There has been a lot written about the State Pension Age (SPA) in the UK in the last year. This was primarily because the UK Government has been carrying out its first periodic review of the SPA. John Cridland was asked to carry out an independent review of the State Pension Age, which reported in March this year with over 150 responses received and 12 recommendations made plus a proposal for an auto enrolment review. This was followed by the Secretary of State for Work and Pension’s report on the first Government review of State Pension age, as required under the Pensions Act 2014 last month, in which Cridland’s central recommendations on the timetable for SPA change were accepted, ie:

  • The State Pension age should continue to be universal across the UK, increasing over time to reflect improvements in life expectancy.
  • The State Pension age should increase to age 68 between 2037 and 2039.
  • The State Pension age should not increase by more than one year in any 10-year period (assuming there are
    no exceptional changes to the data used).
  • Individuals should get 10 years’ notice of any new changes to State Pension age.

However the report was noticeably silent about Cridland’s other recommendations, including:

  • that means-tested access to some pension income will remain at 67 and will continue to lag a year behind for rises thereafter.
  • that the conditionality under Universal Credit should be adjusted for people approaching State Pension age, to enable a smoother transition into retirement.
  • supporting working past State Pension age
  • to do more to help carers in the workplace:
  • the provision of a Mid-life MOT
  • support for the use of older workers as trainers

Other commentators have given their analysis, some, like the Work and Pensions Parliamentary Select Committee, have pointed out that many people will not live to see the new SPA, something rather lost in the massive groupings Cridland referred to where the lowest average was across a group titled “Routine”. These were described as socio-economic groupings but seemed in reality to be more occupational. There is some reference to healthy life expectancy, but no attempt to quantify how this varies by population. It therefore gives the rather misleading average of around 10 years of healthy life expectancy at age 65 for both men and women.

Contrast this with the Office of National Statistics’ (ONS) rather more comprehensive look at the subject and, in particular, these graphs:

The graphs are more encouraging for women in terms of life expectancy, but no more encouraging for healthy life expectancy.

Other commentators such as the OECD have suggested that the top 5-10% wealthiest stop receiving it altogether to allow it to be more generous for everyone else. The most prominent actuarial view so far has probably come from Paul Sweeting, who proposes a means tested approach to paying state pension which allows the pace of SPA increase to be slower but at the same cost. While I share most of Paul’s analysis of the problem, I do not share his conclusion that the only solutions are faster increases to the State Pension Age, or means testing. My problems with means testing as opposed to universal benefits boil down to two main objections:

  • People will not contribute to other savings vehicles if they think these will just reduce benefits elsewhere. This was how the Minimum Income Guarantee killed the Stakeholder Pension.
  • Many people do not claim means tested benefits which they are entitled to. Whether through pride or fear of the dauntingly long forms the DWP produce for any claimed benefit or a combination of the two, a study in 2003 indicated that 1 in 6 people did not claim benefits representing over 10% of their total income.

I therefore think there has to be another way, and I think it might be a form of universal basic income (UBI). Compass have produced one of the more recent reports on the feasibility of this, and there are many different forms, with full schemes or pilots now running mainly at a regional level at present in the United States, Canada and India amongst other countries.

The basic features of most of these schemes are that the personal allowance is abolished in favour of a regular income paid to everyone, perhaps with different rates at different ages but not means tested. Different schemes make different adjustments to existing taxes and maintain different combinations of existing benefits, both means tested and universal. Compass have modelled five possible schemes, and believe that paying a lower UBI but leaving in place the current means-tested benefits system while reducing households’ dependence on means testing by taking into account their UBI when calculating them may be a feasible way forward.

The main arguments for a UBI approach are:

  • it would directly address most of the inequality of outcomes discussed above, particularly the decile likely to be condemned to 18 years of work in ill health and a retirement of 4 years by 2037 unless both their life expectancy and healthy life expectancy increase, at exactly the time when both appear to be slowing (at the 0.4 months pa rate of improvements since 2011, these expectancies would only have increased by 8 months by 2037)
  • by providing a guaranteed minimum income, the safety net we provide as a society would be much more robust, and that reducing the reliance on means testing would tackle the problems of take up and the inevitable poverty traps which means testing creates
  • people could choose to work less and have more time for other things (although previous experiments suggest this number would be small), alternatively it would make retraining much easier
  • people would have more bargaining power in the labour market, which is clearly problematic in the UK in particular, with the stagnation of real wages for a considerable period now

Many people think their jobs are useless and that they are trapped in them with no marginal income to let them transition to something more meaningful. Neither does it seem as if getting everyone into work is good for us physically, further exacerbating the healthy life expectancy problem at lower deciles.

I am therefore surprised that there is not more research into feasible UBI schemes. The reference section at the back of the Compass report was shorter than that in many of my 3rd year undergraduate dissertations, and yet it is clearly an area in urgent need of some modelling. Anyone out there fancy joining me in a working party to look at this?

