You can read Toby’s paper on funding the unfunded pension liabilities of the public sector here.

He could hardly have been more contentious , though Nangle stops short of calling for the state pension to be funded. (One of my friends thinks the state pension  is already a CDC scheme and that it  would be better linked to market returns than the promises of politicians).

Though it stops short of  pension wonderland, this paper takes us pretty far down an unexplored rabbit-hole .

It is a must read for anyone seriously interested in pensions as a societal , fiscal or economic driver of positive change.

Public sector pensions are not like the state pension , if you want to change their pension age or indexation, you have a different set of challenges. They are not a political plaything.

Putting public sector pensions on a funded basis should not change the benefits “savers” get, it would principally be a societal, fiscal and  economic move. Transferring a huge slab of off-balance sheet liabilities to the Treasury’s balance sheet would indeed be radical

In his Foreword, William Wright of New Financial writes

This paper makes a strong political, fiscal, and macroeconomic case for
reform. Shifting to a funded model would enable these schemes to become
global investment powerhouses – the NHS scheme would be the third
largest pension scheme in the world. They would become more politically
sustainable, driving better long-term outcomes for public servants and setting
an example for the rest of the UK pension system to follow.

The cost of funding these schemes would be lower for the government, providing a
better deal for taxpayers. And for good measure, transitioning these schemes
would lead to higher levels of investment, deeper capital markets, and a
more stable international investment position for the UK

But of course it isn’t as simple as that. A Government run funded pension scheme the size of the NHS could be a lot cheaper to run than smaller funded schemes but it would generate monstrous fees to the private sector however it disintermediated (something Nangle acknowledges). The act of funding would radically change not just the pensions industry but of UK financial services ( of which Nangle is a past and no doubt future player). We should be aware of conflicts (Nangle is).

You wouldn’t fund an unfunded liability without very good reason and this paper sets out the reasoning. Nangle concludes in favour of asset backing.

Costs aside, we can see that while there are good academic arguments to be made for PAYG’s equivalence to
asset-backing, the fiscal, political, and macroeconomic arguments in favour of asset-backing support this path of
reform.

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My position  – partial funding – shared outcomes

In my view there is a case for the investment of member (saver) contributions provided that it results in “shared outcomes”. Over time, all of Nangle’s arguments suggest that this money would generate surplus funds to pension liabilities, the option to pay Christmas bonuses to public sector pensioners and to return to the Treasury a balance, would be popular. By limiting funding to what the member pays, the loss of cashflows to the Treasury could be manageable (especially if it was introduced on a stepped approach).

This approach of outcome sharing is not “risk-sharing” as the tax-payer bears the market risk from failure of assets to perform. A “risk-sharing” approach – CDC – might follow – though this would be politically and societally difficult.

The advantage of shared outcomes is that it introduces a substantial  part of the workplace to the upside of long term investment in productive assets. It is easier to share positive outcomes than risk.

Nangle does not underestimate scale

What I consistently like about Nangle’s paper is its boldness. He does not dodge bullets.

To put the scale of these schemes into perspective, the £47bn that the OBR estimates was paid into these schemes in the year 2022 to 2023 is more than half as big as the total £80bn in contributions paid into private sector defined benefit schemes,
private sector defined contribution schemes, LGPS, and personal pensions combined.

“Radical” is radical in this case. “Paid into” would be better described as “paid through” as the notional deficits and surpluses attributed to the various schemes are just like weirs on rivers. Money is sluiced by the Government Actuary on the basis of need, it is assumed that there will always be water up river. There is no big reservoir but simply a river. Funding is about creating a reservoir.

The Thames weir at Old Windsor

Nangle breaks down the case for funding these schemes (the reservoir approach) on three grounds

1. It makes these schemes more politically acceptable to the UK population as a whole (I would prefer this to be considered “societal” rather than “political”
2. It is fiscally sensible – the funded approach works (even net of fees) – which is why people like Edi Truell want to fund DB pensions with their capital
3. It is economically sensible; we envy the Canadians when the Ontario Teachers Plan swoops to buy up parts of UK infrastructure, we gasp at what schemes like CALPRS in California can do. Wouldn’t it be good to have pension funds that double up as sovereign wealth funds?

Personally I find these arguments compelling but we know of many funded pension schemes (especially US municipals) that are run badly and have ended up bankrupting towns and sectors. The reservoir can run dry. Funding introduces a different kind of risk and the old adage “if it ain’t broke- don’t fix it” has merit.

Simply holding up LGPS as a case study on how to do it, isn’t quite right. The 140% funding achieved by LGPS resulted from an arm-wrestle with participating employers for contributions which weren’t needed. Simply filling up the reservoir doesn’t serve much purpose. The same can be said of the PPF with its exorbitant levies and over-funding.

Which is why I favour a system where surplus is shared (leading perhaps  to some risk being shared too).

I expect that if instead of Toby, the paper had been written by a GAD actuary, it would have been very different. Nangle’s strengths are his popularist approach which explains things in ways that even I can understand. GAD’s strength is that they know where the bodies are buried!

Even at 22 pages, Nangle’s paper is headline stuff, GAD would still be producing charts a further 400 pages downstream. That is the problem, there will be arguments for and against to a point that no change will happen unless it is bitesize.

I suggest that the answer to the funding issue is in step-change. The best time to have introduced that change was 20 years ago, as the foreword reminds us, the second best time is now.

Thanks Toby and thanks to NEW FINANCIAL. This is a really interesting paper , exposing an elephant that has sat in the room too long.