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- Con Keating
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- Richard Smith
The people I hang out with are bifurcated between the DC people (consumer facing) and those who deal (institutionally) with funding. Put Richard Smith among the consumerists and you get Jo Cumbo writing for him, put Con Keating at the head of the “institutionalists” and you get Toby Nangle feeding ideas.
I sit in the middle, I’m as interested in drawdown as I am gilt consumption , but expert in neither. I guess that most DC people know that gilts and DB pensions are linked and that gilts spill into DC pensions because actuaries are everywhere , but when they read a headline about gilts and pensions they flick the page, they are consumerists.
Dare I try my Sunday morning’s readers with “gilts”, I think Toby is trying to help, here goes.
Do I want to go deeper, knowing already that I am close to being out of my depth? Can I wade so deep into the sea that I end up swimming?
What I want to know is why savers into DC pots should be holding as much (or should I say as little?) as DB schemes do institutionally. In short,why does the Office for Budget Responsibility think that open DC and open DB schemes will match each other for gilt holdings? Oh and why has demand from closed DB schemes and insurers? Though that’s like asking a gay couple why they don’t expect to breed children?
But if DC pension schemes are serious about providing pensions – rather than just pots – something institutional people believe (though I’m not sure most retail advisers do) then the current holding of 7% in gilts by DC schemes suggests a collective world that doesn’t include much liability matching. Here’s me playing with the FT’s clever modeller. The gilts in the dark blue are dominant for closed DB scheme, fall away as the OBR look at annuities and open DB pension schemes but collapse when they look at DC pensions and that’s today!
So take away support from the two big blocks of dark blue on the left and you can see why the gimme that Governments have had for fifty years that pensions will take up the requirements to borrow over the long term (these gilts are “long-dated” because the liabilities are “long-dated”- or were) and you see why Rachel Reeves and Hunt and chancellors before, are trying to get a wake up call to the country, pensions will not finance the Treasury for much longer.
Toby grabs the issue as it matters to Government (and to tax), collapsing his fancy chart into a single number – 19% being what he thinks the reduction in demand for gilts will be as “pensions” walk away from what we know today as “pensions”. When DC takes over and doesn’t provide guaranteed pensions…
I started this article trying to bridge the thinking of institutionalists who look at a 19% hole in Government borrowing as bad news and consumerists who mouth through gritted teeth – WTF (that’s rude for not giving a damn – well clothed readers).
Actually, I think that what consumerists are waking up to , is that the big consumer base is wanting three things that they aren’t getting
- A retirement income for as long as they live
- Value for money
- Something done about now
Which is why the consumerists may need to start thinking about whether the DC world needs to step up and do more matching to pay pensions (buying a lot more gilts) or whether it can manage the payment of retirement income with value for money about now without buying a lot of gilts but with all the new money that is coming into “decumulation”.
There are three options as I see it. The Plowman view is a choice of three default routes
The first is a massive purchase of annuities as we revert to a pre 2014 world where annuities are the default (preceded by drawdown from balanced funds DC run for oldies today)
The second is a world where CDC does a job with best endeavours to manage growth assets through CDC. This means no guarantees, but limited gilt matching and a lot of growth assets looking for infrastructure through private equity investment.
The third is that DC schemes start running DB sections that pay pensions with the security of annuities but with investment based on open pension schemes (less gilts but still some to meet guarantees).
I suspect a lot of the DB people have given up on DC as a lost cause but that should not be the case. The requirements of the Pension Schemes Bill make all three options possible though a return to some kind of open DB provision is only being argued by me and Peter Cameron Brown and a few other covert pension people!
My guess is that sooner or later we will have to reinvent DC as a pension rather than a “pot” system and at that point we will start asking whether DC could in the end bridge the gap.
As I have written before, it means that we have to think beyond simply collapsing the DC system into deferred annuities and for consumerists to start understanding that is not what DB pensions set to do up to 75 years ago.
I will return to the chart that I use to remind myself why we need open DB and CDC to make pensions work and why annuities are no more than an admission of defeat for collective pensions.
But therein is another story. As the OBR explain, and as I see from the initial reaction to the future from master trusts, the future for Britain’s borrowing looks pretty rocky without a return to gilts purchasing and there doesn’t seem to be a route from pensions into doing that.
But as the Government is calling out for, there is a possibility that much of the funding of Government spending, which is still done through pensions purchasing long-dated gilts, could switch to long-dated equities (CDC) or pick up where DB left off.
We will of course not get DC pensions of that kind funded by employers, but there is some demand to back pension from banks and other lending sources and capital backed DB pensions have a chance to work with collective unguaranteed DC pensions to return us to a pension rather than a pots and annuity system.
It is clear that government will have a hard time financing their deficits and capital investment programmes with gilts or at the least that if they do issue gilts on the scale necessary, gilt yields will have to rise by around 100 basis points.
As DB schemes now have negative cash flows, they will for choice be net sellers of gilts. Similarly, the Bank of England is a net seller of gilts as it winds down the £600 billion plus quantitative easing portfolio. Lastly, it is unreasonable to expect to be able to rely on the kindness of foreigners – approximately one third of the ‘foreign’ demand of recent decades actually came from LDI funds domiciled in Ireland and Luxembourg, which were of course owned by UK DB pension schemes.
There is no reason to believe that DC pension schemes will buy gilts at the levels seen by DB – there are no explicit liabilities to be hedged by some misconceived LDI strategy. This extends to CDC.
The effects of gilt issuance on the scale necessary to finance both deficits and the investment programmes of infrastructure and new towns will markedly further harm government finances and indeed growth.
We have proposed that much of the proposed capital investment can be achieved by Development Agencies with the power to borrow and the power to apply land value capture taxes. This would result in the issuance of 30-40 year Development Bonds at rates, we estimate, of around 100 basis points above gilt yields. This is a method of finance much utilised in Europe.
A very balanced article, Henry.
I have two observations:
DB pensions have their origin as an occupational pension providing deferred remuneration for the individual for the remainder of life after the retirement date set by the employer. I am old enough to remember employers keeping pensioners on the company payroll, at say half salary. Where funded, the employer funds the deferred remuneration on a collective basis respecting the life span of the pensioners, hence the attraction of long dated gilts to the employer sponsored DB pension fund.
DC pensions (formerly personal pensions) are in essence a saving vehicle for later life. Employers are merely paying a contracted payment into the individual’s savings pot, whether that is managed by the individual (e.g. a group personal pension) or by the pension provider (e.g. a mastertrust). Like all savings vehicles the individual has to consider the value of the savings pot on a regular basis. The individual has no certainty how long he will remain invested in that particular vehicle, e.g. change of employment, uncertain retirement age, better returns on an alternative investment, switch to decumulation etc. This makes the highly volatile long dated gilt less attractive to the DC pension fund.
Having said on that, as someone in their 70’s, in my own SIPP I have recently invested a proportion of my fund in the Treasury 2056 5 3/8th Gilt at a price just a fraction below par. This will give me an income for the remainder of my life (after administration costs) of say £100 per week for £100,000 invested. When I am over 100 I will then get slightly over £100,000 back to fund the remainder of my life or to add to my estate. The significance is that with the SIPP I am self investing and comfortable that I do not have to consider any time horizon shorter than my lifespan.
Beats the 4% rule for drawdown and capital is protected; but I wish that we could offer a better system than that for Peter Cameron Brown, he should get in touch with his namesake who’ll be taking transfers in to the UKAS DB scheme
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