What would be gained from increasing the state pension for all?

09. January 2024 · Write a comment · Categories: Actuarial, Antifragility, Cartoons, Pensions, Regulation, Risk
Source: https://youtu.be/31xY6rYiu2E

When I was nearing qualification as an actuary at the turn of the century, one of the recommended texts for both the specialist pensions (the then equivalent of SP4 and SA4) exams was Alastair Jollans’ 1997 paper to the Staple Inn Actuarial Society (SIAS) entitled Pensions and the ageing population. At the time there was quite a lot of actuarial comment about how superior a funded pension system was to a pay-as-you-go system and the example of Chile in particular. The following sentence from Alastair’s paper stuck with me at the time:

It is also clear that the Chilean scheme made a huge psychological difference, and this may be one of the major advantages of funding.

Meanwhile the Labour Government had been moving to reform the State Earnings Related Pension (SERPS) with its Green paper of 1998 A new contract for welfare: partnership in pensions, and replace it with a new State Second Pension (S2P). It had two aims – giving more help to people for whom private pensions were not an option and helping moderate earners to build up better second pensions through the introduction of stakeholder pensions. The intention was that S2P would become flat-rate over time with the following reasons given for this (bold mine):

Although SERPS is an efficient second pension, it is earnings-related. It does least for those on low incomes who have most difficulty in building up a good second pension. Many people on modest incomes will also receive limited benefits from SERPS or from the private provision they may make instead.

So the limitations of the current system (where the new State Pension has replaced S2P and auto-enrolment has replaced stakeholder pensions), as previously discussed here, were recognised from the outset of the experiment of moving to funded pensions.

Fast forward to now and Chile’s system is tottering, leading to mass protests. It turns out that the psychological advantage of its funding approach was only an advantage for those that could afford it, whereas the 40% who gained no benefit from invested funds (a remarkably similar proportion to the UK statistics) preferred the psychological advantage of a guaranteed state pension. Even the FT admits it needs reform, although fairly technical in nature:

At the very least, a sensible reform now should be to eliminate the investment limits by asset class and introduce an investment policy based on risk metrics at the portfolio level. The government should also relax the restrictions on alternative investments and eliminate the ill-designed hedge requirements.

The Council on Foreign Relations was less restrained in 2022:

Pensions were never a good fit for strictly private management, as basic building blocks of the welfare state are definitive public goods. Yet the failure of the system has reverberated beyond the retirees trying to make ends meet. Pensions became a leading cause for the millions of Chileans who took to the streets in protest in 2019, spurring the formation of a Constituent Assembly to write a new Constitution that will be voted on in September.

The best path for pensions would be a reform that ensures adequate retirements for more Chileans. This requires a more robust public system with dedicated funding to sustain it. If legislators can make this happen, they can reduce the financial hardship too many of Chile’s elderly now face. And, to the benefit of democracy in both Chile and its neighbors, they could also thereby restore at least some of the political legitimacy that the old system helped to put in doubt.

In my first post in this series, I explained why the State Pension needs to be much bigger than the Triple Lock is ever going to get it to. The second post then moved on to discuss the leaky pensions budget and what to do about it. In this third and final post in the series, I focus on why increasing pensions should be a priority when there is so much destitution in all parts of our society.

We are living in anxious times, with discomfort about the state of the world now so extreme that many of us are disconnecting from it and, instead, treating it as a personal mental health challenge requiring breathing exercises and mindfulness and radio programmes like Radio 2 Unwinds with Angela Griffin and similar. This follows a pattern with other crises, where we have been encouraged to abandon collective action to protect our pay and conditions by ever more onerous anti-union legislation or to abandon collective action to combat climate change by ever more onerous anti-protest legislation. Instead we are constantly encouraged to look inward and focus on our own wants and the things about ourselves which are standing in the way of those wants, ie to approach the world solely as a consumer. It is much more convenient for the companies working in the retail markets if we all behave this way.

Moving away from the collective provision of state pensions for all to a reasonable level and instead towards the individual provision of funded occupational pensions follows this pattern. However, as we have seen, many have been left in poverty without any asset security as a result of this move. This leaves them more vulnerable to sickness, debt and generally less resilient to the uncertainties of the future.

Seth Godin recently blogged about the engineering philosophy essential to creating something both useful and fit for purpose. It involves asking who is it for and what is it for.

Increasingly I feel that we have lost sight of these two questions in how we provide pensions, my answers would be:

  • Who is it for? Everyone.
  • What is it for? To increase people’s resilience.

In the case of resilience, the discussion has been kept at a, in my view deliberately, high level of abstraction so that most people feel that it is not their concern. McKinsey produced a particularly incomprehensible example here, but it is probably unfair to pick on them as they are just one of many, and they did at least mention societal resilience. A great technique for excluding people from the discussion is to produce a proliferation of definitions which noone can agree on (five were identified in this article in Nature by Rockstrom et al, for instance). However, as Rockstrom identified, in essence a resilient system needs just five characteristics:

  1. Diversity, ie support comes in multiple forms and does not assume everyone is the same;
  2. Redundancy, ie if one part of the system fails, there is always a good Plan B and mechanisms available to replace system failures quickly and efficiently;
  3. Connectivity, ie our supply chains are diversified and the resources we need drawn from a wide range of sources, and our populations are kept well connected with each other and the services they need;
  4. Inclusivity and equity; and
  5. Adaptive learning, ie we review whether the system is working reasonably frequently and learn from experience.

