Nick Foster – Page 13

Public sector pensions and liabilities

30. April 2014 · Write a comment · Categories: Actuarial, Demographics, Economics, Pensions, Prediction, Regulation

Sometimes the best explanations of things come when we are trying to explain them to outsiders, people not expected to understand our particular forest of acronyms, slangs and conventions which, while allowing speedier communication, can also channel thinking down the same tired old tracks time after time. Such an example I think is the UK Government Actuary’s Department (GAD) paper on Pensions for Public Service Employees in the UK, presented to the International Congress of Actuaries last month in Washington.

Not a lay audience admittedly, but one sufficiently removed from the UK for the paper’s writers to need to represent the bewildering complexity of UK public sector pension provision very clearly and concisely. The result is the best summary of the current position and the planned reforms that I have seen so far, and I would strongly recommend it to anyone interested in public sector pensions.

There are two points which struck me particularly about the summary of the reforms, designed to bring expenditure on public service pensions down from 2.1% of GDP in 2011-12 to 1.3% by 2061-62.

The first came while looking at the excellent summary of the factors contributing to the decline of private sector pension provision. Leaving aside the more general points about costs and risks, and those thought applicable to the (mainly) unfunded public service schemes which have been largely addressed by the planned reforms, I noticed two of the factors thought specific to funded defined benefits (DB) plans:

A more onerous burden on trustees of plans, including member representation, and knowledge and understanding; and
Company pension accounting rules requiring liabilities to be measured based on corporate bond yields.

As the GAD paper makes clear, the Public Service Pensions Act will result in a significant increase in interventions on governance in particular in some public sector schemes. The Pensions Regulator’s recent consultation on regulating public service pension schemes is also proposing a 60 page code of practice be adopted in respect of the governance and administration of these schemes. This looks like the “onerous burden” which has been visited on the private sector over the last 20 years all over again.

The other point is not directly comparable, as company pension accounting rules do not apply to the public sector. However, as pointed out by the Office for National Statistics (ONS) this week, supplementary tables to the National Accounts calculating public sector pensions liabilities will be required of all EU member states from September this year onwards, to comply with the European System of Accounts (ESA) 2010. These are carried out using best estimate assumptions (ie without margins for prudence) and a discount rate based on a long term estimate of GDP growth (as compared to the AA corporate bond yield required by accounting rules).

The ONS released the first such tables published by any EU member state, for 2010, in March 2012. This for the first time values the liabilities in respect of unfunded public sector pension entitlements, at £852 billion, down from £915 billion at the start of the year.

I think there is a real possibility that publication of this information, as it has for DB pension schemes, will result in pressure to reduce these liabilities where possible. An example would be one I mentioned in a previous post, where mass transfers to defined contribution (DC) arrangements from public sector schemes following the 2014 Budget have effectively been ruled out because of their potential impact on public finances. If such transfers reduced the liability figure under ESA 2010 (which they almost certainly would) the Government attitude to such transfers might be different in the future.

The second point concerned the ESA 2010 assumptions themselves. There was a previous consultation on the best discount rate used for these valuations, ie the percentage by which a payment required in one year’s time is more affordable than one required now, with GDP growth coming out as the preferred option. Leaving aside the many criticisms of GDP as an economic measure, one option which was not considered apparently was the growth in current Government receipts, although this would seem in many ways to be a better guide to the element of economic growth relevant to the affordability of public sector provision. Taking the Office for Budget Responsibility (OBR) forecasts from 2013-14 to 2018-19 with the fixed ESA 2010 assumptions for discount rate and inflation of 5% pa and 2% pa respectively gives us an interesting comparison.

The CPI assumption appears to be fairly much in line with forecasts, but the average nominal GDP and current receipt year on year increase over the next 6 years of forecasts are 4.47% pa and 4.61% pa (4.72% pa if National Accounts taxes are used rather than all current receipts) respectively. A 0.5% reduction in the discount rate to 4.5% pa would be expected to increase the liability by over 10%.

Another, possibly purer, measure of economic growth, removing as it does the distortions caused by net migration, would be the growth of GDP per capita. If we take the OBR forecasts for real GDP growth per capita and set it against the long term ESA 2010 assumption of 1.05/1.02 – 1 = 2.94% the comparison is even more interesting:

In this case the ESA assumption is around 1% pa greater than the forecasts would suggest, making the liability less than 80% of where it would be using the average forecast value.

