The New York Times reports that Boeing employees are striking to get back their DB pensions which they exchanged for DC pots in America’s 301K system (thanks Norma Cohen)

Retirement pay is also a key issue. A decade ago Boeing stopped offering a type of pension that pays out a predictable sum in retirement. “That’s a wound that may never heal,” Mr. Holden, the union leader, said.

Union members want the pension to return in a new contract and said the additional 401(k) contributions offered by management were not enough. “It’s important for people to have long-term security,” Mr. Bouapha said

In London, the Financial Times’s senior columnist John Plender calls for a review by the CMA into the pension fund transfer market that is exchanging DB pension promises for bulk annuities.

This from a master trust that I would like to help offer pensions not annuities.

If you choose to buy a pension with your Investment account, the amount of the monthly pension will depend on the remaining amount of your account after the lump sum and at the rate at which cash is converted into pension (the Annuity rate).  The actual conversion of the Investment account to a pension will depend on market conditions at the time of retirement. Pension benefits will be secured by the purchase of a pension (known as an annuity) from an insurance company and so the rate cannot be guaranteed in advance.

Let’s be clear, a pension is not an annuity. An annuity is explained on this link by Paul Lewis , it is a good financial product that converts a pot to a lifetime income by way of an insurance policy but it is not a pension. A bulk annuity is not a pension either and what the good workers at Boeing are after is not an annuity but a pension.

The Insurance company, to meet its obligations is required to take an insurance risk premium from the saver at the point of sale and this typically amounts to around 20% of the purchase price of the annuity. This is referenced by John Plender who quotes  Graham Pearce and John O’Brien of consultants Mercer point out that the risk transfer transaction process is inefficient and costly.

Most plans have to overhaul their investments in advance to satisfy the insurers’ demand for a highly liquid, low-risk fixed income portfolio — only for insurers to potentially reinvest in illiquid fixed income after the transaction. Pension plans are thus denied the opportunity to earn an illiquidity premium for some time. Insurers, they say, need to add the cost of delays in reinvesting the assets into their upfront premium pricing.

The cost of securing pensions if pension schemes do not annuitize is substantial too. If you want to avoid that premium, (we estimate to be 7-8%) then the alternative is pooling using a CDC style non-guaranteed structure. Here the cost is not that of guarantees but of the uncertainty that income might go down from time to time.

To date, we have crowned insurance buy-out with a “gold standard”, but there is a real question whether they provide value for money in terms of outcome. They cost more and therefor need a scheme to be substantially in surplus to meet their costs without a substantial cash injection from the employer/sponsor. This diagram from the USS accounts shows that although the scheme is solvent under TPR and PPF funding basis’ , it would require a cash injection of £28.3bn to get bought out by an insurance company.

But to buy-out , would be to forsake the upside that USS’ £73.1bn of assets can produce

• A major source of productive finance as indicated in its most recent accounts
• A means to reduce the cost of the pension to sponsor and member as “self-sufficiency” is achieved
• The investment of billions of pounds worth of teacher’s university’s and tax-payer’s money (foregone) over the past five decades.

Thankfully, USS is not considering buy-out and is intending to make use of its fund for the good of all its stakeholders.

Only 10% of us buy annuities for a reason

When George Osborne told the British Public in April 2014 that nobody would ever have to buy an annuity with their retirement savings again, the nation breathed a sigh of relief. Annuity rates, thanks to the Government’s QE policy were offering a lifetime income that was barely worth having and people were having to take the offer. Annuity rates have improved since then but they are still 10-15% less than what an occupational pension scheme would typically pay, if it took your pot and exchanged it for a scheme pension.

That is not because of the greed of insurance companies, annuities aren’t a rip-off. It is because the way that annuities work is fundamentally inefficient. Plender points not just to the inefficiency of their investment structure but to the capacity issues which arise from concentration of demand into a small sector of the capital markets

…risk transfers reinforce the bias in the UK financial system against equity. For good measure, the Prudential Regulation Authority has been concerned that the insurance sector may have absorbed too many assets too quickly, giving rise to financial stability risks. The concentration among just nine insurers in the business also points to the risk of one-way markets.

There is a myth in financial services that people can’t work out value for money from financial products. The public can and the public do. The way that annuities work – using the voodoo economics of the “matching adjustment”, makes them good value for those who are 75 or older. But the public has worked out that they do not offer good value for younger people converting pots to pensions and increasingly trustees are working out the same when it comes to swapping their billion pound pots for bulk annuities.

People want more for their money than annuities can give them. People want pensions, whether in the United States or in the UK. Thanks to John Plender, William McGrath, Michael Tory and the boys from Mercer for reminding us of that!

I do not agree with the suggestion ,mooted in the article, that insurers get hit with a windfall tax for the bulk annuities falling into their lap, we need insurers to take the long tail risk of longevity which is where they should be focussing their efforts.

But I do agree that Rachel Reeves should be thinking very hard about the financial advantages of encouraging pension schemes to run on and incentivising them to do so.

We need schemes to be in and stay in surplus, we have the PPF’s £12bn surplus  for those that cannot make it. The combined surpluses are enough to accelerate DC contributions and pay money back to companies so they can invest in the RnD that drives productivity.

We cannot have productive finance from pension schemes, if they are simply investing in annuities. Joe Public has sussed this , trustees get it, now let’s see a genuine fillip for pensions. Long may they run.