So what would be gained from increasing the state pension for all?

  • Marginalising older people when their bodies already feel less resilient and forcing them into the boxes required by our processes of means-testing are likely to extinguish many of these voices from the national discussions we need to have. A significant increase in pensions for all, instead of the ridiculous triple lock which is only tolerated as it slowly gets us to this goal without having to have the discussion about what a decent pension would be, is what is needed.
  • A larger state pension would give us all more security through redundancy, ie a decent baseline underneath the other sources of income. Our invested pensions are not as diversified as they look and very vulnerable to a range of system-wide events and our means-tested benefits are very frequently prone to error and delay. The prospect of this greater level of security and certainty in retirement would also ease the burden of many working age families who are supporting older relatives, and the effects would therefore extend well beyond the retired population.
  • Poverty crushes the diversity of a population, as the cartoon above from the UN Special Rapporteur on poverty Olivier de Schutter makes clear. We need diverse people with diverse thought and we need to include them in our society and listen to what they have to say.
  • Focusing on those of retirement age to allow them to live better will save money in other areas. According to a Guardian study, an 85-year-old man costs the NHS about seven times more on average than a man in his late 30s. Health spending per person steeply increases after the age of 50. It would also reduce reliance on an inefficient and fragmented disability benefit system.
  • Increasing the state pension would obviously have a much greater effect at the bottom half of the income deciles than at the top and would therefore have a big impact on inequality. As the Institute of Fiscal Studies said of increases to the minimum wage for working people between 2011 and 2021:

...inequality in male earnings rose between 1980 and the Great Recession, driven by rising wage inequality at the top and rising hours inequality at the bottom. This trend appears to have stopped in the last decade, as growth in the minimum wage outstripped wage growth further up the distribution, and hours worked stopped falling disproportionately for low-wage men.

Increases to the state pension would be likely to have just as dramatic an effect.

And we all gain from a more equal society, even those we redistribute away from. As the Equality Trust have shown in their research, high levels of income inequality are linked to economic instability, financial crisis, debt and inflation; less social mobility and lower scores in maths, reading and science; an increase in murder and robbery rates; reduced longevity, more mental illness and obesity, and higher rates of infant mortality. People in less equal societies are less likely to trust each other, less likely to engage in social or civic participation, and less likely to say they’re happy.

My view is that we need to start somewhere in creating a more equal, and therefore more resilient, society here in the UK. And I would start with pensions.

There’s a hole in our bucket

02. December 2023 · Write a comment · Categories: Cartoons, Pensions, Regulation

In my previous post, I talked about out how dependent the bottom half of the income scale was on the state pension of £10,600 pa, and how an increase of at least 40% to the state pension was needed to reset the balance between a guaranteed income and that based on the markets to European levels.

However there was another aspect of the state pension which I did not mention last time and which also needs to be addressed.

Who gets it?

Source: ONS – Almost all pensioners (97%) received income from State Pension, with an average amount of £195 per week. Some peaks in the distribution may be explained by the basic State Pension rate, which was £137.50 per week in FYE 2022, as well as the new State Pension full rate, which was £179.60.

As the graph above shows, by no means does everyone get the full state pension (although legacy state benefits mean that some get considerably more).

As the Undefined Benefit: Fixing the UK Pensions System report mentioned in my previous post explains:

To qualify for this full state pension, an individual needs to have made 35 years of National Insurance contributions or have equivalent credits. To qualify for any fraction of the state pension, an individual must have made at least ten years of contributions or have equivalent credits. Thus, even the UK’s first pillar, the state pension, is to a degree contribution based. This stands in contrast with countries such as Canada, Mexico, the Netherlands and New Zealand, which have adopted a residence-based, non-contributory basic pension. Residency-based pensions increase coverage and seem to be effective in reducing poverty rates in old age.

How much?

Returning to the PLSA’s retirement living standards again, we have the following:

Source: PLSA – these are single retirement living standards outside London

You will note that the retirement living standards assume:

  • income tax is payable;
  • people are mortgage and rent free; and
  • it also does not cover care costs.

The minimum level would then require a 21% uplift to the basic state pension, assuming no meaningful private or occupational pension assets (which we saw last time was a reasonable assumption for most of the bottom half of the income scale).

According to the Government’s figures, in 2020-21, 5% of all older households (ie where the household “reference” person was 65 or older) were mortgagors, 6% were private renters and 15% were social renters (down from 19% in 2010-2011). The remaining 75% of older households were outright owners (up from 71%). So we are going to need more for our minimum level to meet the needs of the 25% who are still paying rent or mortgages. The average household income spent on rent amongst older renters is 38% for private renters and 27% for social renters.

Assuming this household income is the basic state pension and the average housing costs of the group we are concerned about (ie totally or almost totally dependent upon the state pension) are in line with social housing rent, we would need an additional 37% uplift to the state pension (to mean that taking 27% of it would get you back to where you started) to 66% of state pension, ie a total of £17,600 pa before the latest state pension increase. If you are aiming for the moderate retirement living standard you would need over twice as big an overall state pension at £35,600 pa.

