The FTSE All-Share Index, originally known as the FTSE Actuaries All Share Index, along with the FTSE 100, represent nearly all of the market capitalisation and the top 100 companies by size listed on the London Stock Exchange respectively. They are mentioned in all BBC news bulletins. When they go up, we all feel better. When they go down, they are seen as portents of doom.

Let me show you a different actuaries’ index instead:

Figure 1 shows the ACI and each of the components. The composite ACI represents the average of the six components (with sign of change in cool/cold temperatures reversed). The ACI is increased by reduction in cold extremes, consistent with increased melting of permafrost and increased propagation of diseases, pests, and insects previously less likely to survive in lower temperatures. A positive value in the ACI represents an increase in climate-related extremes relative to the reference period.

The threat of climate change is real, independent of speculative trading and the news media cycle, and increasing with each degree of warming we are unable to stop. Alongside this are the increasing risks of extreme weather events, which is most neatly described for North America currently by the Actuaries Climate Index. This focuses on six components in particular which have the most impact on human societies:

  1. Frequency of temperatures above the 90th percentile (T90);
  2. Frequency of temperatures below the 10th percentile (T10);
  3. Maximum rainfall per month in five consecutive days (P);
  4. Annual maximum consecutive dry days (D);
  5. Frequency of wind speed above the 90th percentile (W); and
  6. Sea level changes (S).

It then tracks them all over time, as shown in the graph above.

It seems clear to me that we should be reacting much less to the booms and busts of economic cycles and much more to climate-related threats. This is for two main reasons:

1. More people are at threat of death or injury as a result of climate change than even the 2008 crash in our financial systems. The World Health Organisation (WHO) predicts that, between 2030 and 2050, climate change is expected to cause approximately 250,000 additional deaths per year, from malnutrition, malaria, diarrhoea and heat stress. However, the additional deaths are already here. Taking just two examples from the WHO:

  • In the heat wave of summer 2003 in Europe for example, more than 70,000 excess deaths were recorded, with the frequency of such events steadily increasing.
  • Globally, the number of reported weather-related natural disasters has more than tripled since the 1960s. Every year, these disasters result in over 60,000 deaths, mainly in developing countries, which means that 40,000 of those deaths pa can already be directly attributed to climate change.

On the other hand, the 500,000 additional cancer deaths and 10,000 additional suicide deaths since 2008 cannot be attributed directly to the 2008 crash, as the analysis shows. These are more a result of the austerity policies which have been applied since 2008. Unnecessarily.

Climate change on the other hand does not care whether we react to it or not. It will relentlessly change the chemistry and biology of everything around us as the Earth and the inhabitants of the Earth adapt. We may survive it, in reduced numbers, or we may not. The Earth does not care. Responding to the threat will not make more climate-related events happen unless our response is to, by and large, ignore it.

2. One depends on the other. We cannot base our economies on a FTSE-led GDP-growth-at-all-costs model because it is not physically possible to maintain it without losing the environment from which our growth originates. As Finbarr Livesey points out in his excellent From Global to Local, the circular economy which the overwhelming consensus of studies show would increase employment and contribute to economic growth is taking a long time to arrive. In Europe, where we consume around 16 tonnes of stuff each per year, figures from Siemens in 2016 suggest that 95% of it and its energy value is lost through the life cycle of the products themselves.  As Kate Raworth  and others have pointed out, we need to focus on different measures of success if we are going to direct our economies in a more sustainable, less volatile and doom-laden direction.

There are plans to extend the Actuaries Climate Index to Europe (including the UK in this instance!), with a recent feasibility study concluding “that the prospects for constructing an analogue to the Canada-US ACI over the European region are promising”. I hope we see such an index soon, because, as Randall Munroe illustrates here, we have not been here before.

I look forward to the day when a new global actuaries’ climate index is on every news bulletin, making us feel better when it goes down and seeing any rise as a portent of doom. Because this time it really would be.

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Great infographic from futurism.com summarising the likely impacts of each additional degree in warming which I thought was definitely worth sharing!

