrong. I don’t think we need prominent risk warnings for DB or state pensions. I do think we need risk warnings for CDC pensions but that they need to be proportionate to the risk and in particular to the risk of not sharing risk.
But – and this will be the big lesson for DC from 2022, we need to make it clear to people that DC is a singularly dangerous place to be, that unless people actively engage with their pre-retirement planning and set out their strategies, they are at risk of being in the wrong funds at the wrong time and that could be disastrous.
Of course. it is unlikely that such warnings will be pasted onto benefit statements and retirement packs , unlikely that there will be communication plans sponsored by employers or by the funders of commercial workplace pensions or even Government, because the risks of “de-risking” are not the kind of things that the people in charge want to talk about.
2022 has taught us that DC is a scary place , that de-risking can be as disastrous as scamming; it’s taught us that there is current investment pathway that doesn’t carry big risks. That cannot be right.
We need a proper way to turn pots to pensions and so long as we advertise a workplace “pension”, we are in breach of our duty to our consumers. We are failing to either manage or communicate the risks we are asking them to take and misrepresenting the product we are selling.