Means-tested benefits

At this point, if you are shouting at your phone or computer “but you are ignoring means-tested benefits!” you would be correct. Age UK give a handy guide to means tested benefits, but in a nutshell we have:

  • Cold Weather Payment – £25 a week for each 7-day period of cold weather. This only applies between 1 November and 31 March each year.
  • Council Tax Support – there is no set amount of Council Tax Support. What you get depends on your circumstances and where you live. Each local council is responsible for operating its own Council Tax Support scheme so the amounts of support given across the country may vary.
  • Housing Benefit – Housing Benefit is money to help you cover your rent if you’re living on a low income.
  • Income Support – this is going to be fully replaced by universal credit by the end of 2024. Universal Credit has come in for a lot of criticism – this is the Trussell Trust’s take on it.
  • Pension Credit – the bit of this that we are interested in is the Guarantee Credit, which tops up your weekly income to a guaranteed minimum level. In 2023-24, this level is: £201.05 if you’re single and £306.85 if you’re a couple (note that these are still below the levels of the basic state pension).
  • Universal Credit – for a single person over 25 this is currently £368.74 per month but there are many circumstances which can lead to deductions to this amount and the Trussell Trust (see above) has this to say about it:

These are at the lowest levels in 30 years and aren’t protecting people from destitution, meaning they are unable to afford the essentials we all need to eat, stay warm and dry and keep clean.

The trouble with means-tested benefits are:

  • Not everyone claims them. An FT article from April 2022 claimed that there were £15 billion of unclaimed means-tested benefits – for a variety of reasons, but with lack of internet access (18% of older households) being a major one. This compares with £5 billion currently spent on Pension Credit and £6 billion spent on Housing Benefit for over 65s, so you can see the size of the problem here;
  • They create, in some cases, high effective marginal tax rates for people who want to earn a little extra income, by removing benefit as income increases;
  • If a benefit is not universal, there is a danger that the recipients will become so marginalised that their voice is no longer strong enough to defend it, and people might not feel like full citizens of the society they live in. Applying for benefits requires admitting poverty which can be humiliating;
  • Means-tested benefits are often poorly targeted. The Report of the UN’s Special Rapporteur from 2019 on extreme poverty and human rights, whose recent comments gave me the title for this post, included the following amongst its 11 recommendations: Initiate an independent review of the efficacy of changes to welfare conditionality and sanctions introduced since 2012 by the Department of Work and Pensions;
  • There are good reasons for people not to want to claim means tested benefits, as the UN report says: The basic message, delivered in the language of managerial efficiency and automation, is that almost any alternative will be more tolerable than seeking to obtain government benefits.
  • Means-tested benefits cost a lot to administer. The latest National Audit Office guide to the Department of Work and Pensions (DWP) for instance (from 2015-16) indicates the following split:

Of a total budget of £176.6 billion, departmental expenditure in addition to benefit expenditure was £6.3 billion. Attempts to reduce this figure since 2016 appear to have resulted in big increases to under and over payments. Simon Duffy of Citizen Network, who has looked at this extensively and attempted to compare the net benefit to recipients to the total administrative costs including those of the tax system, estimates that, to make people £1 better off, the DWP spends £0.22.

It therefore seems to me that, in order to provide a guaranteed minimum level of living standards in retirement, not dependent upon pensioners being invested in the right way, or filling in the right forms or their employment history, and not vulnerable to the punitive sanctions currently applied to conditional benefits like Universal Credit, we are going to need a state pension somewhere north of 66% above its current level. So how do we pay for it?

How do we pay for it?

My very rough estimate of the amount required to top up everyone below the full state pension in the graph at the top of this post is around an additional 23%.

The current state pension cost around £110 billion pa in 2022-23 or 4.4% of GDP. Allowing for the Pension Credit, Housing Credit and Winter Fuel Allowance at half their current levels following the increase to state pension proposed (a very conservative estimate I believe, which also does not include the smaller increase that those on legacy benefits will need) brings it up to 4.75% of GDP. So what I am proposing would cost up to an additional £73 billion pa in state pension or an additional 2.9% of GDP, or a total of 7.65% of GDP plus the 23% uplift required to top everyone up to the full state pension bringing it to 9.4%, which would put us above the current OECD average of 8% of GDP, although still less than is currently paid by Italy, Greece, France, Austria, Portugal, Finland, Spain, Poland, Belgium, Slovenia and Germany. It is therefore something that we can afford to do in the world’s 5th largest economy if we make this a priority.

These additional payments of around £125 billion would result in immediate increased income tax payments (assuming all at the 20% rate) of £25 billion plus the ONS estimate between 18% and 28% of the poorest 40% of households’ income is spent on indirect taxation, averaging 23% or £29 billion. However, as Richard Murphy has pointed out, there is currently a risk that millions of pensioners will have to complete tax returns (in many cases for the first time) next year due to the triple lock bringing pension levels above the frozen personal allowance. HMRC will therefore need to be reformed so as to be able to collect tax on pensions via PAYE and allow pensioners to receive net pensions in future.

My view is that raising the guaranteed state pension to a level which will be sufficient post tax is preferable to just lifting the personal allowance above the new state pension level. Why? Because:

  • Everyone would get the new personal allowance, reducing taxation of the wealthiest as well as the poorest, with no particular benefit to the poorest; and
  • One of my problems with means tested benefits is that they marginalise people so that they do not feel like full members of society. The same applies to not paying tax. If you pay tax, you are more likely to want a say in how that society is organised.