 

Global Warming Scenarios

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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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The Institute and Faculty of Actuaries (IFoA), through its Actuarial Research Centre, is inviting research teams and organisations to submit proposals for a research project on modelling pension funds under climate change. The research is intended to address the need for pensions actuaries to understand the potential magnitude of climate change impacts, and hence if and when climate change might be relevant to the funding advice they give. What areas in particular might be useful to look at through the lens of a pension actuary?

The current concentration of carbon dioxide in the Earth’s atmosphere is around 400 parts per million by volume (ppmv), or a little over 140% of the generally accepted pre-industrial level of 280 ppmv. What level we can cap this at depends on how we respond in every country in the world. There are therefore many opinions about it:

Source: IPCC AR5: Fig 2.08-01 

Here RCPs stand for Representative Concentration Pathways, and are meant to be consistent with a wide range of possible changes in future anthropogenic (i.e. human) greenhouse gas emissions. RCP 2.6 assumes that emissions peak between 2010-2020, with emissions declining substantially thereafter. Emissions in RCP 4.5 peak around 2040, then decline. In RCP 6.0, emissions peak around 2080, then decline. In RCP 8.5, emissions continue to rise throughout the 21st century. What this means is that the best we can hope for now is a scenario somewhere between RCP 2.6 and RCP 4.5, with the US Government’s Environmental Protection Agency appearing to believe that RCP 6.0 is the most realistic scenario. As you can see, RCP 4.5 assumes an eventual equilibrium at around 500 ppm, or about 180% of pre-industrial levels and RCP 6.0 an equilibrium at around 700 ppmv, or about 250% ppmv.

Equilibrium climate sensitivity is defined as the change in global mean near-surface air temperature that would result from a doubling of carbon dioxide concentration. A doubling of the pre-industrial level to 560 ppmv (ie between the RCP 4.5 and RCP 6.0 assumption) has been projected to result in a range of possible outcomes:

Source: IPCC 2007 4th Assessment Report, Working Group 1 (Figure 9-20-1)

This is certainly a bit of a we know zero kind of graph, but has worryingly fat tails indicating reasonable chances of 10 degrees plus added to average global temperatures. To put this in context, let’s use the approach taken in Mark Lynas’ excellent “Six Degrees“, where the combined research into the effects of each additional degree above pre-industrial global temperatures is collated to allow us to view them as distinct possible futures. Some examples are as follows:

One degree

We are nearly here (around 0.8ᵒ so far):

  • Return of the “Mid-west American dust bowl” but with greater vengeance
  • Increase in hurricane activity
  • Loss of low lying islands, eg Tuvalu

Two degrees

The “safe” level we are trying to limit increases to:

  • Release of greenhouse gases begin to alter the oceans. May render some parts of southern oceans toxic to Ca CO3 and thus to one of life’s essential building blocks, plankton.
  • Heatwaves like 2003 which killed 35,000 people in Europe and led to crop losses of $12 billion and forest fires costing $1.5 billion will occur almost every other summer.
  • Crippling droughts can be anticipated in Los Angeles and California
  • From Nebraska to Texas the anticipated drought would be many times worse than the 1930s “dust bowl” phenomenon.
  • Polar bears would probably become rapidly extinct.
  • Mediterranean countries will become drier and hotter with significant water shortages.
  • IPCC estimate sea level rise of 18 to 59 cms.
  • Monsoons would increase in India and Bangladesh leading to mass migration of its populations.
  • International food price stability will have to be agreed to prevent widespread starvation.

