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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EU referendum

The increasing complaints about the counter-productive nature of most “expert” interventions in the EU Referendum Debate appear to have had no effect on their supply. In one of the latest, the Institute and Faculty of Actuaries (IFoA) has commissioned the National Institute of Economic and Social Research (NIESR) to research The Impact of Possible Migration Scenarios after ‘Brexit’ on the State Pension System. Concerned that this might be ignored, the IFoA helpfully released the following key findings in a press release:

  • Reducing annual migration numbers, for example by c150,000*, could cost the State more than £3bn per year by 2032 and more than £8bn per year by 2057
  • To offset this funding gap in 2057 might require a further increase in the State Pension Age from 68 to 69 or a reduction in State Pension of £300 per year
  • Government could also use policy levers such as National Insurance contributions, or the level of State Pension benefits to mitigate against the net increase in Government costs
  • Raising the potential earnings profile of immigrants could also mitigate, or even reverse, impacts

The report itself adds two important caveats to these findings. First, the net effect on the government budget is not statistically significant. Second, the increase in total state retirement benefits over the time period considered, without any change in migration policy, of around £94b dwarfs the higher costs due to any changes in migration scenarios considered. Only the second of these made it into the press release, several paragraphs down.

I am guessing, perhaps unfairly, that most of the UK press will only use what is in the press release. In which case they will not understand that the baseline scenario against which the six migration scenarios the report studies is itself based on Office of National Statistics (ONS) Principal Population Projections which show net migration falling to 185,000 from 2020-21, and remaining constant at that level in subsequent years. Now this may happen but, considering how much attention is being devoted to the immigration question within the EU currently, I would regard it as highly unlikely to represent the non-Brexit position. Which makes the comparisons rather meaningless. And there is of course the problem of projections to anything like 2057 which I have commented on before. The immediate conversion of financial scenarios into specific policy responses like changes to the State Pension Age is, I am afraid, pure Project Fear behaviour.

I am not a Brexiteer, but the constant barrage of “evidence” like this is not going to win any arguments for the Remain side in my view, which is shared by many others. My view is that Brexit might finally make it clear to us that our problems of democracy are at a national level rather than an EU one, as suggested in Chris Bickerton’s excellent The European Union: A Citizen’s Guide. This might be worth a certain amount of economic sacrifice. On the other hand staying in the EU might make action in areas where cooperation is required – such as climate change, pollution, migration and tax reform – more likely, although the EU’s track record internationally is mixed here. EU membership probably makes some kinds of policy change more difficult, perhaps encouraging more thought before radical change.

What has become obvious is that announcing the Referendum has done nothing for the discussion except to turn it into an adversarial one. I have lost count of the number of online petitions I have been invited to sign up to by people who have lost sight of the need to have a discussion and just want their side to win at any cost.

If enough people voting for a particular outcome do so with a clear reason about what they would do to improve our society after the vote, we will have won whatever the outcome. If it’s Brexit, we will need to roll up our sleeves, as we will have made life more difficult for ourselves in purely economic terms, but if the feeling of control and responsibility for sorting out our national problems energises a large segment of the population it will be a win. If it’s Remain, but we realise that the EU cannot continue as it is and that a massive shift of control away from the elite political class of all nations is required, whether via DiEM25 or something perhaps more relevant to the concerns of the UK, that would also be a win. What we need above all is for the most energetic and innovative people amongst us to decide to vote and follow it through.

The only way we will lose is if we vote for Remain and then just continue as we are.

So, if anyone under the age of 30 is reading this, I would encourage them to:

  1. Register to vote (you have until Tuesday 7 June) and can do this here;
  2. Stop listening to my generation and that of my parents (if you are, your deference to age and experience in this case is misplaced!); and
  3. Make up your own minds.

And whatever we all decide on 23 June, we can make it work out okay for all of us. Of that I am quite certain.

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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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For a brief period this week, before the Panama leaks brought everyone back in the room, one of the BBC’s main headlines was that a change to the UK State Pension was projected to make around three-quarters of people currently in their 20s and two-thirds of those currently in their 30s worse off than under the current arrangements. Figures of £19,000 and £17,000 “over the course of their retirement” were bandied around.

The reason the analysis had been carried out by the Pensions Policy Institute (PPI) was that the Department of Work and Pensions (DWP) is required to carry out an impact assessment of such proposed changes and had given the PPI the task.