Some options for funding more than the remaining balance of £71 billion, picked out from Richard Murphy’s very conservative estimates here, are as follows:

  1. Ending higher rates of tax relief on pension contributions. This would raise £14.5 billion in tax a year;
  2. Abolishing the VAT exemption for financial services within the UK might raise £8.7 billion of additional tax revenue pa;
  3. Reforming national insurance charges on higher levels of earned income in the UK might raise an additional £12.5 billion of tax revenue pa;
  4. Aligning capital gains tax and income tax rates in the UK might raise more than £12 billion in additional tax a year;
  5. Reforming the administration of corporation tax in the UK might raise at least £6 billion of tax a year;
  6. Abolishing the inheritance tax exemption on some funds retained in pension arrangements at the time of a person’s death might raise £1.3 billion a year;
  7. Reforming inheritance tax business property relief might raise £3.2 billion of tax a year;
  8. Reforming inheritance tax agricultural property relief might raise £1.0 billion of tax a year;
  9. Reforming Companies House might raise £6 billion of tax a year;
  10. Reintroducing close company rules for income and corporation tax could raise at least £3 billion of tax a year; and
  11. Abolishing the domicile rule for tax purposes might raise £3.2 billion of tax revenue a year.

I am sure you would have your own list. And you may not agree with the size of guaranteed state pension increase I have suggested. And I fully admit that these are very approximate figures made to illustrate what might be possible. However I hope I have made a reasonable case for what would be required as a guaranteed income for all pensioners if it were a political priority.

Next month, I will be attempting to tackle the question of why it should be a priority or, in other words, what would be gained by increasing the state pension for all?

Why the State Pension needs to be much bigger than the Triple Lock is ever going to get it to

07. November 2023 · Write a comment · Categories: Cartoons, COVID-19, Pensions

An excellent report came out in August this year from Common Wealth entitled Undefined Benefit: Fixing the UK Pensions System on the problems and potential alternatives for the UK pension system. One of the most eye catching points made in the report was that, despite pension gains since 2010 in terms of average pensions, the overall coverage of pensions remains very patchy and uneven, particularly towards the bottom end. This graph in particular caught my eye:

The bottom half have very little total net wealth and virtually no private pension wealth at all. This makes them almost entirely dependant on the State Pension and any other income-related (in the absence of a full pension) or other benefits they may be entitled to.

Coincidentally, the IFS have also produced a paper on pensions recently, including this graph (note the cut off at age 74):

The new State Pension (nSP as the Government refer to it) came into effect in April 2016 and currently stands at £203.85 per week or £10,600 pa. This compares with the Pensions and Lifetime Savings Association’s (PLSA) moderate level of retirement living standards which require £23,300 for a single pensioner and £34,000 for a couple. The moderate level includes such things as:

  • Some help with maintenance and decorating each year.
  • £74 a week on food (including food away from the home).
  • 3-year old car replaced every 10 years.
  • 2 weeks in Europe and a long weekend in the UK every year.
  • Up to £791 for clothing and footwear each year.
  • £34 for each birthday present.

The plan for closing the gap between these two levels of income has historically relied on occupational pensions in the UK, to a much greater extent than in most countries. However there are problems with this approach. First of all, not everyone has an occupational pension:

This is the current situation with pensions in payment, which is supposed to be being addressed by automatically enrolling employees into workplace pensions. However, the TUC noted as recently as 2020 that, due to the way the rules operated around low-paid and young workers, 6.3 million employees were still without a workplace pension. A survey of 2,000 employees by Unbiased and Opinium, also in 2020, similarly concluded that 17% of over 55s were still without any pension savings.

Secondly, as defined benefit occupational pension membership has fallen, the amounts which will be provided by the defined contribution arrangements which have replaced them are comparatively uncertain. The Pensions Policy Institute’s (PPI) DC Future Book 2023 has looked at the average employee and employer contribution rates under auto-enrolment:

They then projected whether this combined minimum contribution of 8% (on top of the full new State Pension) would be sufficient to meet any of the PLSA’s retirement living standards:

The combination of pension freedoms and not enough in your pot does of course allow crash paths like these, and perhaps explains the slightly more positive pension position shown in the chart from the IFS report compared to the first chart. By cutting off at 74, the IFS could well be surveying people on the steep descents above while they are still depleting their pots to maintain a slightly higher income.

Of course many other models are available – these projections used the PPI economic scenario generator developed by King’s College with many of the economic assumptions taken from the OBR and there are further details at the end of the report – but that seems beside the key point to me here.

Irina Dunn famously daubed the phrase “a woman needs a man like a fish needs a bicycle” on the back of a toilet door in the University of Sydney in 1970. The pension industry has been very successful in attracting funds and innovative in developing products, and occupational pensions coverage overall at some level has clearly increased substantially as a result of auto-enrolment. But none of the bells, gear arrangements, lightweight alloys or any of the other innovations can change the fact that a state-of-the-art defined contribution investment bicycle can never guarantee to float a goldfish to the water level it needs to thrive. You need the state to fill the tank.