Three degrees

  • Africa will be split between the north which will see a recovery of rainfall and the south which becomes drier. This drier southern phase will be beyond human adaptation. Wind speeds will double leading to serious erosion of the Kalahari desert.
  • Indian monsoon rains will fail. ·
  • The Himalayan glaciers provide the waters of the Indus, Ganges and Brahmaputra, the Mekong, Yangtze and Yellow rivers. In the early stages of global warming these glaciers will release more water but eventually decreasing by up to 90%. Pakistan will suffer most, as will China’s hydro-electric industry.
  • Amazonian rain forest basin will dry our completely with consequent bio-diversity disasters
  • Australia will become the world’s driest nation.
  • New York will be subject to storm surges. At 3° sea levels will rise to up to 1 metre above present levels.
  • In London, a 1 in 150 year storm will occur every 7 or 8 years by 2080.
  • Hurricanes will devastate places as far removed as Texas, the Caribbean and Shanghai.
  • A 3° rise will see more extreme cyclones tracking across the Atlantic and striking the UK, Spain, France and Germany. Holland will become very vulnerable.
  • By 2070 northern Europe will have 20% more rainfall and at the same time the Mediterranean will be slowly turning to a desert.
  • More than half Europe’s plant species will be on the “red list”
  • The IPCC in its 2007 report concluded that all major planetary granaries will require adaptive measures at 2.5° temperature rise regardless of precipitation rates. US southern states worst affected, Canada may benefit. The IPCC reckons that a 2.5° temperature rise will see food prices soar.
  • Population transfers will be bigger than anything ever seen in the history of mankind.

Three degrees obviously needs to be avoided, let alone ten, but the problem is that business as usual for the finance industry may not be the way to get there. As some recent research has suggested, financial market solutions to environmental problems, such as carbon trading, may be ineffective. As the authors state: By highlighting the tenuous and conflicting relation between finance and production that shaped the early history of the photovoltaics industry, the article raises doubts about the prevailing approach to mitigate climate change through carbon pricing. Given the uncertainty of innovation and the ease of speculation, it will do little to spur low-carbon technology development without financial structures supporting patient capital.

Patient capital is something developed economies have been seeking for some time, whether it is for infrastructure investment, development projects or new energy sources, and no good way to create it within the UK private sector has been found yet, including various initiatives to try and get an increase in pension scheme investment in infrastructure projects. It therefore seems to me to be the wrong question to ask what impacts climate change are likely to have on the assumptions used for pension scheme funding, when it is the impact of the speculation which pension scheme funding encourages which is one of the main drivers of our economies towards the worst possible climate change outcomes.

A more productive research question in my view would be to bring in legislators and pensions lawyers as well as environmental scientists and others researching and thinking in this area alongside actuaries to look at how we could change the regulatory framework within which pension scheme funding and investment within other financial institutions where actuaries are central takes place. There is already research into what changes may be necessary to international law to reflect the new Anthropocene era the planet has entered, where the dominant feature is the impact of human activity on the environment. In my view this should be extended to the UK legislative and regulatory landscape too.

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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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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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Group of pins

Two women were fighting on my train the other morning. It was a packed train, with people standing the length of the carriage, so I didn’t see it so much as hear it. The first woman felt she had been pushed by the other one and complained very loudly and with much swearing. The second woman made some comment about the first woman’s mother and it escalated from there, getting louder and louder. Neither was prepared to let the other have the last word and, seeing the impact the mother comment had had, the second woman used it again. At which point the first woman hit her. The other passengers had been sitting and standing grim-faced up until this point, but now one or two intervened. One, who had the bearing of a lay preacher, attempted to assume sufficient authority to stop the argument. He was ignored. Another one stood and put the second woman in his seat and stood between them.

The second woman continued to make comments, but as much to herself as to the first woman. She kept stamping her feet in frustration. She was clearly in unbearable discomfort, but not from any physical pain. Finally she called the police and, as we pulled into New Street Station, started to give a physical description of her assailant. “Everyone on the train saw it” she said several times, while the passengers around her stared in any direction but hers.

I don’t know what happened next in the lives of these two women, although an announcement was made a couple of days later on the same service that police were working their way through the train for witness statements about the incident. They never appeared in my carriage, and I am not sure what I would have said if they had. And I don’t know what your reaction to my story is – whether that the other passengers, including me, should have acted differently or some commentary on the behaviour of the two women. I am, however, reasonably confident that you will have a reaction, perhaps quite a strong one, despite my limitations as a narrator. The reason I am confident about this is that I found myself, involuntarily, completely absorbed in the dispute, upset when one of the women expressed upset, constructing back stories for each of them, questioning their strategic wisdom at various points and, by the time we arrived at New Street Station and I dispersed with all the other witnesses, emotionally drained. And a look at the faces around the carriage suggested to me that most of my fellow passengers reacted similarly.