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Oceanic whitetip shark. (2014, August 29). Wikipedia, The Free Encyclopedia. Retrieved
11:13, July 22, 2017
from https://simple.wikipedia.org/w/index.php?title=Oceanic_whitetip_shark&oldid=4875771.

Changing people’s behaviour is hard. Even if we have agreed that it needs to change, actually acting on this new knowledge is hard enough, but getting that agreement in the first place by shifting our beliefs is even harder.

It gets worse. The research suggests that providing risk information is ineffective in changing behaviour. You might need to read that again before it sinks in: risk information is ineffective in changing behaviour.

Professor Theresa Marteau, Director of the Behaviour and Health Research Unit at the University of Cambridge, and her team have been looking at the four behaviours responsible for the majority of premature deaths worldwide: smoking, eating too much, drinking too much (alcohol) and moving too little. The original focus of their work concerned how people responded to genetic test results indicating a greater predisposition to diabetes, cancer and other diseases. What they found is that the genetic test may get someone past the first barrier, ie agreeing that they need to change their behaviour, but not the second part, ie actually doing it.

As Marteau says: Few of us would swim in waters signed as shark-infested. On the other hand, when the risk of future disease is up against the pleasures of current consumption, it doesn’t tend to compete very well. Marteau summarises their findings as follows:

Put simply, we overestimate how much our behaviour is under intentional control and underestimate how much is cued by environment.

In my view, this research is directly applicable to the financial services industry and explains a lot of behaviours which have up until now often been considered as separate rather than related problems, eg:

  • The failure of consumers to shop around adequately in the annuities and investment markets (we know we should but get easily discouraged by the difficulty of the process);
  • The stampede to take transfer values out of defined benefit pension schemes (the possibility of immediate consumption trumping deferred gains); and
  • The surge in the tax take at HMRC caused by people removing all of their cash from defined contribution pension schemes (same again).

Turning to my own profession for a moment, and looking on the Become an actuary part of the Institute and Faculty of Actuaries website, we find: Actuaries use their skills to help measure the probability and risk of future events. A little further on we find: It is essential that actuaries have excellent communication skills to enable them to communicate actuarial ideas to non-specialists in a way that meets the needs of the audience.

So, in a nutshell, producing risk information and then communicating it.

As a pensions actuary, I spent most of my time overseeing calculations which underpinned reports to clients which I would then summarise in presentations in order to get them to move a little bit further towards fully funding their pension schemes than where they were starting from. And then we had to condense the whole of that process into a single meeting where we tried to persuade the people who were actually doing the funding as part of the negotiation of the final deal. While, unconsciously, I am sure that just my presence was having some kind of placebo or nocebo effect, all of my conscious effort was directed on providing risk information and communicating it.

And actuaries are not alone in focusing on the provision of risk information as the most important element in guiding consumer behaviour. From the Financial Conduct Authority’s Retail Distribution Review, to the Pensions Advisory Service and Pension Wise, we are obsessed with it.

However if we are going to really change behaviour in response to the many risks these consumers face, we need to be spending much less time on producing risk information (which coincidentally may be done for us in the future by increasing capable machines anyway)and much more time focusing on the design of the financial environment we all operate within.

But if changing the environment is so much more effective for changing behaviour, perhaps what we need is a framework of standardised definitions to characterise any interventions we make. Fortunately the social scientists are way ahead of us on this and have produced just such a framework. TIPPME (typology of interventions in proximal physical micro-environments) has been developed and demonstrated by applying it to the selection, purchase and consumption of food, alcohol and tobacco. As the authors state: This provides a framework to reliably classify and describe, and enable more systematic design, reporting and analysis of, an important class of interventions. This then allows evidence to be collected into what works and what doesn’t in changing behaviour across populations.

Our physical health and what interventions cause us to look after it better are thought sufficiently important for a coordinated approach to designing the risk environment, rather than the piecemeal legislation and partial solutions offered by commercial providers we have had to date, to be worthwhile. I would suggest that our financial health needs to be given similar consideration. This looks like a promising way forward that could result in truly evidence-based financial regulation, with the prospect of lasting change to the way we help consumers navigate a path through the financial seas. Far away from the sharks.

 

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This work is licensed under a Creative Commons Attribution-NonCommercial 2.5 License.

Daniel and Richard Susskind in their book “The Future of the Professions” set out two possible futures for the professions. Either:
• They carry on much as they have since the mid 19th century, but with the use of technology to streamline and optimise the way they work
• Increasingly capable machines will displace the work of current professionals

Their research suggests that, while these two futures will exist in parallel for some time, in the long run the second future will dominate. The actuarial profession is particularly vulnerable. As the Susskinds write:

Accountants and consultants, for example, are particularly effective at encroaching on the business of lawyers and actuaries.

Actuaries both here and in other countries are waking up to what is coming, but the response of the profession is a whole has been quite slow.