The ESA 2010 assumptions are intended to be fixed so that figures for different years can easily be compared. It would clearly be easy to argue for tougher assumptions from the OBR forecasts (although the accuracy of these has of course not got a great track record), but perhaps more difficult to find an argument for relaxing them further.

Whether the consensus holds over keeping them fixed when and if the liability figures start to get more prominence and a lower liability becomes an important economic target for some of the larger EU member states remains to be seen. However if the assumptions cannot be changed, since public sector benefits now have a 25 year guarantee in the UK (other than the normal pension age now equal to the state pension age being subject to review every 5 years), then the cost cap mechanism (ie higher member contributions) becomes the only available safety valve. So we can perhaps expect nurses’ and teachers’ pension contributions to become the battleground when public sector pension affordability becomes a hot political issue once more.

We can poke fun at the Government’s enthusiasm to take on the Royal Mail Pension Plan and its focus on annual cashflows which made it look beneficial for their finances over the short term, but we may also look back wistfully to the days before public sector pensions stopped being viewed as a necessary expense of delivering services and became instead a liability to be minimised.

The misbehaviour of mistakes

25. April 2014 · Write a comment · Categories: Cartoons, Risk

The Comedy of Errors
– with apologies to William Shakespeare in the week of his 450th birthday

There are two ways that mistakes can happen when you are carrying out an experiment to test a hypothesis. Experiments usually have two possible outcomes: accepting a “null” hypothesis, which means concluding that the experiment does not challenge its truth, and rejecting a null hypothesis, which means concluding that the experiment does provide sufficient evidence to do so.

Type 1 errors, otherwise known as “false positives” are when you think there is evidence for rejecting the null hypothesis (eg deciding there actually is something wrong with a smear test) when there isn’t. Type 2 errors, otherwise known as “false negatives”, are when you accept the null hypothesis but you really shouldn’t (eg telling someone they are all clear when they are not).

Saddam Hussain once famously said “I would rather kill my friends in error, than allow my enemies to live”. This suggests that he was really very much more concerned about Type 2 errors than Type 1 errors.

He is not alone in this.

A recent widely reported academic paper published in Nature claimed to have a test that “predicted phenoconversion to either amnestic mild cognitive impairment or Alzheimer’s disease within a 2–3 year timeframe with over 90% accuracy”.

The latest statistics from the Alzheimer’s Society suggest that around 1 in 14 or 7% of over 65s will develop Alzheimer’s. Probably not all of these people will contract the disease within 3 years, but let’s assume for the sake of argument that they will. Even so this means that, out of 1,000 people over 65, 930 people will not get Alzheimer’s within 3 years.

Applying the 90% accuracy rate allows us to detect 63 out of 70 people who actually will get Alzheimer’s. There will be 7 cases not picked up where people go on to develop Alzheimer’s. However the bigger problem, the Type 1 error that Saddam Hussain was not so bothered about, is that 10% of the people who do not and will not get Alzheimer’s will be told that they will. That is 93 people scared unnecessarily.

So 63 + 93 = 156 people will test positive, of which only 63 (ie 40%) will develop Alzheimer’s within three years. The “over 90%” accuracy rate becomes only a 40% accuracy rate amongst all the people testing positive.

In statistical tests more generally, if the likelihood of a false positive is less than 5%, the evidence that the hypothesis is true is commonly described as “statistically significant”. In 2005 John Ioannidis, an epidemiologist from Stanford University, published a paper arguing that most published research findings are probably false. This was because of three things often not highlighted in the reporting of research: the statistical power of the study (ie the probability of not making a type 2 error or false negative), how unlikely the hypothesis is being tested and the bias in favour of testing new hypotheses over replicating previous results.

As an example, if we test 1,000 hypotheses of which 100 are actually true but with a 5% test of significance, a study with power of 0.8 will find 80 of them, missing 20 because of false negatives. Of the 900 hypotheses that are wrong, up to 5% – ie, 45 of them – could be accepted as right because of the permissible level of type 1 errors or false positives. So you have 80 + 45 = 125 positive results, of which 36% are incorrect. If the statistical power is closer to the level which some research findings have suggested of around 0.4, you would have 40 + 45 = 85 positive results, of which 53% would be incorrect, supporting Professor Ioannidis’ claim even before you get onto the other problems he mentions.

