This letter appeared in the FT on August 6th and has given me some cause for thought.
Toby Nangle (Markets Insight, July 20) discusses how the UK pension system might be reformed and better use made of its assets.
Perhaps we should start by asking who is the pension system for; government, business, the City or those who are being asked to contribute?
With any long-term saving scheme the focus should be on the best interests of those the schemes are being sold to, particularly those in the lower half of the income distribution.
Those selling the schemes probably wish to sell schemes that benefit themselves and it should be the role of legislators/regulators to try and represent pension savers’ interests.
I don’t think the market can be relied upon in this respect.
I would also suggest that UK pension policy needs to be considered in parallel with housing policy, the so-called housing crisis.
Many UK baby boomers in retirement own their own homes and therefore require less income for a full life in retirement as they do not need to pay rent.
This will not be the case, particularly in the south, for future generations. This development is a consequence of the ultra low interest rate policies followed after the credit crunch and the financial crisis of 2007-08, which boosted assets/houses prices and helped to wipe out defined benefit pensions.
Huge chunks of pension risk were transferred to the pensioners. Pension reform needs to tackle these issues.
Tim Shepherd Oxford, UK
There are three ideas here
- That the Government should regulate pensions by considering the value that accrues to the saver rather than the economic interest to the seller.
- That there is a generation of savers arriving at retirement who are relatively advantaged (especially through home ownership)
- That pension risk has been transferred to subsequent savers who won’t be so lucky
I think this articulates what Tim Shepherd is saying as my thinking is broadly similar. For most people of my (lucky) generation, the concerns around financial security are largely mitigated by the prospect of living rent-free in later life and pensions are not the worry that they could be because of that. If we did not have that comfort, would we have allowed the old private pension system to disappear as we did? I suspect not. Where the covenant was with the tax-payer and not the shareholder the old defined benefit system has stuck.
Tim’s question is whether the housing stock on which my generation relies, will trickle down to subsequent generations or whether there really is a housing crisis which will lead to genuine insecurity over pensions for our children. We will have to wait and see but I suspect that the days of “my house is my pension” are behind us.
The second question is whether a revamped private sector pension system fuelled by auto-enrolment and managed by value rather than by cost-control can do the job that DB schemes have done – provide security beyond the state pension sufficient for pensioner needs. This remains to be seen. It might, given sufficient support from the key stakeholders – Government, employer and saver. But a lot of things will need to fall into place for this to happen. I suspect that reforms over access (dashboard), contributions (2017+) and over pension payment, will improve confidence , but we need to see investments delivering stonking returns over time, for the risk transfer to pay off.
How are money is managed is of crucial importance, not just for the Treasury but for the security of members in generations to come. We cannot de-link GDP from pension security, pensions need to boost GDP so that GDP can boost pensions. There is a strong argument for home-bias in pensions and the Treasury will increasingly argue for it.
I do think we will see a return to “risk-sharing” rather than “risk-transfer” and that this will happen relatively soon. CDC is designed to make that happen. The acceptance that capital backed pensions may replace traditional sponsorship is another step towards risk sharing. But fundamentally, the principle of collective pensions needs to be re-established.
We can’t go on kidding ourselves that we can all be our own CIOs and manage our financial affairs in later life as if we had both the skills and the money to manage the risks of markets and our own personal liabilities. There needs to be a pooling of these risks to make them manageable. The VFM of pensions ultimately is about the delivery of the pension , not a flat pack with an instruction manual on how to do it yourself.
Listen to the very wonderful Pete Matthews explaining the mechanisms of getting money out of a pension. This is how it works at present. judge for yourself if these mechanisms represent a sustainable future for the “risk-transfer”.
The fundamental issue is that a DB pension is deferred remuneration for a period of employment. In the employment contract the employee is given a promise of an annual pension from Normal Retirement Age (or in other situations e.g. ill health or death) as set out in the Trust Deed and Rules at that time. As investment returns fell it appeared to employers that the cost of those promises was rising with and relative to wages, hence the pressure to switch to DC.
The stated aim of the first stage of the Labour Government’s Pension Review is to improve investment returns. The goal being to reduce the cost of achieving a given pension outcome whether in local government or the wider workforce. Significantly the review is Government led with the nod to the pensions industry being given equal weighting as that to unions. It will be surely not be lost on the Government that DB and (whole life) CDC pensions give (per LCP) a 50% better outcome than DC arrangements.
I suspect that one of the first things they will be looking at is the DB Funding Code, given the perverse result it created during quantitative easing. With negative real returns, pensions 20 years into the future create a much larger liability figure than year 1 pensions. As demonstrated by the USS this has led to unnecessary contribution levels and the consequential restriction of publicly funded services.
Bad news for the risk transfer market and for the employers who used it to try to remove a fictional liability from their balance sheets (it was always a contingent not a real liability). Remember the DB pension promise survives buy-out and hence those employers that moved when the cost of buy-out or mortality risk hedging was high have effectively squandered the employer’s resources.
Is it over to the Unions (given their role in the public sector) to return some sanity to the pensions environment?
Not just the USS. There’s been overfunding in LGPS for years at the same time as stretched budgets led to service cuts.
I don’t think falling investment returns were the cause of DB scheme closures (investment returns were high in the 1990s). It was the combination of new accounting standards, other regulation and “de-risking” recommended by so many actuarial consultants. The asset allocation shift from equities and other return-seeking assets to lower return gilts and other bonds then made the “falling investment returns” self-fulfilling.
Your other points are well made, however, PO.
Precisely the point I was making about the LGPS and why it was first on Labour’s agenda.
My own belief was that it was the fall in real investment returns coupled with the introduction of the s75 debt in the Pensions Act 1995 determined by the actuary’s estimate of the insurance company buy-out cost (not the actual cost of a buy-out or the insurer’s assumed cost of providing the pensions) that concerned employers. The link to Gilt yields was therefore established by actuarial standards in 1995 when the real gilt yields were just around 3.8% (Nominal yields 8% 20 year RPI assumption 4.2%) – a world away from November 2021 when the real yield was -2.81% (1.0% nominal – RPI assumption 3.8%). There appears to have been no fundamental re-appraisal of the Gilts model as an assumption of the future.
All well made points. Very good blog today.
I do not think the working man / woman ever relished or voted at all for the prospect of being their our own CIOs. It is a situation foisted upon them by an “industry” for its ends, and that chose to de-risk and prioritise its own financial interest over that of the worker in retirement (and of the economy).
At the heart of this blog lies the question – what / who are pensions for?
The whole de-risking paradigm / experiment sucked capital out of businesses, and increased assets under management for the asset management industry, who used that to turn their income streams into %age of assets annuities. And at the same time they moved away from a sense of investment delivery or having real targets for schemes. Its utterly bonkers to think that only 2 – 3 years ago the industry was making a living off the notion that returns of 1 – 2% (gilts + 0.5% – 1.0%) were in any way an acceptable way to run pension schemes, and by implication given their enormous scale and impact, an entire economy. As as been said before, if we set our aspirations so low, we might just meet them.
The fundamental problem with the current arrangements is the prevailing view of pensions as a “financial product”. Inevitably the product provider (who has the information and power) gears the system in their favour, lowering their deliverables and transferring all of the risk on to the worker, and continues to charge them for doing so !!!
Pension are a social promise, and one that has to involve employers, employees and future workers (all as Trustees) engaging to deliver an aged wage in retirement, and that can only be done through an invested economy and invested schemes.