First of all, the full summary of the analysis, coverage of which on the BBC has at least started to become a little more measured by today, is as follows:

PPI nSP

As you can see, the numbers that came out were weekly losses of up to £17 per week for some groups and weekly gains of up to £13 per week for others. These numbers were themselves based on complicated projections about how benefit changes would be phased in and also how much the State Second Pension would pay people many decades into the future (the DWP paper can be found here). They were then aggregated by multiplying by the number of weeks in retirement until the pensioner was expected to die, based on the current State Pension Age timetable and the principal projections from the ONS 2015 Life Tables. The total amounts expected to be paid to people in retirement, however, were not (for those in their 20s this would be around 24 x 52 x 155.65 (the start rate for the new State Pension) as a minimum = £194,250 in 2015 terms). Neither was any explanation made of just how many years people were being projected to live. For £17 a week to translate into £21,000, the person currently in their 20s will need to be in retirement for nearly 24 years. It is not clear exactly when this person is expected to retire: the current tables only go up to a date of birth of 6 April 1978 (when State Pension Age is expected to be 68) with a vague intention to increase it to 69 by the late 2040s. An assumption of a retirement age of 69 looks consistent with the projections, which indicate a life expectancy at that age of 22.95 years for males and 24.81 years for females born in 1995.

And that last bit leads me on to why this particular news story is in my view just foolish. I tend to get a bit crotchety whenever anyone projects anything as a fact to a date beyond my personal life expectancy (less than 33 more years, according to the ONS). We are talking about people being worse off in the 2050s and 2060s. Here are a few more projections for you with those kinds of timelines:

  • World population will be 9 billion by 2050 (UN – currently it’s 7 billion)
  • Total energy demand in CO2 equivalent doubles from current levels by 2060 (IPCC)
  • Banking assets in London exceed 9 times UK GDP by 2050 (Mark Carney, Governor of the Bank of England)
  • 60% of government bonds across all countries will be classified as junk by 2050 (Standard & Poors)

The vast majority of people are going to be better off who retire in the next 15 years (at least in terms of their State Pension), as will most people retiring in the decade after that. Beyond that we are in the region of the unknowable – almost certainly a very different-looking world which will have required several further adjustments to state pensions before we get there. So please let’s not waste time having foolish arguments about made up winners and losers.

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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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Fiscal spaceI was a pensions actuary for some years, and spent most of that time advising trustees of defined benefit (DB) pension schemes about what to do with their funding debts (we called them deficits or shortfalls, but so as not to confuse them with what the UK Government means by a deficit, ie spending greater than receipts in any given year, I will stick with the term debt here). It seems to me that there are many parallels between this kind of debt and the kind that governments run:

  1. The debt has built up over many years, and the reasons it was built up are often no longer a priority for the sponsor trying to pay off the debt (whether this is former employees for companies, or bailed out banks for governments)
  2. It is very sensitive to things which are not under the control of the sponsor (whether this is gilt yields or pensions legislation for companies, or the state of the world economy for governments)
  3. The debt position can change very quickly
  4. The sponsor usually has more attractive options for investing money than paying off the debt

Pension scheme debts fall broadly into three categories:

  • Small debts, where the company sponsoring the pension scheme can easily afford to service the debt and is relatively large financially compared to the debt. Think Norway, with their massive sovereign fund, or South Korea on the graph above. There are a wide range of ways of dealing with a debt like this: if the funding target was not to buy out the benefits with an insurance company at this point, I would generally try and encourage the trustees and sponsor in that direction because of point 3. However there are many other completely reasonable approaches here and the point is that, whichever is chosen, it is unlikely to seriously affect the ability of the company to implement its business plans.
  • Large but manageable debts. The company does need to put in place a proper funding plan here. How quickly it would be asked to pay off the debt would depend on what is called the employer covenant, which is the willingness and ability of the company (or sometimes group of connected companies, which is where the willingness comes in) to pay. Strong companies are allowed more options and longer repayment periods if they want them, although in some cases they may just want to fully fund and remove the ongoing costs of meeting the regulatory and administrative requirements of running a DB pension scheme. Think of the UK in this category. The paper from which the graph above is taken is concerned with the green zone cases like the UK, for which it concludes that reducing debt in the current circumstances of very low real interest rates (the same problem making pension debts so large) and demand shortfalls in the economies in question (the rather more important debt) is likely to be undesirable as the costs will outweigh the benefits.
  • Large and unmanageable debts. The company cannot afford a funding plan. In most cases the scheme does not have access to sufficient assets to buy policies to pay full pensions to its members with an insurer. An organisation called the Pension Protection Fund (PPF) then gets involved, which guarantees to pay full pensions to pensioners and 90% to non-pensioners, in exchange for all the assets it can get from the defaulting scheme and its sponsor. The sponsor usually needs to be insolvent for its scheme to enter the PPF, although sometimes it is allowed to return phoenix-like without the pension scheme but with the PPF as a stakeholder receiving a share of company profits over an agreed period.

