I’m one of the lucky ones who with 43 years under my belt have security ahead of me (financially at least). Gordon Aitken recognises that there is some guilt mixed in with the pleasure.
Why should I be doing so well while those who don’t get a DB pension and the prospect of a collective pension that I’ll be transferring into a CDC plan using my DC saving?
Well Gordon Aitken explains that what’s coming my way is down to a different attitude to paying people for most of my time working (I’ll be 65 in a month).
Here he is explaining this.
It is the right thing for me to do – to include a link to Gordon’s newsletter. It is a great inspiration for this blog!
His newsletter, Breaking Down the Insurance Black Box, covers UK pensions, annuities and the insurers that pay them: https://gordonmaitken.substack.com
Thanks Gordon Aitken
Agreed: Mr Aitken is a Good Thing. His point is interesting too.
But DB pensions were presumably doomed once politicians loaded more and more responsibilities on them thus making them more expensive. (Plus Gordon Brown deciding to tax their investment income.) There’s no such thing as a free lunch.
I agree with Dearieme that DB pensions or more particularly their employers have been punished by politicians seeking to avoid embarrassment. This has been compounded by the ABI and insurance brokers pretending to be pension consultants maintaining that all pensions have to be annuities. This led to the unthinking application of the insurance companies extremely profitable for them pricing model to calculate required deficit contributions which have cost British employers and the wider economy billions if not trillions of pounds with no consequential benefit for employees and resulting in the pension adequacy issues we now face.
While whole-life CDC does destroy some of these myths, you do have to remember that the other collective pension alternative – the open defined benefit collective pension scheme also shares the same efficiency benefits and possibly even more so as the sponsor’s contingent guarantee replaces the need to service the provider’s capital. It will surprise many employer’s if they bother to investigate the contributions required to fund for a particular accrual rate (the target rate in a CDC model) calculated using a realistic assumption for future investment returns using a non-volatile base. Further any returns achieved above the assumption will ultimately reduce the employer’s future employment costs under the balance of cost framework.
It does appear that using a very conservative investment return assumption and workforce profile, the 8% minimum auto-enrolment contributions would leave a meaningful surplus margin if funding a 1/120th of salary pension accrual. How many employers have been given equivalent information for their own workforce, let alone consider the retirement income their employees obtain from their contractual DC contributions.
It is important to remember that even in the halcyon days of DB well under half the working population ever stood to benefit. It was SERPS/S2P that started to fill the gap, before they suffered a death of a thousand cuts.
“using a realistic assumption for future investment returns”: but you need a crystal ball to form a “realistic assumption for future …”.
I hesitate to suggest that a considerably stronger approach, than either pretending that future returns are unknowable (crystal ball gazing) or adopting a single, supposedly realistic, long-term rate and treating it as though it were an enduring fact, could be a decomposition-of-returns approach.
This replaces an appeal to realism with an explicit, evidence-based process for forming, testing and revising expectations.
It does not eliminate uncertainty, but it makes prudent judgements behind the forecasts more transparent and defensible.
For equities, a useful starting point is to decompose expected nominal returns into dividend yield, the income, if any, expected from holding particular shares;
expected changes in earnings per share reflecting expected economic growth, productivity gains, inflation, currency and changes in profit margins, among other factors; and changes in valuation, the re-rating effect of the prices investors are willing to pay for each share’s earnings.
More precise estimates take account of matters such as reinvested dividends, likely share issuance and buybacks, and the interaction between expected earnings growth and expected valuation changes.
But the framework is still more useful than a crystal ball because each component can be examined separately.
For bonds, the starting yield to maturity provides a more directly observable anchor for expected returns, subject to reinvestment, default, interest-rate and inflation risks.
For rental property and other assets, analogous decompositions can be constructed too.
In summary, expected investment returns can be estimated by decomposing returns into their constituent components, using current market information and explicit economic assumptions over a defined forecasting horizon. Said estimates are reviewed periodically in the light of experience and changing market conditions, re-set when appropriate and, where required, with an explicit prudential margin of safety.
Workers liked and benefitted from DB pensions. Employers supported and liked the costs. But the financial service companies, as they once explained to me, hated DB because it wasn’t a product they could replicate. They preferred to provide pots, taking a fee for AUM, leaving all the risk on the working man/woman.
The 2000’s suffered from a total absence of Policy or Ministerial direction, and into that vacuum the insurers stepped and took control. Their good, our bad.
The result was Policy geared around ‘de-risking’ of DB resulting in colossal overfunding, and then the transfer of de-risked overfunded pension schemes to Insurers.
No one wins apart from insurers.
But, eventually Policy buffs have realised you cannot de-risk an economy to growth. The converse happens.
Policy buffs also appreciate now that if you cap pension inflation via annuities, then a cycle of high inflation will erode the spending power of those annuities (the fomerky DB pensions) casting more strain back onto the State.
If you hang around long enough, you see that everything comes in cycles, and the cycle is quickly by necessity veering ( at long last) to growth and pensions that keep pace with prices.
Let’s get behind this and put our shoulders to the wheel.
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