We would have got much more reliable results if we had just focused on the negative in these examples. With a power of 0.8, we would get 20 false negatives and 855 true negatives, ie 2% of the negative results are incorrect. With a power of 0.4, we would get 60 false negatives and 855 true negatives, ie still less than 7% of the negative results are incorrect. Unfortunately negative results account for just 10-30% of published scientific literature, depending on the discipline. This bias may be growing. A study of 4,600 papers from across the sciences conducted by Daniele Fanelli of the University of Edinburgh found that the proportion of positive results increased by over 22% between 1990 and 2007.

So, if you are looking to the scientific literature to support an argument you want to advance, be careful. It may not be as positive as it seems.

Inflation and Age

16. April 2014 · Write a comment · Categories: Economics

A recent piece of research into how the way people spend their money changes as they age got me thinking about how age might currently influence a particular household’s own Consumer Price Inflation (CPI).

The Office of National Statistics (ONS) produces a monthly inflation report for each major sector of expenditure, alongside the updates for CPI. The latest of these, out yesterday, showed CPI falling to 1.6%, finally less than wage inflation in the UK. However CPI is based on an average basket of goods to determine how people’s cost of living is increasing and this of course differs from person to person. In particular, the spending habits of the population, when split by the age of the household reference person (the ONS term for what used to be known as the “head of household”, when it was always the man of the house even when that house was owned by the woman: this was changed in the 90s), differ markedly.

The graph is based on the latest splits available of spending by the 12 categories used by the ONS to determine CPI (these are from 2012, although the overall averages these figures provide give CPI figures of 0.1% or less different from the actual figures so I think they will do for illustrative purposes).

What we can see straight away is that the gap between CPI for under 30 year old households and the 65-74 year old households has shrunk from around 0.8% pa to around 0.5% pa. However, under 30 year olds are still experiencing consistently higher inflation than the rest of the population. In fact this section of the working population are still experiencing inflation well in excess of the average wage inflation of 1.7% announced today.

The big winners since July have been the 30-44 year olds, with their households down to 1.5% pa inflation from 2.7% pa at the start of the period. And if your head of household is between 50 and 74 you are now experiencing average inflation year on year of only 1.4% pa.

The people who have not won quite so much (other than the under 30s) have been the over 75s, with their households at 2.6% pa at the start of the period and at 1.6% pa (ie bang on the average) at the end. Interestingly, the under 30s and over 75s have an average inflation above the headline rate, and everyone in between is coming in below it.

Why the differences? Well the change in the inflation rate has varied hugely amongst the 12 categories of spending.

Food and non-alcoholic drink inflation has fallen from 3.9% to 1.7%, Clothing and footwear from 2.5% to 0.2% and Transport from 1.5% to -1.0%, so any sector with spending habits weighted towards these areas is going to have done better than average. The 30-64 year old households spend between 5.9% and 6.1% on Clothing and between 15.9% and 16.7% on Transport compared to the averages of 5.6% and 15.2% respectively. However the over 75s spend 18.8% of their income on Housing, fuel and power, which has seen inflation remain stubbornly high at 3.1% pa, and have higher than average spending on Health (4.6% against 1.5% average) and Household goods and services (8.3% against 6.8% average), both of which saw an increase in inflation over the period. Education appears to be in a world of its own, with inflation falling from 19.7% at the start of the period to 10.3% at the end. Perhaps fortunately for those placing a lot of faith in the headline rate, Education does not account for more than 3% of spending in any group (it’s 3% for the under 30s) and only 1.6% overall.

So, as always, the picture is more complicated than the headline rate. And, when it comes to inflation, age matters.

The Cost of Defined Benefits is Defined

10. April 2014 · Write a comment · Categories: Pensions, Regulation

The Pensions Regulator has just published a remarkable survey. As it says:

In August 2013, The Pensions Regulator (the regulator) commissioned quantitative research into the running costs of defined benefit (DB) pension schemes. The specific objectives of the research were:

To understand the costs of administering a DB scheme;
To contextualise and understand scheme costs against services received;
To compare and contrast scheme costs by size, specifically at what size do scale efficiencies become apparent.

What they found instead was that costs for what they termed small schemes (those with 12 to 99 members, schemes with fewer than 12 members were excluded from the survey) were so variable that, even ignoring the top and bottom 5% of schemes, they ranged from £264 per member per year to £2,744 per member per year (over 10 times as much). This is far larger than any variation by size of scheme: the average for a small scheme is £1,054 per member per year, whereas the average for a very large scheme (more than 5,000 members) is £182 per member.