I saw my role as to help trustees negotiate hard for a funding settlement with the sponsor, on the understanding that the sponsor would also negotiate hard. It was always clear to me that the sponsor’s responsibility was to grow its business and it would look to direct most of its profits to that end. The trustees were there to ensure that the (in the main) employees of the past who had been made a pension promise were not forgotten by the employees of the present and future and their employer when resources were being directed.

Imagine what the trustees’ role might be if this whole basis of funding was turned on its head: companies directing ever more of their profits into debt repayment at the expense of any sort of investment in the future of their businesses. To the extent that this threatened the future income stream to the scheme as the business fell apart, trustees and their actuaries might find themselves making very different arguments (perhaps along the lines of the flexibility the regulator promotes and the importance it stresses of trustees having a good understanding of the employer’s position and plans, including how any plans for sustainable growth enhance the employer covenant). But we would then be in a situation where what the company was expert in, ie running its business, had been subordinated to funding a pension scheme, while what the trustees and their advisers were expert in, ie funding the pension scheme, had become less important than protecting the long term health of the company. This would appear to be sub-optimal.

But it is not that different from having a government that makes its highest priority to reduce a debt which it does not fully understand and certainly cannot fully control, while cutting back on all the things that governments do which support the economic health of a country, from investing in infrastructure and housing to promoting real social security for the economic units, ie us, within it.

And imagine what would happen if we treated schemes with large unmanageable debts like Greece. The current deal which looks like it might be agreed tomorrow involves asset sales, spending cuts, tax increases and reform of both its tax and pensions system in return for three year loans and debt restructuring and reprofiling. This would be the equivalent of not only putting the sponsor into administration and selling off all its assets but also immediately demanding pension contributions from the workers who had been kept on into a scheme which would never give them any benefits just before firing them with no pensions (pensioners left without pensions was a scenario which occasionally happened in the UK before the PPF and sometimes led to naked pensioners demonstrating on the beach). The sell off would, as it always does (and certainly has in the case of Greece) pay off the banks first before moving on to the unsecured creditors. Insolvency practitioners know that they can get more for a company by selling it as a going concern rather than as just a bunch of assets. The PPF similarly understand that a proportion of future profits can be in their best long term interests as a creditor rather than dancing around the flames of a fire sale. The Troika, the IMF and their enforcer, the ECB, appear to have lost sight of this.

The current austerity fixation is not bringing good private sector practice into the public sector. On the contrary it is removing the public sector foundation required for the private sector to flourish. And that is just bad business.

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Election forecasts

The result of the forthcoming General Election is not in much doubt it would seem. Eight different polling organisations’ latest polls are shown above, and the similarities between them are so much more striking than the differences. It appears that we will be going through the motions of a process which is to a large extent predetermined on 7 May. The election result is not where the uncertainty lies.

However, the day afterwards, when the general public no longer has any say in what happens, is still deeply uncertain. Although the parties have all let us have their manifestos, details about how they would behave in the event of a distribution of seats which seems to be largely already decided in most cases (presumably because the parties think we might vote differently if we knew) are very sketchy. Does this meet the definition of democracy, ie a system of government by the whole population? The Electoral Reform Society would say not. I would argue it does.

If the election result is largely as expected what would it tell us about the views of the electorate? I think it would tell us:

  • They don’t want austerity on the scale of 2010-12 again (which is one reason why the Conservatives and Liberal Democrats together don’t appear likely to get a majority);
  • They are not as obsessed with immigration policy as the two main parties think they are (which is why they seem prepared to vote for a range of different approaches to managing immigration with no approach commanding majority support);
  • They don’t want a referendum on whether to stay in the EU (which is why the Conservatives and UKIP together will not be able to get a majority); and
  • They don’t support the current student fees system and don’t believe it is indistinguishable from a graduate tax (which is another reason why the Liberal Democrats and Conservatives together seem unlikely to get a majority).

There are probably several other attitudes amongst the electorate that can equally well be divined in the negative in a similar way (the BBC summaries of the parties’ positions on a range of issues can be found here), but the point is that a finely balanced pattern of parties of the type we look likely to end up with does not represent an inability to make a decision. It does however represent a determination not to allow any single party to make decisions. That seems to meet a reasonable definition of democracy to me.

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