For the actuarial profession, we will see the extension of some trends which have already begun, eg:

  • Automation of processes not just leading to greater efficiencies but reconfiguring both what work is done and how it is done, eg propensity pricing and pensions valuations
  • Para professionalization, like CAA Global for instance
  • Globalisation
  • Specialisation
  • Mergers of businesses as markets consolidate
  • Flexible self employment

And the emergence of trends that have hardly started at all yet, eg:

  • The end of reserved roles for actuaries
  • Different ways of communicating advice (Richard Susskind got into trouble with the Law Society in the mid 1990s for suggesting that most legal communication between lawyers and their clients would be delivered via email in the future, which would strike us as an obvious observation now)
  • Online self-help for users of actuarial advice (ask discussed by the Pensions Policy Institute in their report last year)
  • The advance of roboactuaries and their assistants

Focusing on the last of these, a paper produced by Dodzi Attimu and Bryon Robidoux for the Society of Actuaries in July 2016 explored the theme of robo actuaries, by which they meant software that can perform the role of an actuary. They went on to elaborate as follows:

Though many actuaries would agree certain tasks can and should be automated, we are talking about more than that here. We mean a software system that can more or less autonomously perform the following activities: develop products, set assumptions, build models based on product and general risk specifications, develop and recommend investment and hedging strategies, generate memos to senior management, etc.

They then went on to define a robo actuarial analyst as:

A system that has limited cognitive abilities but can undertake specialized activities, e.g. perform the heavy lifting in model building (once the specification/configuration is created), perform portfolio optimization, generate reports including narratives (e.g. memos) based on data analysis, etc. When it comes to introducing AI to the actuarial profession, we believe the robo actuarial analyst would constitute the first wave and the robo actuary the second wave

They estimate that the first wave is 5 to 10 years away and the second 15 to 20 years away. We have been warned.

One of the implications of this would be far fewer actuarial students required and, in my view, a much smaller appetite amongst actuarial firms for employing students while they were sitting actuarial examinations, particularly the core rather than specialist ones. This in turn would suggest an expansion of the role of universities in supporting students through these stages of their actuarial education, massively increasing the IT and data analysis skills of the next generation of actuarial students and developing far more opportunities for students to develop skills more traditionally seen as “work-based”, such as presentation, project management and negotiation skills. Some universities, such as my own at the University of Leicester, are using the preparatory work in anticipation of the Institute and Faculty of Actuaries’ launch of Curriculum 2019 to do all of these things.

But universities and the education professionals in general face their own challenges from the rise of technology and increasingly capable machines:

  • The development of learning labs offering personalised learning systems
  • Online education networks, like Moodle, once used just to support traditional university teaching activities, but now starting to actively supplant them
  • Other online education platforms, like the Khan Academy
  • The rise of Massive Open Online Courses or MOOCs. For instance, more people have signed up to Harvard University’s MOOCs in one year than have enrolled at the University in its 377 year history

The actuarial profession and the higher education sector therefore need each other. We need to develop actuaries of the future coming into your firms to have:

  • great team working skills
  • highly developed presentation skills, both in writing and in speech
  • strong IT skills
  • clarity about why they are there and the desire to use their skills to solve problems

All within a system which is possible to regulate in a meaningful way. Developing such people for the actuarial profession will need to be a priority in the next few years.

Of course it is still possible to laugh at what Artificial Intelligence and Machine Learning (here and here) have not managed to do yet, despite their vast ambitions. But it should not blind us to the fact that those ambitions will be realised in our working lifetimes in many cases. And we need to start preparing now.

 

 

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Public.Resource.Org SI Neg. 2001-1900. Date: na...Oblique aerial view from approximately 12,000 feet, 50 miles from the detonation site, two minutes after the detonation of a hydrogen bomb during an unidentified US atomic weapons test, circa 1950s. At this point in time, the mushroom cloud rose to 40,000 feet...Credit: Unknown USAF photographer. (Smithsonian Institution)

Public.Resource.Org SI Neg. 2001-1900. Date: na…Oblique aerial view from approximately 12,000 feet, 50 miles from the detonation site, two minutes after the detonation of a hydrogen bomb during an unidentified US atomic weapons test, circa 1950s. At this point in time, the mushroom cloud rose to 40,000 feet…Credit: Unknown USAF photographer. (Smithsonian Institution)

I have just started reading an excellent new book by Cathy O’Neil, Weapons of Math Destruction, where she sets out the case against devolving important decisions to mathematical models without adequate feedback loops. The opening example she gives, of a teacher fired from her job in Washington because a school feeding students into her school was manipulating test scores, makes her general point very well. I am looking forward to the chapter on insurance.

However, the thought that this raised in my mind is how, increasingly, we don’t even need the algorithms and mathematical models to behave in a robotic fashion – we constantly follow rules set by others rather than using our own judgement. Indeed regulators push us more and more in this direction. They are nearly all under-staffed and over-tasked and need shortcuts to manage their workloads. And the most obvious shortcut is to focus on the very big and the very different. The very big are normally very much better staffed than the regulators and difficult to win arguments with. Regulators are therefore left with the very different. So regulators make life for the very different very difficult. And, before long, the very different no longer exist and the systemic risk in your population of banks, schools, hospitals or whatever it is has increased.