So the conclusions are clear: the costs of running a DB scheme are not primarily dependent on how big your scheme is, but how well you administer your scheme, how well you manage your advisors and service providers and how disciplined you are in setting an investment strategy and managing its implementation. For a small scheme, the irrelevance of size to costs is further illustrated by the following scatter graph helpfully supplied in the report, showing no correlation between total running costs per member and scheme size for schemes with 12 to 99 members:

This is not necessarily a call for more independent trustees. The proportion of small schemes which used independent trustees (22%) was not so much less than the proportion of large schemes (1,000 to 4,999 members) which used them (35%) and yet the variation in costs for large schemes (£80 to £689 per member per year) was not nearly as great. But it is a call for a much greater weighing of costs and benefits in the services trustees procure for small schemes.

So there is considerable work to do for small DB schemes, particularly with the additional costs likely to result from the Regulator’s recent proposals, which were consulted upon earlier this year. Another point that comes out of the survey is that the vast majority of schemes, of all sizes, regards the year in question where these costs were measured (2012) as having higher costs than an “average” year. Perhaps this is true, or perhaps there is some denial going on here about what the new normal looks like.

If you want to see how your scheme compares to others of its size, the Regulator has provided a handy checklist to capture the information. This would seem to be an exercise which many small schemes, if they are not already aware of this as an issue, would be well advised to carry out as a matter of urgency.

Sponsors are not currently getting good value from some of these schemes, particularly small schemes, which account for 1,689 (or 36%) of the 4,696 DB scheme universe (excluding hybrid and public sector schemes). The cost of defined benefit has been defined. And it needs to come down.

Actuaries and Placebos

09. April 2014 · Write a comment · Categories: Actuarial, Economics, Pensions, Regulation

Source: Wikimedia Commons – Original work of the US Federal Government – public domain

Placebos are medicines or procedures “prescribed for the psychological benefit to the patient rather than for any physiological effect” according to the Oxford English Dictionary. Originating as a way of doctors to clear their consulting rooms of people they did not feel could be helped with real medicine, placebos’ status, as Ted Kaptchuk makes clear, underwent a dramatic fall from acceptability after the Second World War and the general adoption of the randomised controlled trial to establish the efficacy of medical treatments. The lack of research since into the various aspects of treatment collectively called “the placebo effect” (Kaptchuk is a notable exception to this) is bemoaned by Kaptchuk, who feels an important element of successful treatments is not getting the attention it deserves.

This may be changing. After all, the impacts of placebos and nocebos (from the latin meaning “I will do you harm”, these are as mysterious as placebos, but make you feel worse rather than better) can be dramatic. Ben Goldacre does a five minute routine on them here (warning: it’s a bit rude). A recent Horizon documentary also looked at placebos, with the suggestion that they might have had an impact on the UK Olympic Team GB cyclists as well as in more serious cases like those of Parkinson’s sufferers.

Why am I talking about them? Because, in a more general way, to quote Seth Godin: “A placebo is a story we tell ourselves that changes the way our brain and our body work”. Godin asks why, if a placebo can make wine taste better and improve the way your back feels, we should be squeamish about discussing them.

The main reason, of course, is the feeling that it is unethical to promote treatments and products which have no scientific basis. This also explains why people operating within professions – whether medical or otherwise – are so wary of them. Professions see themselves, in the Baconian tradition, as bodies of people with expert knowledge using that expertise scientifically for the benefit of society. Placebos do not fit into this world view at all.

Imagine two pensions actuaries: Actuary A is a very experienced practitioner, known for years by many of his clients and a trusted source of wisdom. Everything he says, which he conveys with a practised seriousness and sonorousness, interspersed with frequent not-completely-discreet stories about the antics of other people he has met in his long career, is accepted by his clients like tablets of stone brought down from the mountain.

Actuary B is a young relatively newly qualified actuary. He has just obtained his scheme actuary certificate after toiling away in the background providing much of the analysis and calculation work underpinning the consultancy provided by the more senior actuaries in the firm, including Actuary A. He is seeking his first scheme actuary appointment, and has been trouping along to trustee meetings behind Actuary A for some carefully selected clients which the firm would like to move from A to B. B realises quickly, confirmed by his first trustee meeting where one of the trustees looks him up and down quickly and tells him that he doesn’t trust anyone with shiny shoes, that these clients have been selected because of their particular reluctance to pay the elevated charge out rate of Actuary A. Unfortunately this does not mean that they are keen to see a cheaper actuary installed on their schemes, quite the reverse in fact. The trustees who are most incredulous about the fees associated with actuarial advice seem also to be those who set most store in the mystical wisdom of Actuary A and his booming voice.