This means raising the State Pension, not by some arbitrary formula involving price inflation, earnings inflation and the number you first thought of, but to what we regard as a reasonable level to live on and which we want to be able to guarantee noone falls below. Comparing the UK with other comparable flat rate state pension pillars in Europe we find the following (from March 2022):

This would suggest an increase of somewhere between 40% and 100% to the current State Pension level to reset the balance between a guaranteed income and that based on the lottery of the markets to European levels.

Many people talked about the need to increase societal resilience as we emerged from the pandemic, instead we appear to be moving in the opposite direction, with no clear idea yet about how to deal with NHS waiting lists, even less idea of how to deal with rough sleepers. And on pensioner poverty we have this:

Source: DWP Households Below Average Income: an analysis of the UK income distribution: FYE 1995 to FYE 2022 Figure 25 – Percentage of pensioners in relative low income, FYE 2003 to FYE 2022 (ie below 60% of median income)

After a concerted attempt to reduce the percentage of pensioners in relative low income during the pandemic, the curve is upwards again, as it has been since at least 2012.

Things have got so bad that Olivier De Schutter, the UN’s special rapporteur on extreme poverty and human rights, has described the UK’s main welfare system as “a leaking bucket” and said that our poverty levels violate international law.

This cannot go on. We can certainly afford to have a welfare system which does not violate international law. And we can afford a much less leaky bucket when it comes to pensions too. I will provide some ideas on how in my next post.

Actuaries and Hooky Street

03. October 2023 · Write a comment · Categories: Actuarial, Cartoons, Climate Change, Economics, Pensions

The latest publication from the Institute and Faculty of Actuaries (IFoA) is called Beyond the next Parliament: The case for long-term policymaking. It refers to a number of previous reports, such as the Great Risk Transfer report from April 2021 and the two more recent climate papers (here and here), all of which contained much thoughtful analysis even if I did not always agree with all of the recommendations.

The case for long-term policymaking is certainly something that needs to be made loudly and often, although I was perhaps expecting some discussion of concepts like cathedral thinking, ie a capacity to plan and implement projects over multiple generations, or intergenerational justice, an issue of particular importance when discussing responses to climate change, in tying these various reports together within a long-term narrative. The Good Ancestor by Roman Krzanic is a great starting point for considering such questions.

Instead the IFoA have chosen to go in a different direction entirely in linking this previous work together, displaying imprisonment by current short-term political thinking in a paper supposedly focused on the long-term to such an extent that I am now left feeling that I disagree with them about nearly everything.

Take pensions, for instance (bold type is mine):

With the decline of defined benefit (DB) pension schemes, the responsibility for investment and longevity risk is increasingly being placed on the individual.

In a world where responsibility for funding retirement is increasingly being placed on the individual, there is remarkably little consistent consumer information about how much someone should save into their pension, or what a ‘good’ pension pot constitutes.

The IFoA remains concerned that many UK households are not saving enough for later life, are not accessing free guidance or paid-for financial advice, and remain ill-equipped to deal with the risk of running out of money in retirement.

It is almost as if the transfer of risk to individuals is something inevitable, or beyond the ability of mere humans to control. In the words of the late great John Sullivan, in the theme song from Only Fools and Horses:

Cause where it all comes from is a mystery. It’s like the changing of the seasons and the tides of the sea.

Why Only Fools and Horses you ask? Well have you ever heard a better description of defined contribution pensions than:

No income tax, no VAT. No money back, no guarantee

The IFoA’s main concern is that UK households are not doing enough about this new “responsibility” to provide for their own retirement. And the state? The state pension is mentioned only once here:

Naturally, the next UK Government will need to address the adequacy question as part of a wider pensions strategy for the UK that also considers big questions such as the sustainability of the State Pension and the triple lock.

This of course is so-called “positive economics” in action, which makes much of only relying on objective data analysis, but within a policy framework which is not up for discussion. Increased state provision, which one would have thought would at least need to be considered in the mix in this case, is reduced to obsessive focus on tiny questions like the triple lock while being kept generally outside this policy framework. Instead we get this:

We recommend that the government should reinvigorate its public messaging around minimum pension saving levels – particularly through workplace auto-enrolment pension schemes – to ensure that consumers are not lulled into a false sense of security as to whether their pension saving will be adequate to achieve their retirement income goals.
In doing so, government should use expertise and evidence on testing behavioural responses to different messages and channels, to identify those that are most effective in impacting saving behaviour.

So at a time when, according to the Resolution Foundation, the marginal rate for low to middle income households have an effective marginal rate of tax of 63%, the IFoA apparently think it is acceptable to push the cost onto them even more in order to achieve a sufficient pension at retirement. A certain cost and uncertain benefit. It is not a basis for a minimum income guarantee.

The second section sets out the problems associated with long-term care, again asking for a greater contribution by individuals via an expansion of insurance and savings-based financial products.

We are back to the changing of the seasons and the tides of the sea in the next section on keeping pace with rapid digital transformation, which states that:

there has been a trend away from broad risk pools and toward more granular pricing based on an individual’s specific rating factors (i.e. their risk characteristics)

Note the use of the passive tense there – it implies that noone is responsible and there is no way we can swim against this current back up to those old broad risk pools however hard we try. And so we shouldn’t try. The only option is to instead try and lower the premiums at the bottom end a bit – which is explained in their other report, The hidden risks of being poor: the poverty premium in insurance. The model for this is Flood Re, which is explained here. Of course this probably won’t work if you are underinsured as, it seems, 80% of us are.

