We all know that the only things guaranteed are death and taxes. The joke is that taxes don’t happen naturally but they might as well do.
But guarantees exist all over the place and the quality of the “guarantee” is assessed by the capacity of the organisation offering it, to fulfil on the promise. “Most guarantees aren’t worth the paper they are written on” – is another truism
When it comes to retirement income, “guarantee” is a highly contentious word. Famously CDC differentiates itself from other forms of pension by offering no guarantee. The pension you get from CDC depends on the market – stock market, bond market, inflation market, the market in dead souls (longevity). You get what the market can offer you and in the market you trust.
But defined benefit pensions offer more than this. There are strict funding rules that mean that you can expect to receive the benefit that has been defined by scheme rules – typically a percentage of your final salary, or your career earnings – some times a cash sum. Although there is an organisation behind the promise that is bound to fulfil on it, such pensions are not allowed to be termed “guaranteed”.
Meanwhile, annuities offered by insurance companies and purchased with the money set aside to pay pensions are “guaranteed”. Why?
I have great difficulty working out why income from an annuity is “guaranteed” and income from a scheme pension isn’t. The only explanation that might be forthcoming is that there is more certainty that an annuity will get paid. But work I have studied from reputable actuarial adviser Redington , suggests that a pension backed by capital under the capital backed funding rules issued by the Pensions Regulator is more likely to get paid than an annuity. The analysis was commissioned by the Pension Superfund
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Increased governmental pressure has been placed on the pension industry to demonstrate its capability to offer an equally secure end-game solution as that of insurance buy-out.
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Both the likes of Pension SuperFund Capital and insurers offer UK defined benefit pension schemes a potential ‘end-game’ solution by which members benefits can be better secured. UK insurers must prescribe to the Solvency II regime which limits how capital can be sized and structured by an insurer, compared to Pension SuperFund Capital operating under pensions regulations.
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Redington, the pension consultants, compared the agreed long-run portfolio of Pension SuperFund Capital to the portfolio of a typical buy-out provider (Insurer), analysing each using risk/return metrics, solvency capital requirement tests, and credit security provisions.
Many will find these numbers “mumbo-jumbo” but what they add up to is that the strength of the funding position of a capital backed journey plan exceeds the stress test of working 99.5% of the time over a five year period (100.5%) while the annuity offers slightly less (98%).
If it was a boxing match, it would probably be scored a draw or a win to the capital backed approach.
There is nothing in this analysis that suggests that an annuity should be granted the adjective “guaranteed” and that a scheme pension backed with capital should not.
We must ask just why the covenant of a pension is considered inferior to that of an insurer and we must conclude that it is out of force of habit.
The habit that insurers have of convincing both trustees and regulators that they provide greater security than a scheme pension is based not on fact but on prejudice. If the sponsor of a pension provides equivalent certainty to the insurer (as Redington’s analysis suggests) , why is the insurer allowed to call its income stream guaranteed while the scheme pension has to settle with some nonsense around “certainty”?
In my opinion , this is because the pension industry is captained by a weak lobby and the insurers by a strong one. The insurance lobby is appealing to the PRA and the Bank of England, the pension lobby to the DWP and TPR. The insurers have won the battle before the battle has commenced.
But we are moving to a new world, a world where Emma Reynolds, the Pension Minister is as much a minister of the Treasury as the DWP, a world where the Government can promote the idea that pensions paid from master trusts run on harder for longer and one where the annuity is seen for what it is , “buying out of investment markets“.
I think there is a time when people can give up on long-term investment and that is when they are reaching their end-game, I do think there is a place for annuities and it is when the risks of later life become “unwanted” and can better be insured in most instances (you need large pools and strong nerves to self insure).
“Guarantee” has been captured by insurers to back up the myth that the annuity is the “gold standard”. It is now impossible for a pension scheme to talk of its sponsor guaranteeing pensions, even when empirical evidence can be put forward to show there is a higher degree of certainty that a scheme pension will be paid. The capture stretches as far as the regulators who are complicit with the insurer’s lobby.
It’s time that the word “guarantee” was returned to occupational scheme benefits and I hope that we will be able to talk about guaranteed pensions again, very soon.