Now if I say that I think there are placebos at work here I do not mean that these clients are not receiving carefully constructed advice, appropriate to their needs and in compliance with all legislative and regulatory standards. What I am saying is that, from the lack of shine on Actuary A’s shoes, to the gravitas (I think it used to be referred to by a different generation as “bottom”) brought to bear on any particular issue by Actuary A, there are many things which do not add anything to the quality of advice (which in some cases has been almost entirely constructed by Actuary B), but which are valued at least as much (if not more, in Actuary B’s view) by the client.

As Simon Carne has pointed out recently, supported by John Reeve in this month’s The Actuary, the physical advice is subject to an ever increasing body of regulation, to the point where some clients might be deterred from even asking an actuary the time. However, everything about the environment in which the advice is conveyed – from the tone of voice; to the way the actuary sits; to the degree of direct eye contact; to the choice of gestures used; to, where meetings are held at the firm, the whole experience of someone entering the building and being led into a room deliberately designed to make an impression – is not. In the same way that a presentation is not just the collection of slides put together on PowerPoint, we need to give more recognition to the fact that the advice that is valued by clients is a lot more than that which is written or even spoken.

Although, judging from the number of times I have had to be the bearer of bad news (with the expectation that that will be the case preceding me and therefore helping me in delivering that message in many cases), perhaps the more usual term for this element of actuarial advice should be nocebo rather than placebo.

Where would you rather be working in your later years: UK or Germany?

08. April 2014 · Write a comment · Categories: Demographics, Economics, Pensions, Prediction, Regulation

As a quick illustration of the differences between how businesses in the UK and Germany approach change this chart from the recent Economist Intelligence Unit research carried out for Towers Watson takes some beating. To UK eyes, an insane proportion (45%) of German businesses are proposing to make physical changes to their workplaces by 2020 to accommodate a greying workforce. There is an even more dramatic contrast when the issue of flexible working hours is raised. Less than half of UK businesses intend to offer more flexible working hours by 2020, compared to over three quarters of German businesses.

Neither are we interested in training our older workers apparently. Only 28% of UK businesses intend to ensure that the skills of their older employees remain up to date, compared to 48% of German businesses.

So where are UK businesses preparing to manage change then? Giving employees more choice over their benefits is cited by 60% of UK businesses, compared to 45% in Germany and the European average of 48%.

But is this the positive step it is presented as? It seems unlikely to me that these UK businesses that don’t want to invest in older workers’ working environments or give them flexibility over hours or location or train them is interested in providing any choice over benefits that doesn’t also cut their costs. There are going to be some battles ahead over exactly how the pensions changes in the Budget are to be implemented. Judging from this survey, they are going to be hard fought.

Freedom for DBdom?

31. March 2014 · Write a comment · Categories: Actuarial, Cartoons, Defined Ambition, Economics, Pensions, Regulation

My father used to regularly paraphrase Benjamin Franklin at me about nothing being certain except death and taxes when I was growing up. However, having spent the turn of the century advising members of small self-administered schemes how to navigate the 6 (some claimed there were in fact up to 13) different tax regimes for pensions which then applied so as to get the maximum possible benefit from them, I was a cheerleader of the tax simplification which the 2004 Finance Act brought in and which demolished all that.

Now it seems that actuaries are no longer going to be necessarily required for members of defined contribution (DC) schemes to get at their savings. In an age of increasing uncertainty about both death and taxes, I find myself cheering this too.

But why stop there? In their consultation document, the Government states that:

With the right consumer guidance, advice and support, people should be able to make their own choices about how to finance their retirement. Everybody’s circumstances are unique and it should not be for the State to dictate how someone should have to spend their savings.

It then adds:

Those who want the security of an annuity will still be able to purchase one. Equally, those who want greater control over their finances in the short term will be able to extract all their pension savings in a lump sum. And those who do not want to purchase an annuity or withdraw their money in one go, but would prefer to keep it invested and access it over time, will be able to purchase a drawdown product.

So the question has to be asked: why are these freedoms and choices not to be extended to defined benefit (DB) members as well?