Section 3 remains one I can cheer about, laying out more clearly than I have seen before to the financial community the risks of climate change, with the work on biodiversity at a somewhat earlier stage. However a framework is immediately assembled in the next section, Going for growth to build a better Britain (a slogan which I am sure Liz Truss would have been quite happy with), to limit the options for tackling these risks. An example:

Even though there is evidence that infrastructure development can promote growth and job creation, governments may be forced to defer such funding until the national balance sheet looks healthier. Although governments may be partially able to finance infrastructure projects, given their capital constraints they also need to attract investment from the private sector.

Unbelievably, the rest of this section then focuses almost entirely on what can be done to lure the private sector into investing in preventing their own doom (not framed in those terms of course, but in terms of boosting growth rather than curbing emissions) along with everybody else’s. As long as private investors are looked after, everything else seems to be a secondary consideration. John Sullivan again:

C’est magnifique, Hooky Street.

Of course I am just having a bit of fun here with the Only Fools and Horses references and I am certainly not suggesting that everyone involved in financial markets is a Del Boy looking to take advantage of every punter or government that comes their way. That would be a caricature as gross as referring to the “dead hand of the state” or talking about public servants as “The Blob”. What I am saying is that the jostle of the market place cannot be the primary solution to many of the problems so accurately analysed here.

I realise I have been very slow to fully appreciate the IFoA’s general direction of travel, but by putting all of these reports together in one place they have clarified this for me. I believe that the overall programme of recommendations here would condemn the poor to further immiseration and uncertainty while letting government largely off the hook for solutions and companies largely off the hook in terms of further regulation. It would further accelerate the financialisation of our economy with the promise of additional financial markets to be exploited by the already wealthy.

This is not acting in the public interest but as a cheerleader for protecting the long-term profits of fund managers. And I despair that, three years on from the IFoA’s Economics Member Interest Group coming into existence, there should still be so little pluralism on display here in economic thinking that this is regarded as a balanced narrative.

It is clear to me that views outside the IFoA’s current policy framework will need to come from elsewhere. I am currently researching a paper on alternative approaches to pensions provision with Alan Swallow which I hope we will be able to publish something about soon.

Chasms

12. May 2023 · Write a comment · Categories: Demographics, Economics, Pensions, Science Fiction

I recently finished reading Chasm City by Alastair Reynolds, which I highly recommend. In it, sufficiently rich people have been able to buy a programme of treatments which make them immortal. Not that they can’t die, but they needn’t if they’re careful. Good science fiction, I thought.

Then I read Paul Kitson’s (the new UK Head of Pensions Consulting at EY) piece on LinkedIn where he wrote (bold mine):

Pension schemes, corporate sponsors, members – everyone, in fact – must now contend with a forward looking plan that (somehow!) considers on one side the possibility of future pandemic outbreaks shortening life expectancy, and on the other side the many £billions being spent on ‘regenerative medicine’ (AKA “the ending of ageing” or “escape velocity for death”!).

So perhaps not entirely, I thought.

In Chasm City, the immortals who live in “the Canopy” have two main problems:

  1. Hanging on to their wealth and, if possible, increasing it, as forever is a long time to finance.
  2. Boredom.

One particular group amuse themselves by hunting poor people in “the Mulch” (lower level where the poor live). Others indulge in increasingly dangerous pastimes to inject some urgency into the otherwise featureless expanse of their lives. No wealth moves from the Canopy to the Mulch, not even in a trickle.

I am just finishing Do Androids Dream of Electric Sheep by Philip K Dick (a classic, I know, but I hadn’t read it before, although I have seen Bladerunner). One of the features of the post-apocalyptic world of 1992 described are “mood organs” which allow you to dial up a given mood at any time, eg 481 is “awareness of the manifold possibilities open to me in the future” whereas 888 is the desire to watch TV, no matter what’s on it. Again, good science fiction, I thought.

Then I read a piece in this months’ Actuary magazine called Apt apps, about doctors being recommended by NICE to offer patients with insomnia the Sleepio app as an effective and cost-saving alternative to sleeping pills. So perhaps not entirely, I thought.

The first book was written in 2001 and the second in 1968, so it would seem that lead times are variable.

Both books deal with the fragility of identity, whether via memory implants and religious viruses in Reynolds’ book or how we go about separating androids from people from “chickenheads” in Dick’s. The divisions between the life experiences of the different groups are so stark, but it is the characteristics of the people in them which takes up everyone’s time and attention in both books, rather than the structure of the societies which create such extreme winners and losers. Which suddenly doesn’t feel like science fiction at all.

Meanwhile what has happened to England’s life expectancies by decile of deprivation in the last 10 years?

Source: ONS https://www.ons.gov.uk/peoplepopulationandcommunity/healthandsocialcare/healthinequalities/bulletins/healthstatelifeexpectanciesbyindexofmultipledeprivationimd/2018to2020#health-state-life-expectancies-data

So not quite immortality yet at the top, but inequality is clearly worsening in life expectancy. The Government Actuary’s Department gave an upbeat view last year on what the impact of the recent Levelling Up White Paper might be. Others are upbeat too.