What O’Neill rightly focuses on as the main danger of widely used models is their lack of a feedback loop. If nothing tells you when your model is not reflecting the world it is modelling, it will not be long before it is doing a great deal more harm than good. And when a regulators uses a model which does not rely on inputs from the system it is regulating, then the model becomes the world it is regulating, often with bizarre consequences. One of the main reasons that the 2008 crash was so dramatic is that so little was done to prevent it even as warning signs grew. This was because, in the model used to regulate banks, these warning signs didn’t exist. Unfortunately and worryingly for us, the lessons learned, in the main, were not that model-led regulation was bad, but that the models used just needed to be more complicated.

Every call for what is being regulated to be simplified (by breaking them up into smaller units, in the case of banks, or simplifying the regulations themselves, rather than the regulatory arms race of measure and unintended loophole we seem doomed to keep repeating) has been resisted, resulting in a regulatory framework which becomes more bafflingly complex with every passing year. This is a process recognised in Government and there have been occasional attempts to reverse the tide. To date, with little effect.

And the regulators themselves? They are cash-strapped and at the mercy of inconsistent Government policy. So we have CQC inspectors (of NHS Trusts) and Ofsted inspectors (of schools and colleges) making short visits, producing reports based on anything anyone has said to them on these short visits, allowing for no factual corrections, subject to no cross examination, just to get through their caseloads without causing headaches for their political masters, but often resulting in inconsistent scrutiny or, in some cases, in abrupt reversals in conclusions in successive inspections. At the same time, it appears clear that you can evade your financial responsibilities almost completely if you are rich and unscrupulous enough. Our regulatory systems have proved unreliable in too many areas and have in my view lost credibility as a result.

So where do actuaries fit in to all this? They are one of the professions centrally involved in building, updating and interpreting models across a wide range of financial firms. Everything from the amount a firm makes in pension contributions, to the amount held in reserve by an insurer or a bank, to the detailed agreements in a corporate restructure, often involving staggering sums of money. This work cannot be carried out effectively by playing to an unreliable regulator.

Upon accepting the Army-Navy Excellence Award on November 16, 1945, Robert Oppenheimer, who ran the US Government’s Manhattan Project in Los Alamos to develop the world’s first nuclear weapons, proclaimed: “If atomic bombs are to be added as new weapons to the arsenals of a warring world, or to the arsenals of the nations preparing for war, then the time will come when mankind will curse the names of Los Alamos and Hiroshima.” He realised that responsibility for the use to which your work is put can never be wholly given away to someone else.

If mathematical models are to be the dominant regulatory tool of a financial world, and of the consultancies and financial firms competing in that world, then the time will come when mankind will curse the names of the highly paid professionals who followed inappropriate rules rather than exercising their own expert judgement when it mattered.

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800px-Tata_Steel_Logo_svgThe Government has launched a consultation into what unique arrangements could be put in place purely for the British Steel Pension Scheme (BSPS) so that:
• It won’t be a burden on the new owner of the steel business in the UK
• It won’t be a burden on the Pension Protection Fund (PPF)
• It won’t be a burden on UK PLC

The consultation document states that “In such a complex situation, the Government needs to listen to a wide range of opinions in order to decide what course of action we should take. We are therefore seeking views on the options and proposals set out in this paper. We would welcome both answers to the specific questions posed and also wider thoughts on the ideas discussed.” It therefore seems strange that they have chosen the period leading up to the EU Referendum to launch the consultation, when a wide range of opinions is likely to be the last thing they get. It is almost as if they are trying to bury a bad consultation.

In fact it is not complicated, because this is the poor collection of options it is considering (my responses are in italics):

Option 1: Use existing regulatory mechanisms to separate the BSPS

ie the regulatory mechanisms which have been good enough for:
• MG Rover Pension Scheme
• United Industries PLC Pension Scheme – United Industries PLC section
• Caithness Glass Group Benefits Plan
• Denby 2001 Pension Scheme – DH Realisations Limited (formerly known as Denby Holdings Limited) segregated part
• Do It All Pension Plan – Do It All Ltd Section
• Allied Carpets Group Plc Pension Scheme
• Polaroid (UK) Pension Fund
• The Royal Worcester & Spode Pension Scheme
• Woolworths Group Pension Scheme – Woolworths Group Sections 129
• British Midland Airways Limited Pension and Life Assurance Scheme – UK DB Section
Railways Pension Scheme – Relayfast Group Shared Cost Section
• Royal Doulton Pension Plan – Royal Doulton (UK) Limited segregated part of section
• HMV Group Pension Scheme
• Industry Wide Coal Staff Superannuation Scheme – UK Coal Operations Section
• Industry Wide Mineworkers Pension Scheme – UK Coal Operations Section
• The Kodak Pension Plan
• Saab GB Pension Plan – Saab Great Britain Limited segregated part
Amongst many others (only 5,945 schemes of the original 7,800 defined benefit schemes protected by the PPF remain outside).

Consultation question 1: Would existing regulatory levers be sufficient to achieve a good outcome for all concerned?

Yes. These levers were good enough for all these other schemes.

