My friend Peter Tompkins is an actuary of some renown but his position is not my position. He is firmly in the camp of the insurers taking on the risk of defined benefit pensions , specifically replacing corporate promises with insurance guarantees.
My glass is half full. The secular change in the last 30 years is private sector DB to DC. DB is now over and the sponsors have derisked and got on with the business of flying planes (BA) rather than running hedge funds. The clock isn’t going to turn back and the runoff will sensibly be managed by insurance capital underwriting the longevity risk. U.K. business is now liberated into making widgets or flying planes not running an annuity risk portfolio.
It’s DC where our focus must be – making sure that we have billions of capital invested by citizens who know they are taking some risk by investing in equities but who do so none the less. Should our economy ever grow again then we should be seeking to raise the levels of saving and ensuring that pensions once again provide investment capital but without the damage that U.K. corporates faced in having to pay for the demographic changes which hit their pensions promises.
It does leave public sector DB untouched. That’s a whole other story – a liability which governments will need to tackle as public spending grows to levels where taxation becomes punitive. A topic for another day.
There are contradictions here, around the potential “ponzi” of a public unfunded pension system for our publicly paid employees. I am sure that Peter has a view on the secular shift and what it means for future public pension promises.
We are entitled to our differences on who should take the risk, should it be shareholders, tax-payers or savers? Is is about personal responsibility or is it about efficiency? I can see how Peter and I can stay friends but have such big differences.
But where I struggle to accept the philosophy of Thatcherite self-responsibility is with regards self-sufficiency in financial planning which I see as deficient in all areas of society. There are those like Peter Tompkins who are well organised and manage their affairs properly and there are those like me who need defaults to make sure I do not run out.
Whether we decide to take control of our affairs and opt-out of DB, retirement income from DC funds (probably deferred annuity) or another non guaranteed pension (CDC or derivative of CDC) or we accept the default is based on there being a collective default we choose not to take up. Nest may not be collective but it is doing itself to offer its decumulation default as a collective pension.
My worry is that the insurance industry wishes to take over all the defaults and ensure that the alternative is “wealth management” leaving no scope for people to enjoy the very real advantages of “best endeavour” pension schemes which do what he admires in DC – invest in the economy and ownership of our real assets.
Peter would have this in DC, by which I think he means wealth management but he sees no space for pensions paid from an optimistic view of investment, he sees annuities as the only way for income in retirement to be offered (he ducks the issue of unfunded public sector pensions and by extension the state pension).
His characterisation of the efforts of pension schemes as amateur hedge funds has some validity, the hedging led us to the disaster of September 2022 where hedging wiped a third off the value of our corporate DB pensions. But that was not the fault of the pension system, it was the fault of those who were trying to de-risk it. It has opened the door for insurers to take over. He can point to a failure of DB resulting from a failure to benefit from risks available to those investing over the long term.
This de-risking of our DB system in the first quarter of this century has cost companies the capital they have needed to compete globally. We are to believe this is “secular change”, I call it the extinction of “secular enlightenment”.
Consequent to the wreck that de-risking has done to our DB system, Peter’s mind-shift denies individuals pensions based on the returns from our and global economic growth and sides (like GAD with its shrinking confidence in GDP rising) with those who see our economy grinding to a halt.
I find this view mind-dumbingly negative and so lacking in a wish to embrace risk as to go against the success of capitalism over the last 300 years. Maybe that is what he really refers to in his phrase “the secular change“.
Peter says “The clock isn’t going to turn back and the runoff will sensibly be managed by insurance capital underwriting the longevity risk.” It is worth considering how much capital insurers are dedicating to managing the risk of the pensions they have taken on – in recent times it has been around 1% – courtesy of course to nonsensical accounting gimmicks such as the ‘matching adjustment’.
“ business is now liberated into making widgets or flying planes…”
LOL
We let the actuaries strangle the life out of schemes with over regulation and a cult like zealousness to ‘de-risk’, and then we say the schemes liberated their sponsors.
Our economy is stripped of growth capital and become alien to the concepts of investment and opportunity.
This would take more to unpick than is available at this time in the morning.
Apologies for my earlier comment, but I just rise to the reference to widget makers – I personally find it condescending, and recognise it it as part of the lexicon introduced by the bulk annuity mob to prize the value out of schemes.
The ‘widget makers’ are those business large and small up and down the country that actually form and drive the economy, comprised of the thousands of managers who make investment and hiring / firing decisions every day in response to the needs of the market and their customers. In short, they are the economy, and I value their collective judgement on ‘investment’ more than I trust the spreadsheet financiers who have procured and stripped the stored capital of our nation.
But I get Peter’s central point – and DB or DC is only the delivery mechanics; the greater need is to support a system bedded in growth and opportunity, and some manner of collective endeavour and risk taking. On its current trajectory our DC risks putting all the risks on the working person, while the rewards accrue to the fund management industry,
I would strongly encourage employers to take back control of their employment costs by re-opening DB accrual.
It seems to be forgotten that the DB pension scheme assets remain part of the employer’s asset base, and those assets can be used to provide pension benefits not just for their past employees but also for current and future employees.
Actuaries by the nature of their training and culture only think about risk, but they seem to take a very narrow view of risk, focusing entirely on the narrow definition of past service benefits.
How many employers have failed purely because of excessive deficit recovery plan contributions coupled with PPF risk levy payments which have now proved not to have been required if the Scheme ran on a open accrual basis? I can name many such companies. Has that not increased rather than reduced risk on a national basis?
For the past three years I have been talking to employers about their duty of care to their employees in considering the DC arrangement into which they are enrolling their employees. It has been a shock to many employers to discover the variance in returns on default funds between different providers (as evidenced by the Corporate Advisor’s annual survey – particularly the 5 year average returns 30 years before retirement). When you then consider the equivalent DB pension the same contributions would have provided in an open DB scheme invested with a long term time horizon, the comparison becomes even more stark.
Hopefully the Pension Commission will take this on board.
I think the fundamental problem with DB is the volatility of the way it’s long-term liabilities are measured with short-term indicators, the conversion of ‘best endeavours’ to ‘guaranteed’, plus a change of accounting rules that meant it had to be included on the balance sheet at ‘market value’ not ‘best estimate’.
The combination of these factors leads to a (usually) large and volatile liability. If it was small, or less volatile, it companies wouldn’t have the potential to wreck company plans over night and would become more interested in the potential upside of running on.
Apologies, there’s a typo in that last line which should read
“If it was small, or less volatile, DB wouldn’t have the potential to wreck company plans over night and companies would become more interested in the potential upside of running on.”