The reasons the Government have advanced for the change are equally compelling when applied to DB:

There is a lack of choice for people at retirement, which has become more of an urgent concern now that auto enrolment is boosting DC membership. This is even more the case for DB members who are already numerous (although getting less so daily), as their only choices are how much cash to take up to the 25% tax free limit and (up to a point) when to retire. The other freedom DB members have, of course, is to transfer out, although this freedom makes everybody feel very nervous and is possibly about (see below) to be snuffed out altogether.
Current regulations deter innovation. This is, of course, why defined ambition as an idea has been so slow to get off the ground.
Restrictions on cash commutation imply a lack of trust of members to be able to decide how they spend their savings.
The concern that the annuity market has not maximised income for scheme members. This is mirrored by the high cost of de-risking via bulk annuities, which is the ultimate “flight path” for most DB pension schemes, and which many argue has resulted in a big drag on the growth of UK PLC.

All that would be required to extend these freedoms would be to allow DB members to commute as much of their benefits at retirement, whether for cash or income drawdown, as they wanted, with the rest taken as pension as now.

To be fair to the Government, they do acknowledge the logic of extending the freedoms set out in the consultation to DB members in section 6. But then something strange happens.

Firstly, for public sector schemes, as they are mostly unfunded, the Government says it is concerned about the negative cashflows of members transferring out. If 1% of public service workers did so, the joint Treasury/HMRC analysis is that the net cost would be £200 million. This, I think, provides a revealing peak into the world of state funding, where taking on the Royal Mail Pension Plan was seen as positive for Government finances and off balance sheet private finance initiative (PFI) contracts continue to be negotiated offering doubtful value to the state. It doesn’t matter how much things cost over all, it seems, as long as you are only paying out a bit at a time. The Government often behaves in this respect like the victim of a pay day loan shark. Depending on the commutation terms offered, extended commutation has the potential to solve the public sector pension crisis in a way that Hutton’s Pensions Commission didn’t quite manage to.

Not even considering the option of allowing greater commutation from the schemes themselves, the Government has already decided to ban such transfers from public sector to DC. There is to be no consultation on this.

For private DB schemes, the Government says the decision is “finely balanced”. They are worried about all of those currently captive DB pension investments being spent on Lamborghinis. This rather contradicts the earlier declaration of trust in pensioners to make appropriate decisions about their retirement – after all appropriate investment in support of regular income in retirement (which would presumably be recommended by the “guaranteed guidance” to be offered to DC members) should not differ markedly from the equivalent investments in DB schemes. Whether DB schemes invest on a longer-term basis than individuals is, as the Kay Review made clear, uncertain.

However the Government is very concerned about financial markets – they have section 6 of the consultation devoted to nothing else. It is almost as if individuals can be trusted to look after themselves, with a slightly bigger safety net and a bit of advice, but financial markets cannot.

Again, the Government is not consulting on extending commutation of benefits, but solely on the transfer issue. And apparently removing the current right of all members of defined benefit schemes, except in exceptional circumstances, as proposed with public service defined benefit schemes…must be the government’s starting point, unless the issues and risks around other options can be shown to be manageable.

Even if the Government does manage to stop people pouring out of the exits before April next year, this has to be bad policy. To provide more freedom and choice to one group of pensioners and at the same time to remove a longstanding freedom (and one available at the point members joined the schemes) from the other groups is clearly unfair. What is worse, with an election looming, it is likely to be unpopular.

By the way, one of the things that stands out for me in this whole consultation is the use of State with a big S and government with a small g. It is as if typography alone could portray the “State” as big and bad and “government” as on the side of the little guy. I have done the reverse here.

So, if you DB members want to stop the flickering light of Freedom and Choice dying before it even got going, I advise you not to go gentle but to rage, rage and respond in large numbers to questions 9 and 10 of the consultation in particular. You have until 11 June.

SPA and HLE

26. March 2014 · Write a comment · Categories: Demographics, Pensions, Regulation

One of the pensions announcements in the Budget last week which got less coverage amongst the talk about freedom and the death of the annuity was the one about the minimum age at which pension benefits will be able to be taken in the future. In this respect the Government appears to feel that less freedom is preferable.

Historically the minimum age was 50 except for a list of exempted professions kept by HMRC (or the Inland Revenue as they then were) which included professional footballers. However in 2010 it was increased to 55. From 2028 it is proposed that it is going to be increased again, to 57, thereafter linked to increases in the State Pension Age (SPA).

