Michael Mainelli – “DC pensions – the biggest lie in finance!”

A recent City Mayor called the DC pension the biggest lie in finance, he is right but the statement may not be applicable for long – thanks to Nest – who look like being the first DC pension provider.

I published a sly pension on a Friday afternoon when most sensible people were watching the golf and/or having an early drink. I think it’s the most explosive blog I’ve published in a while because it focusses on the DC pension as a new entity which does not look like an annuity (although buying annuities to cover longevity past 85 and it is backed by money which is borrowed from the DWP and ultimately you and me). It is , as one of my readers puts it- “a social pension”. This is already getting the hairs on people’s backs up.

Byron McKeeby is back to his hobby horse that Nest has been underperforming more aggressively invested pension saving pots, but that is by the by. More interesting is the challenge to Nest’s capacity to stand behind pensions for its 14m savers. Byron (an alias) has this to say (my response in red)

The balance sheet still shows net liabilities of £913m.

NEST (National Employment Savings Trust) is expected to fully repay its loan to the Department for Work and Pensions (DWP) by 2038.

The scheme has already begun repaying the loan and delivered its first profit, as reported in its latest annual report. The loans are expected to be repaid from protected surpluses in future years. This is factored in to the pension plans; protection of payments will happen concurrent to repayment of loans.

The NAO audit report only confirms “ability to continue as a going concern for a period of at least twelve months from when the financial statements are authorised for issue.”

Unlike PLCs, which usually provide a viability statement going out five years, Nest’s own going concern statements go no further, although they refer to forecast estimates which, for example, assert that the DWP loan will be repaid to the UK government ahead of the repayment profile outlined within the loan agreement.

We assume that there is more money coming in because there is more money in pots than (conservatively) expected. More not less Byron!

Perhaps there is scope to repay some or all of these fixed loans earlier after all?

It looks as if there is scope but would you repay loans when they are at fixed interest rates lower than you can get from your money in the bank?

But in the meantime the WACC interest rate is creeping up ever so slightly. This suggests the first instalment repayments, as I’d expect, for the oldest loan tranches with lower interest rates ruling at the time of peak quantitative easing?

I’d agree with that, but is this material?

Further analysis of the DWP loans is not given in the annual report, unless I have missed it. The document, like so many these days, is nearly 140 pages with lots of suitably diverse photos throughout, yet the financial statements don’t appear till page 100.

More analysis of Nest’s liquidity, which is expected of pension schemes under the proposed new SORP, would help this reader.

And we have only just begun to think about the whole question of DC provider’s capacity to provide the covenant for the pensions. Will others apply to do the same or will external capital be required (capital backed journey plans are central to the superfund regime, will DC pensions be governed by superfund rules or will they be given special treatment as DC pensions? Nest seem to be getting on with things, they have begun procuring the longevity insurance that suggests they aren’t awaiting a stack of secondary legislation, they are looking to get on with things NOW!

It looks to me that Nest has been working with whoever in the DWP and Treasury wanted to see DC pots turn to pensions through decumulation pensions.

Nest do not seem to be shy about what is going on. Paul Todd is around on 29th July to answer questions on Pension PlayPen and I will be making sure they are asked, because these questions about capital (and Byron’s moans about performance) need to be heard.

There is another confusion which needs to be ironed out and here I am quite clear that the market is getting it wrong and Nest getting it right.

The purchase of a bulk annuity backstop to protect the pension from longevity of pensions (a blessed thing for people by the way) is going to be paid for by Nest out of its reserves and is insurance for Nest. It is quite usual for defined benefit pensions to take out such insurance as it limits its liabilities for a fixed amount of money which Nest say it has calculated. Those of 85 won’t feel any difference, they will not be asked to sign paperwork, they won’t need to go for medicals, this is between Nest and the insurer and the only difference for pensioners (85+) is that they won’t be able to take a capital sum out in exchange for losing future income (losing pension freedom). This is explained in the earlier blog.

My friend John Mather thinks that at 85 people are kicked out of the pension – this is wrong and it is a misconception that has been created by the pension press. Here is John

The fundamental contradiction in age-limited pensions needs to be killed off a temporary annuity does not cut it. . A pension that terminates at age 85 fundamentally violates the basic principle of retirement income security – that it should provide guaranteed income for life, regardless of how long that life may be.

The proposal becomes even more problematic when you consider the demographics. If 30-50% of the current working population will live beyond age 85, this means that potentially half of all pension recipients would face a complete loss of their primary retirement income precisely when they are most vulnerable – at advanced ages when they have no ability to return to work, when healthcare costs typically peak, and when they may need expensive care services.

I can only say it again, that is not what Nest’s pension will do. Nest will provide a social pension which people can opt-out of till they get to 85. I very much doubt that there will be a rush for cash leading up to 85 or that the cash offered – after 20+ years of pensions have been pai- will be large. Nevertheless, people who so treasure pension freedom can exercise it under the rules spelt out to me.

The lie of the DC pension which we face today could be a thing of the past, thanks to Nest, thanks to the Pension Schemes Bill and thanks to existing rules that Nest are using. Paul Todd is adamant that Nest are right and if they are right , others may follow where the door is open. People can choose to do nothing and default into a DC pension, they can choose to be in a DC pension, they need no longer be in an annuity. Annuities play a part of the answer “an insurance against people living too long” but they are only a part of the pension and of no importance to the pensioner who never gets to buy one.