Why am I telling you this? Because it is a clear example of our domesticated brains in action. The almost physical pain this argument caused me and most of my fellow passengers is the reason we can travel from Sutton Coldfield to Birmingham every day with rarely an incident. It is often referred to these days, in pejorative terms, as Group Think. The shared assumptions and behaviours which allow us to live alongside each other in peace. I then get on a second train each day from Birmingham to Leicester, which I tell everyone is a great train to work on. But this is only because I can trust the 80 or so other passengers not to start an argument. The police could not cope if everyone behaved like the two women in my story. When the police do make an appeal for witnesses, they do so secure in the knowledge that nothing they say or do will encourage more than a handful to come forward, so strong is our group instinct to stay out of each other’s lives if we can. It is not indifference but survival. You need very strong structures to counteract the very strong instinct for Group Think.

However the reason Group Think is used pejoratively is that we have had vivid demonstrations of its power to make large groups of people behave stupidly. For example, herding behaviour in financial markets often causing the very problems people are trying to protect themselves from by going with the crowd. Or regulatory regimes which seem to encourage monocultures to develop, whether in finance, health, education, politics or academia, based on shared assumptions rather than encouraging diversity, because monocultures are easier to regulate. Many professions, including the actuarial profession, have introduced specific professional guidance to encourage whistle-blowing where appropriate, ie standing up to the policies and practices of their own organisations in most cases, which often means doing battle with Group Think. How successful such initiatives prove to be remains to be seen.

Encouraging challenges to Group Think is hard. It normally means going out of your way to allow views to be expressed you don’t agree with. It makes getting your own way harder to achieve. It can seem to us like the opposite of strong leadership and decisiveness when we seek out opinions that will make decision-making more complex. But we have made our society so complex and organisationaly fragile that this is what we are going to need to do more of in the future to stop it all from crashing down around us.

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I wanted to share this lovely account of Vonnegut’s story shapes because it is one very powerful way to categorise different outcomes and, as such, potentially a very interesting way of illustrating them and their implications. I feel sure I will be returning to this theme soon.

Kurt Vonnegut - The Shapes of Stories

From Visually.

 

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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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From time to time I get asked about my banner header showing successive Office of Budget Responsibility (OBR) forecasts for GDP growth against actual GDP growth and, in particular, what has happened since. The OBR produces its forecasts twice a year, in March and December, and the latest one is here. However I have resisted updating my banner to date for a number of reasons:

  • The statement that economic forecasts are wildly inaccurate has become a truism that, in my view, no longer needs additional evidence in support; and
  • To be completely honest, once actual GDP growth started to increase (as was inevitable eventually, and particularly once the Government’s austerity boot’s grip on the economy’s neck started to weaken), the graph no longer looked quite as amusing.

However, I have recently started to question the first of these assumptions so here is an updated graph:

OBR update 2014

Notice how the point at which growth peaks and starts to fall is moving closer with each new forecast. This is as much a part of their models as putting back the upward path a quarter or two with each successive forecast was while that path was still actually falling. Be assured that the OBR will not forecast the next fall before it actually happens.

What concerns me is the forecast consensus which is starting to build around 2014-2018 of GDP growth between 2% and 3% pa (currently narrowing as a forecast to 2.5% – 2.8% pa). This is despite the OBR themselves making no more than a claim of 20% probability of growth staying in this range, as the following fan chart shows:

OBR fan chart

However I don’t see this fan chart turning up in many news reports and therefore my concern is of an election campaign fought under the illusion of a relatively benign economic future. I think it is likely to be anything but, particularly as the Government is likely to stick the boot back in post election whoever wins.

There seems to be no chance of stopping the OBR and others publishing their forecasts, too many people seem to value the power of the story-telling however implausible the plot, so the only course available seems to be to rubbish them as often as we can. That way it may just be possible, despite all the noise about predictions of economic recoveries and collapses we cannot possibly foretell being used to try and claim our political support more generally, to keep in mind that we know zero. And make better decisions as a result.

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