PwC have projected that, assuming the policy of linking SPA to life expectancy continues into the future, we can expect a SPA of 77 by 2089 and 84 by 2134. If this all sounds a little futuristic, it does highlight a concern about the Government proposal of using SPA minus 10 (or even SPA minus 5 which is also being consulted upon) as a national minimum pension age.

The Office of National Statistics (ONS) have produced an interesting split of both life expectancy at birth (LE) and healthy life expectancy at birth (HLE) by deciles of deprivation. Graphing these with the steadily increasing SPAs shown in black and the minimum pension ages in red we can see that the bottom male and female 10% by deprivation already have a healthy life expectancy below the current minimum pension age, with a further 10% being caught by the increase to 57.

Admittedly we might hope for an increase in both life expectancy and healthy life expectancy at all levels by 2028, but the differentials between the poorest and the richest in this respect have been widening for some time. Certainly if the SPA minus 5 idea is adopted, giving a minimum pension age of 62 by 2028, it is difficult to see the bottom deciles reaching that age in good health. And what about a minimum pension age of 67 by 2089 (72 if SPA minus 5)? Do we think that we have policies in place to increase the healthy life expectancy of the bottom decile by the 15 years (or 20 years if SPA minus 5) that would be required to allow them to retire in good health, even assuming they felt able to do so financially?

As I have mentioned before, I think the Government needs to consider ill health early retirement to a greater extent in its policies towards state pension benefits, but this may be particularly urgent with respect to minimum retirement ages. The main problem as I see it would be the assessment of ill health, bearing in mind the current ATOS fiasco.

One alternative approach might be to try and maintain the minimum pension age as a proportion of SPA rather than a fixed number of years earlier. So, for instance, the current proportion (55/65 or 85%) would give a minimum pension age when SPA reached 77 of around 65.5 rather than the 67 proposed.

Leaving the proposals as they stand, however, is likely to lead to an increasingly ill elderly workforce engaged in the lowest paying and most physically demanding occupations. Not free, and without choices. That doesn’t sound like an election winner to me.

Size is very important

23. March 2014 · Write a comment · Categories: Pensions, Regulation

Amongst all the noise about the changes to how you can get money out of your pension scheme it is easy to forget about the more pressing issue of getting money in.

Recent Office of National Statistics (ONS) figures about the progress of pension scheme membership during 2013 under auto enrolment show how far the type of pension scheme and size of your pension pot depends upon the size of the organisation you work for.

Of course the auto enrolment staging dates have not yet dragged in the smaller workforces.

Size of workforce	Staging date range for size of workforce
100,000 or more	1 October 2012 – 1 November 2012
10,000 – 99,999	1 November 2012 – 1 March 2013
1,000 – 9,999	1 April 2013 – 1 October 2013
500 – 999	1 October 2013 – 1 November 2013
100 – 499	1 January 2014 – 1 June 2014
13 – 99	1 March 2014 – 1 September 2016
1 – 12	1 March 2014 – 1 September 2016

So, by the end of 2013 when these statistics were collated, auto enrolment had only arrived for workforces with 500 or more members. But the scale of the task auto enrolment has to tackle is clear. The proportion of employees with no pension at all is 89.6%, 74.6% and 55.7% for workforces of 1-12, 13-99 and 100-499 respectively. These smaller workforces are also very unlikely to have any form of defined benefit membership in their schemes (1.6%, 5.3% and 16.2% respectively).

When it comes to contributions, the most popular contribution range is 4-8% for all but the 1,000 plus organisations (for which a third are in the 12-15% range). It will be interesting to see the impact on this of the increases to minimum contribution rates when they come in.

Perhaps not having to buy an annuity will encourage more people not to opt out even when the contribution rates start to rise. I certainly hope so because, when it comes to pensions, it is not what you do with it that really counts.

The Nature of Risk and Pensions

11. March 2014 · Write a comment · Categories: Actuarial, Defined Ambition, Pensions, Risk

I found this diagram recently in a paper by John Adams from 1999 entitled Risk, Freedom and Responsibility. It attempts to summarise different people’s attitude to risk-taking based on their views about the kind of world they live in, represented by a ball sitting in very different types of landscape. It explains a great deal about pensions.

Much is often made about our seemingly inexorable shift away from collective solutions to problems to individualised ones, aided on the one hand by technology like tablets, smart phones and other devices which make it easier for us to create our own environments and cut ourselves off from each other, and on the other by a loss of trust in many of the traditional collective organisations, such as banks and governments, which have previously been used by us to pool our risks and protect the most vulnerable.