Apparently these are not good enough for Tata Steel.

Option 2: Payment of Pension Debts
Under the defined benefit pension scheme funding legislation, a sponsoring employer can chose at any time to end their relationship with the scheme – even if the scheme is in deficit. However, the employer must pay to do so.

Tata have indicated that Tata Steel UK (TSUK) would not be able to make such a payment, and that this would be unaffordable.

The usual options in this case would be:
• A sale with the pension scheme
• The insolvency of Tata Steel (how ridiculous this sounds shows that the required payment is not unaffordable)
• A sale without the pension scheme, in which case the PPF would be looking for substantial mitigation from Tata Steel and/or a share in the company in exchange for taking on BSPS

Apparently these options are not good enough for Tata Steel.

Option 3: Reduction of the Scheme’s Liabilities Through Legislation

The proposal would reduce the level of future inflation increases payable on all BSPS pensions in payment and deferment to a similar or slightly better level than that paid by the PPF. If adopted, this would mean that in the future existing pensioners would receive lower increases to their pensions than they would under the current scheme rules, or possibly no increases at all. Deferred members would also receive a lower increase to their preserved pension when they reached normal pension age, and would then receive the lower increases to their pension payments.

This approach is not without risk – which is why it is not routinely used.

Actually I am not aware it has ever been used.

Although the intention would be for the scheme to take a low risk investment strategy, there is always residual longevity and investment risk, and it is possible that the scheme would fall into deficit in the future. In the event of scheme failure, the downside risk would ultimately be covered by the PPF and its levy payers.

ie after all of the legislative hyperactivity for the benefit of one scheme, it could easily just end up in the PPF anyway.

Question 2: Is it appropriate to make modifications of this type to members’ benefits in order to improve the sustainability of a pension scheme?

No. As there is no guarantee it will improve the sustainability of the only pension scheme being considered, ie BSPS.
Regulations under section 67 of the 1995 Act
Section 67 of the 1995 Pensions Act (‘the subsisting rights provisions’) provides that scheme rules allowing schemes to make changes can only be used in a way which affects benefits which members have accrued if:
• the changes are actuarially equivalent – this means that an actuary has certified there is no reduction in overall benefit entitlement, only in the way the benefit is paid (for example, indexation is reduced but initial pension level is increased to compensate); or
• the individual member consents.

Consultation question 3: Is there a case for disapplying the section 67 subsisting rights provisions for the BSPS in order to allow the scheme to reduce indexation and revaluation if it means that most (but not all) members would receive more than PPF levels of compensation?

Ie they want to remove the need to get members’ consent before reducing their benefits. The answer is again no.

Option 4: Transfer to a New Scheme
This option would allow for bulk transfers without individual member consent to a new scheme paying lower levels of indexation and revaluation.

A bulk transfer with consent has been used previously as a mechanism for managing exceptional problems around an employer and their DB scheme.

However, the BSPS trustees have concerns about getting individual member consent to a transfer. The sheer size of the scheme means that getting member consent for a meaningful number of members would be difficult and the transfer would only be viable if enough members consented to transfer. Setting up a new scheme and transferring members to it may also need to be done rapidly in order to facilitate a solution to the wider issues surrounding TSUK – and this would be difficult to achieve in the necessary timescales if individual member consent to a transfer had to be achieved.

Consultation question 4: Is there a case for making regulatory changes to allow trustees to transfer scheme members into a new successor scheme with reduced benefit entitlement without consent, in order to ensure they would receive better than PPF level benefits?

No, as it would not ensure that they received better than PPF level benefits.

Governance of the New Scheme

The British Steel Pension Scheme (BSPS) operates as a trust. The scheme is administered by B.S. Pension Fund Trustee Limited, a corporate trustee company set up for this purpose. The assets of the Scheme are held in the name of the trustee company and, as required by law, are separate from the assets of the employers.

The trustee board has 14 members, seven are nominated by the company and seven are member-nominated trustees. The role of the trustees is to ensure that the scheme is run in accordance with the scheme’s trust deed and rules, and the pensions legal framework. The trustees’ duties are also to ensure the proper governance of the scheme and the security of members’ benefits.

Consultation question 5: How would a new scheme best be run and governed?

Under trust, separate from the assets of the employer, and subject to full existing pensions law. You could probably manage with considerably fewer than 14 trustees, but these should include member nominated trustees and, probably, a professional independent trustee.

Consultation question 6: How might the Government best ensure that any surplus is used in the best interest of the scheme’s members?

Pensions legislation already has provisions for how to apply assets to secure full benefits for members with an insurance company and deal with any surplus that occurs (it is usually set out in the scheme rules). A surplus is a highly unlikely scenario.

What the Draft Regulations Would Say
Disapplication of the subsisting rights provisions to the British Steel Pension Scheme Regulations (section 67)
These regulations would disapply the subsisting rights provisions to changes made in relation to indexation and revaluation under the BSPS Scheme Rules. This would mean that TSUK can exercise the power in the existing scheme rules to reduce levels of indexation and future revaluation to the statutory minimum without member consent. We intend to make any disapplication of the subsisting rights provisions subject to certain conditions being met to ensure member protection is not further compromised.