However the Government’s track record is not good on inequality. Sir Michael Marmot produced the Marmot Review on health inequalities in the UK in 2010 and then followed this up with a review of what progress had been made 10 years later. As he points out in his recent interview in The Actuary:

Health spending fell from around 42% to 35% during the 2010s. He notes that this reduction was carried out in a regressive way: “There has been a 16% reduction in health spending for the most affluent, but a 32% reduction for the most deprived groups.” In addition, he says, while unemployment fell over the course of the decade, the income of employed people also went down – so the proportion of people living in poverty rose, as did child poverty.

These are the kinds of interventions that matter for most people rather than sleep apps or regenerative medicine to achieve escape velocity from death. And they are definitely not science fiction.

Actuaries and the Green New Deal

20. September 2019 · Write a comment · Categories: Actuarial, Birmingham, Climate Change, Economics, Legal, Pensions, Regulation, Risk

Images from the Birmingham Climate Strike on 20 September 2019

On the day millions have taken to the streets across the globe to demand a more urgent response to the climate emergency, it seems a good time to write about the crossbench Decarbonisation and Economic Strategy Bill, originally tabled by Caroline Lucas and Clive Lewis in March this year, which has now been formally launched. This “Green New Deal Bill”, as it has been dubbed, sets out a legislative framework for the changes that are needed to make the Green New Deal (a programme of action neatly summarised in the Green New Deal Group’s fifth report here) a reality. The impacts of these proposals would be far-reaching and radical, changing the way our economy operates and what we value. As well as revolutionising the way we live, this would also significantly affect the current work of actuaries and provide many opportunities for people with the actuarial skill set to be centrally involved.

The main proposals which I think would impact actuaries are as follows:

  • Bring offshore capital back onshore to make sure that government, not markets, can make the big economic decisions. This would obviously impact all businesses operating in financial markets. There would also be large movements in the value of some businesses as a result of economic decisions which have previously been left to the market now being made by government. Modelling the impacts of such changes and helping businesses manage the transition are examples of where actuaries can add value here. We are already seeing increasing disinvestments from coal, but this would seem to be just the start of a much wider realignment (one possible view of the potential is discussed here).
  • Greater coordination between the Bank of England, the Treasury and the Debt Management Office. This means the end of the independence of the Bank of England by the look of it, with monetary policy and fiscal policy run in much closer cooperation with each other. It also means more regulation for banks and the supported emergence of local banks and a new national investment bank.
  • New bonds, nationally and locally, and new pension arrangements targeted at the green renewal of our infrastructure. For instance, tax rules on pension schemes could be changed to require a minimum percentage of assets invested in such bonds in order to continue to qualify for tax relief.
  • New objectives for business, and new kinds of businesses. For instance, the UK-based Corporate Accountability Network argues that the whole focus of corporate reporting will have to change, and so too then would corporate behaviour because there is very strong evidence that what is reported by any organisation is what becomes important to it. The Green New Deal Bill provides for changes to both company law and accounting to embrace the need for legally required and enforceable reporting on progress towards any company becoming carbon neutral. This will certainly lead to new business structures as a result and, I would imagine, many new business opportunities for those with actuarial skills as a result.
  • Replacing our measures of progress. This is something I have long supported. The main problem is that there are many possible candidates for this, but that also means that there is a great opportunity for actuaries to be involved in constructing appropriate indices which are globally respected, thereby helping to change what we value away from our current GDP and FTSE fixations.

Of course there are also opportunities for those with actuarial skills to block the transition to an economy that isn’t constructed in such a way as to make environmental destruction inevitable. Employers like these would probably make those with the actuarial skillset very lucrative offers to use their skills. I hope that most of us, and particularly those just at the start of their careers, will resist such offers. We now know that tobacco firms hid the evidence of the damage done by their products for decades and firms such as Exxon have done the same in denying the science on climate change for over 40 years. Please don’t be part of the problem when you could be such a valuable part of the solution.

At Leicester, we intend to launch a new module on our MSc Actuarial Science with Data Analytics programme next year, specifically on the ideas behind the Green New Deal and focusing on the areas where ideas still need to be developed (one of the most exciting things about the Green New Deal is that it is still an area of live discussion, with many of the policy details still being developed). I would welcome any input from members of the Green New Deal Group or those with research interests in this area who would be interested in helping us develop the detailed curriculum of this module before launch.

This is an exciting time for those who are comfortable working with data and communicating what they have found in it. Let’s make sure that those skills are applied to the needs of 99% of the global community.

Catch 22 and Actuarial Practice

03. August 2019 · Write a comment · Categories: Actuarial, Climate Change, Economics, Pensions, Regulation

Source: https://unsplash.com/photos/g0b_tx3i0_8. This image is from Unsplash and was published prior to 5 June 2017 under the Creative Commons CC0 1.0 Universal Public Domain Dedication

Catch 22 can in no way be compared to actuarial practice. One puts its characters in impossible positions, with constantly shifting targets, rewards often inversely proportional to the social usefulness of the characters’ actions and against a backdrop inordinately preoccupied with death. The other has recently been on our TV screens directed by George Clooney.