If this is true, then it would be represented in the diagram by a shift in world view from right to left.

Others focus on the triumph of the American business model or ABM as the dominant school of political and economic thought in the globalised world of today, just as socialism was in previous times. This model leads to a belief in low taxation, small government, minimal market regulation and the reliance of self-interested materialism of individuals within these markets to deliver what we need. Despite its name, it is not a description of how American business actually works, but just one of what Adams would call the “myths about nature” which often determine our thinking about risk and much else besides.

If the triumph of the ABM is true, then it would be represented in the diagram by a shift in world view from bottom to top.

Adams points out that most people exhibit several of these world views and move between them, sometimes very quickly, but I think that it is easy to see where the stereotypical figures from the UK pensions landscape might sit. For instance, many owners of SMEs are calculated risk-takers who believe that things tend to turn out okay on the whole. That is how they became business owners in the first place. So, in the diagram above, taking a few risks with the football is not going to lose it, but there might be a reasonable amount of bouncing around: ie they are individualists.

In the top right hand corner are the hierarchists. They do not believe that the environment in which they operate is fundamentally benign but they do think that it can be managed. This is why their landscape resembles a series of speed bumps: the football cannot be allowed too much freedom or the consequences might be serious and it is possible to deny the football that freedom. This is the world view of a large number of civil servants and actuaries, which is why the public sector is still running defined benefit pension schemes and the private sector (with the smaller schemes overwhelmingly sponsored by individualists) has largely retreated from them. The larger companies, which tend to harbour their fair share of hierarchists, have been the slowest to abandon such schemes.

In the bottom right hand corner are the egalitarians: people who believe that giving the football anything more than a light tap is likely to lose it forever. Nature is unforgiving and cannot be controlled, but the less we do to destabilise the environment, the longer she is likely to let us live. The resource and environment group of actuaries, with their focus on limits to growth and the implications of this, are likely to contain a number of egalitarians in their ranks.

And where are the pension scheme members? Well, even 15 years ago Adams reckoned on at least 40% of the population being fatalists. This is the perfectly flat landscape representing the idea that it does not remotely matter what you do with the ball, the end result will be the same. Adams cites a survey carried out in 1998 on young adults in England in which, when they were asked to imagine that they could only have one of two rights – the right to vote in an election, or the right to obtain a driving licence, 72% chose the driving licence. I think it is probable that this proportion would be higher now.

So we have pension schemes largely inhabited by fatalists and run either by individualists, in the case of smaller schemes, or by hierarchists in the case of larger and/or public sector schemes. The reason they have had to be auto-enrolled into schemes they did not choose to join themselves is because they do not fundamentally believe that it will make any difference, which makes the cost of it at any price too high.

However they are not comfortable being fatalists. The Pension Regulator’s survey of defined contribution (DC) pension scheme members in 2012 revealed that the three things they wanted most of all were:

Someone making clear to them how much they needed to save;
Being able to talk to someone to understand their pensions better; and
Clear communication from their employer and their pension provider.

All of which would make them less fatalistic and feel more in control. Whether you feel this would move them upwards into the individualist camp or diagonally across to the hierarchical camp (or even over to the egalitarian position) probably depends on your politics, but none of these positions are fixed. The recent floods have shaken many business people’s faith in things basically turning out okay in the end, and the credit crunch certainly moved many people out of hierarchist into either egalitarian or individualist territory.

What it suggests to me is that the way we organise pension scheme membership may be fundamentally flawed. Talking to members about their risk appetite or tolerance to risk is starting from an individualist perspective: that the world is a benign place, nothing too extreme is likely to happen and the only choice for you to make is how you want to invest your money. But it makes no sense if, assuming you can be coaxed away from the fatalist position, you turn out to be an egalitarian or a hierarchist. And this position probably makes no sense to the sponsor of the scheme.

When asked, sponsors of smaller schemes are very clear that they do not support the idea of collective schemes. They want to run their own schemes otherwise a large part of the benefits of the arrangements to them are lost. However, if auto enrolment is to deliver the changed relationship between the public and pensions everyone hopes for, I think prospective members are going to need choices about more than investment strategy. If members want to pool risk I think they should be able to, and collective schemes alongside firms’ own DC arrangements, perhaps with joint membership, may be the way to achieve this.

Individualists, hierarchists, fatalists and egalitarians. As Adams points out “the clamorous debate is characterised not by irrationality, but by plural rationalities.” It is a debate which has a long way to go yet.

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