This is a terrible idea. Section 67 has protected many members from reductions to benefits they have already built up over the years. It should be maintained.

These would include requiring the BSPS trustees to agree unanimously that the changes to indexation and revaluation would be in the best interests of the scheme members. We are also considering whether it may be appropriate to make it a condition that the Pensions Regulator agrees to the changes being implemented.

Why has the Pensions Regulator not been asked for its view already?

Consultation question 7: What conditions need to be met to ensure that regulations achieve the objective of allowing TSUK to reduce the levels of indexation and revaluation payable on future payment of accrued pension in the BSPS without the need for member consent, balancing the need to ensure that member’s rights are not unduly compromised?

The objective is inappropriate. Disapplication of section 67 should be abandoned.

Consultation question 8: What conditions need to be met to ensure that regulations achieve the objective of allowing trustees to transfer members to a new scheme without the need for member consent, balancing the need to ensure that members’ rights are not unduly compromised.

They can’t. And this therefore shouldn’t be attempted.

All in all, a very bad consultation rushed out under cover of a much higher profile campaign.

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Go on pick a card

It is election time for the UK Actuarial Profession. The annual Council election is our chance to have our voices heard and to help in setting the strategic direction of the Institute and Faculty of Actuaries (IFoA). And this year I am running!

I think the next 10 years could be one of the most formative periods the profession has seen – with politics and economics at something of a turning point globally, and the place for actuaries and the finance industry more generally within that open to question as never before. I feel, as a former pensions actuary who now works with the actuaries of the future every day, that I have something to contribute to the process of actuaries finding their place in this new world.

So if you are a member of the IFoA please watch my video below and, if you share my priorities for the profession, I would greatly appreciate your vote.

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pension statement

They plop through the letterbox about once a year. Pension statements. They tell you what your units in the various funds you are invested in were worth at some recent date (if you have a defined contribution (DC) pension – I am not talking about defined benefit (DB) pensions today as there are far fewer consequences of not making any decisions with these). They also tell you the estimated yearly pension at your Normal Retirement Date, based on the Statutory Money Purchase Illustration (SMPI) assumptions about what will happen over the intervening years, some of which are set out in the statement. However, for many it is even more scary than the bank statements they leave unopened for six months or their insurance renewals. Why is that?

Well it seems that pensions tick all the boxes for emotional “fear factors” that make some potential threats feel scarier than others:

  • Human-made risks scare us more than natural ones. The basic reasoning is perhaps that natural things have been around for longer and therefore “stood the test of time”. That piece of paper with your pensions details on it is as man-made a thing as things come. And the more that pension providers seek to make them look slick and professional, with brightly coloured diagrams and soundbites extracted from longer bits of text, the more new and untrustworthy they can seem. Ingenious ways of hedging your investment risk within a pension fund which cannot be easily explained are also likely to make it feel more “unnatural” than a more direct investment.
  • Imposed risks scare us more than those we take voluntarily. So one of the consequences of auto-enrolment may have been to make pensions appear as less of a voluntary process. Also the more restrictions that are placed on the investments you hold, the less control you will feel you have because:
    • Some “expert” is needed to explain the restrictions to you;
    • The restrictions almost inevitably mean that you need to behave in a different way to how you would have done otherwise (otherwise the restriction would not have been necessary). This might mean you have to put more money into it than you had intended, or in a different place to where you would have chosen or have to wait longer before you can take it out again.
  • Risks to children scare us more. Newspapers and online articles are full of stories about how much worse off our children are likely to be as a result of threats to our pensions system: whether this is the retreat of defined benefit pensions or the reform of the state pension or the collapse of capitalism.
  • We subconsciously weigh possible harms against potential benefits. This is the one to which pensions are particularly vulnerable. The harms are immediately obvious: money that we could be spending now on things which are important to us now are instead being funnelled away into a fund to which we have no immediate access. The benefits are uncertain, particularly now most of us are in DC arrangements, even within the current set of rules governing how pension schemes operate. But on top of this uncertainty is yet another layer of uncertainty concerning how those rules might change before we get our hands on our cash. We feel powerless and at the mercy of forces we don’t understand.

So what is to be done? I think that pension providers could address many of these fears by doing two things:

  • Keep it simple. Only introduce complexity when the benefits are obvious enough to be explained simply. More complex financial instruments may be appropriate for corporate pensions (although often they are not). They are almost never appropriate for retail pensions. Make sure every fund you offer has an easily accessible factsheet which covers what it invests in, what it is trying to do and how much it will cost. At the end of each year you should be told how much interest (why do we use different words for fund growth depending on where it is invested?) you have earned on your fund and how much you have been charged for having your money in that fund. Just like you would on your bank account. Some funds do this very well already.
  • Keep restrictions to the absolute minimum and let everyone know about them in advance. If someone is not going to be able to take advantage of some particular aspect of the pension freedoms now available, don’t wait until they try and do so. Tell them now. Few, if any, funds currently offer this.

Unfortunately there is probably not much that can be done about future pensions uncertainty. The future of the global economy is very uncertain and the UK’s economic future equally so. There is no political consensus over economic policy and the rules by which pensions are governed in the future seem likely to change in unpredictable ways over the next 30 years. But the simpler the products are, the easier they will be to regulate and the less likely they are to be affected in unforeseen ways by future changes.

I have deliberately avoided the question of pensions guidance or advice. This is because I do not think that people fear pensions advice itself, they fear paying for advice that they don’t understand and then making bad decisions as a result. This is a debilitating fear which is often discussed as if it suddenly struck as an individual approached retirement. In reality it has grown year by year as people feel powerless to affect what happens to the money everyone tells them they have been paid but which they have never seen other than in this annual pensions statement when it lands on the mat.

Take the fear out of that and it would change the pensions environment completely.

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S&P sovereign credit ratings

The Treasury is consulting on the tax relief that should be available in future for pension schemes and their members. The principles for any reform that it has set out are:

  • it should be simple and transparent;
  • it should allow individuals to take personal responsibility;
  • it should build on the success of automatic enrolment; and
  • it should be sustainable.

Simplicity, transparency, personal responsibility and sustainability mean different things to different people, which means that the precise meaning of these principles will depend on the politics of the people proposing them. However the words themselves are difficult to argue with, which is presumably why they have been chosen.

It has then set out 8 questions that it would like answered in response to its consultation. The consultation ends on 30 September. I have set out my responses below. I hope that they will sufficiently incense one or two more people into making their views heard, before the chance disappears.

1. To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension?

On this question I think I agree with Henry Tapper at the Pension PlayPen. He says the following:

In summary, millions of pounds of tax relief is wasted by the Treasury helping wealthy people avoid tax…Incentives are available to those on low earnings who pay no tax, but this message is not getting through, we need a system that resonates with all workers, not just those with the means to take tax advice.

I then think I agree with the following:

The incentive should be linked to the payment of contributions and not be dependent on the tax or NI status of the contributor – if people are in – they get incentivised.

That would certainly make the incentive to the pension scheme member clearer and potentially easier to understand. The other simplification I would support would be the merging of income tax and national insurance contributions – many of the sources I have referenced below are trying to solve problems caused by the different ways these two taxes are collected. This simplification would be an essential part of any pension reforms in my view.

2. Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save into a pension?

This is the invitation to support TEE (ie taxed-taxed-exempt, the same tax treatment as for ISAs). I have up until now been persuaded by Andrew Dilnot and Paul Johnson’s paper from over 20 years ago that this was not a good idea. This pointed out that the current EET system:

  • Avoids problems with working out what level of contributions are attributable to individuals in a DB system
  • Does not discourage consumption in the future relative to consumption now

I have changed my mind. The first point has already been addressed in order to assess people against the annual allowance, although this may need to be further refined. The second point is more interesting. As Paul Mason has pointed out in Postcapitalism, the OECD 2010 report on policy challenges, coupled with S&P’s report from the same year on the global economic impacts of ageing populations point to the scenario pensions actuaries tend to refer to when challenged on the safety of Government bonds, ie if they fail then the least of your problems will be your pension scheme. The projections from S&P (see bar chart above) are that 60% of government bonds across all countries will have a credit rating below what is currently called investment grade – in other words they will be junk bonds. In this scenario private defined benefit schemes become meaningless and the returns from defined contribution schemes very uncertain indeed. A taxation system which seeks to extract tax on the way in rather than on the way out then looks increasingly sensible.

I think that both the popularity of ISAs and the consistently high take up of the tax free cash option by pensioners, however poor the conversion terms are in terms of pension given up, suggest that tax exemptions on the way out rather than on the way in would be massively popular.
3 Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions?

Based on my comments above, I think the whole idea of personal responsibility for saving adding up to more than a hill of beans for people currently in their 20s may be illusory. People do take responsibility for things they can have some control over. Pension savings in the late twenty-first century are unlikely to be in that category.
4 Would an alternative system allow individuals to plan better for how they use their savings in retirement?

As I have said I favour a TEE system like ISAs. I think some form of incentive will be required to replace tax exemption, such as “for every two pounds you put in a pension, the Government will put in one” with tight upper limits. The previous pensions minister Steve Webb appears to broadly support this idea. Exemption from tax on the way out (including abolition of the tax charges for exceeding the Lifetime Allowance) would also aid planning.
5 Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated?

I think this is inevitable due to the fact that defined contribution (DC) schemes receive cash whereas defined benefit (DB) schemes accrue promises with often a fairly indirect link to the contributions paid in a given year. In my view taxation will need to be based on the current Annual Allowance methodology, perhaps refined as suggested by David Robbins and Dave Roberts at Towers Watson. The problem with just taxing contributions in DB is that you end up taxing deficit contributions which would effectively amount to retrospective taxation.

A further option discussed in Robbins and Roberts is making all contributions into DB schemes into employee contributions. I would go further and apply this to both DC and DB schemes – a sort of “reverse salary sacrifice” which could be encouraged by making the incentives on contributions only available on employee contributions, which would then be paid out of net pay. Any remaining accrual contributions made by employers in a DB scheme would be taxed by an adjustment to the following year’s tax code.
6 What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome?

I think everything points to the need for the retirement of DB for all but the very largest schemes. It would be better to do this gradually starting soon through an accelerated Pension Protection Fund (PPF) process rather than having it forced upon us in a hurry later in the century when PPF deficits may well be considerably higher than the current £292.1 billion.
7 How should employer pension contributions be treated under any reform of pensions tax relief?

As I have said, I think they should be converted into employee contributions based on higher employee salaries. This would make it clearer to people how much was being invested on their behalf into pension schemes.
8 How can the government make sure that any reform of pensions tax relief is sustainable for the future.

They can’t, and any change now will almost certainly be revisited several times over the next 50 years. However, systems where people feel they can see what is going on and which are tax free at the end are currently very popular and I would expect them to remain so for the foreseeable future. That takes care of political sustainability in the short term. What about longer-term economic sustainability? Faced by an uncertain and turbulent next 50 years where I have argued that personal responsibility (rather than communal responsibility) for pensions will seem increasingly irrelevant, I think what I have proposed will allow us to transition to a system which can be sustained to a greater degree.

We are entering what may prove to be a traumatic time for the world economy if Postcapitalism is even half right. Pensions taxation seems a good place to try and start to move our financial institutions in a more sustainable direction.

Nick Foster is a former pensions actuary who now lectures at the University of Leicester

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Go on pick a card

Defined ambition has failed.

  • This was mainly because, tasked with suggesting a less onerous alternative to defined benefit (DB) schemes that gave more protection than defined contribution (DC) schemes, the pensions industry (including actuaries) did not get behind the least bad option, but instead presented a spectrum of options
  • The public and employers were unimpressed
  • And employers had enough on their plate anyway dealing with auto-enrolment
  • So they have now all (or nearly all) enrolled their employees into DC
  • And the reason they are in DC now is the same reason they were in DB before: because they were offered so many choices they lost sight of the fact that there was a choice.

DA options

The time to significantly influence corporate pension provision would appear to have passed until people realise how hard it is to make sufficient provision via a DC scheme. That may not be until the money actually runs out as the finance industry has a proven track record in keeping people in schemes (eg the early personal pensions and later endowment mortgages) long after they retain the capacity to do them any good.

In the meantime, people with DC pensions and madly transferring DB members now have freedom and choice. I predict that this too will fail.

  • This will mainly be because, tasked with providing cost-effective advice to people to empower them to make good decisions about their financial future, the pensions industry do not get their act together and just present a spectrum of options
  • The public will be unimpressed
  • And employers, who might have been persuaded to increase employee education and engagement in pensions, will have enough on their plate anyway dealing with auto-enrolment
  • So now most of them will be managing their own retirement with not enough money, vulnerable to pensions scammers and paying far more tax than they need to
  • And the reason they will not be in an annuity now is the same reason they were in one before: because they were offered so many choices (see the Pension Wise website, inexplicably still in an unfinished Beta state) they lost sight of the fact there was a choice.

Pension_Wise_Logo

The time to significantly influence individual pension provision appears to be rapidly running out.

How does this story end, I wonder?

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shutterstock_84989578

The Institute and Faculty of Actuaries (IFoA) is introducing a new mandatory Actuarial Profession Standard (APS) in relation to review of actuarial work. The existing requirements in the APS applying to scheme actuaries will be withdrawn.

APS X2 Review of Actuarial Work will come into force on 1 July 2015 and is accompanied by a detailed, practical Guide. One of its key requirements is that actuaries, for any piece of work they wish to have reviewed, will need to consider the need for that review to be independently carried out, ie by someone not otherwise involved in the work in question.

I should declare straight away that I have a conflict of interest about this new standard, having set up a business because I felt scheme actuaries should have access to peer review services from an experienced scheme actuary outside their organisations. I am delighted that an idea which seemed a little odd to some when I first started offering these services in 2013 should now be regarded as sufficiently mainstream by the IFoA to prompt a revision of peer review guidelines.

Under APS X2, review processes are defined as either work review or independent peer review. Whereas work review is a general term covering all forms of review processes, the term independent peer review can only be applied to review processes involving reviewers not otherwise involved in the piece of work under review.

There are many reasons why you might want to have your work independently reviewed, for example:

  • Work reviewed within a firm might be influenced by the respective positions of the actuary and his/her reviewer within the management structure of the organisation;
  • Even if the work is reviewed by a colleague completely objectively, it might not be seen to have been;
  • There is a risk of group think in any organisation. Review from outside can significantly reduce this risk;
  • An independent reviewer may have a different range of experiences to draw on from those within your organisation. This can be particularly useful when reviewing work where there are potential conflicts of interest or concerns over how best to communicate a piece of work.

If this sounds of interest and you think it might be time to take a look outside for some of your peer review needs, my details can be found by following the link.

 

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