The most recent link between the two was provided by John Taylor’s excellent Institute and Faculty of Actuaries (IFoA) presidential address last month. He encouraged us all to look at Jimmy Reid’s 1972 speech at Glasgow University (an extract showing the passion with which it was delivered can be seen here). So I did. John picked out the following passage:

I am convinced that the great mass of our people go through life without even a glimmer of what they could have contributed to their fellow human beings. This is a personal tragedy. It’s a social crime. The flowering of each individual’s personality and talents is the precondition for everyone’s development.

Inspiring as that is, my eye was drawn to a different passage of Jimmy Reid’s speech:

Society and its prevailing sense of values leads to another form of alienation. It alienates some from humanity. It partially dehumanises some people, makes them insensitive, ruthless in their handling of fellow human beings, self-centred and grasping. The irony is, they are often considered normal and well adjusted. It is my sincere contention that anyone who can be totally adjusted to our society is in greater need of psychiatric analysis and treatment than anyone else.

They remind me of the character in the novel, Catch 22, the father of Major Major. He was a farmer in the American Mid West. He hated suggestions for things like Medicare, social services, unemployment benefits or civil rights. He was, however, an enthusiast for the agricultural policies that paid farmers for not bringing their fields under cultivation. From the money he got for not growing alfalfa he bought more land in order not to grow alfalfa. He became rich. Pilgrims came from all over the state to sit at his feet and learn how to be a successful non-grower of alfalfa. His philosophy was simple. The poor didn’t work hard enough and so they were poor. He believed that the good Lord gave him two strong hands to grab as much as he could for himself. He is a comic figure. But think, have you not met his like here in Britain? Here in Scotland? I have.

This got me thinking about the investment requirements of the Green New Deal, as this would need to be a huge programme of work to transform our infrastructure and economy away from the carbon-burning planet-trashing Doomsday machine it currently is, which in turn would need huge levels of investment.

I have previously written about some of the views about how we might reduce our current reliance on carbon: the one with the most coherence in my view being the Green New Deal.

However there is a problem. Since our current system, the one which needs to be transformed, is currently predominantly doing the financial sector’s equivalent of rewarding people for not growing alfalfa (for example the misallocation costs estimated by SPERI at £2.7 trillion between 1995 and 2015 from having too large a financial sector here), any Green New Deal spending, at least to start with, is going to have to come from the Government.

The authors of the latest report from the New Economics Foundation anticipate that the massive increase in public spending required to make it happen would be between £20 billion and £40 billion a year. This level of public spending is inconsistent with our current ways of measuring fiscal space, or the room for additional Government spending. Government borrowing is normally expressed in terms of a percentage of GDP and has historically been around 1.3% pa in normal times (ie other than wartime or bailing out the banks). They therefore suggest:

  • The development of a new framework, defined in terms of the threshold beyond which there is a significant risk of adverse economic effects. This would have prevented the damaging austerity policies since 2010, for instance.
  • The parallel development of a tool which would allow policymakers to accurately assess the implications of holding back fiscal space compared with the implications of borrowing for investment, and therefore allow politicians to come to an informed view on the best combination of fiscal intervention or fiscal prudence at a given point in time, including with respect to climate related risks.
  • More explicit cooperation between the Bank of England and the Treasury, including the use of a new public investment bank (or network of banks) such as a green national investment bank (GNIB) – to increase commercial lending to green industries.

A particular interesting aspect of the GNIB is the proposal to make it independent of political interference. In the same way as those economists who argue for independent central banks so that governments don’t pursue damaging monetary policy in particular for electoral gain, some advocates of the GNIB believe it could be used as a backstop against governments underusing fiscal space for ideological reasons.

Richard Murphy points out that https://www.gov.uk/government/statistics/individual-savings-account-statistics shows £40 billion was saved in cash ISAs in 2017 / 18, and suggests that Green ISAs, backed by a Green Investment Bank and paying, say, 3% a year would be more attractive than current cash ISAs, therefore potentially meeting the GND funding requirements on their own.

Simon Wren Lewis, in his discussion of the many of the arguments around the Green New Deal and how it should be funded, makes the following excellent point (amongst many others):

No one in a 100 years time who suffers the catastrophic and (for them) irreversible impact of climate change is going to console themselves that at least they did not increase the national debt. Humanity will not come to an end if we double debt to GDP ratios, but it could come to an end if we fail to combat climate change.

The Catch 22 of the title originally described the catch which kept pilots flying highly dangerous missions in World War 2 – they could only get out of them by being certified insane, but the very fact of trying to get out of them showed that they were in fact sane and therefore they had to keep flying. If we want far fewer actuaries to be employed in not growing alfalfa in the future and far more working on making the finance structures of our economy work better, whether to support a Green New Deal or more generally, we first need to embrace the idea that our current economic priorities are indeed insane.

 

Whether or not there is a strike, USS’s future depends on trusting its members

11. July 2019 · 1 comment · Categories: Actuarial, Defined Ambition, Legal, Pensions, Regulation

On 23 March 2018, Universities UK (UUK), the universities’ employer body, issued an offer to the University and College Union (UCU) to end the Universities Superannuation Scheme (USS) pensions dispute. The UCU agreed to put it to their members and, on 13 April, announced that the proposals had been accepted by a margin of around 2 to 1. The main proposals, as summarised by Sally Hunt the UCU general secretary, revolved around the setting up of a Joint Expert Panel (JEP).

The JEP’s members were proposed by UUK and UCU – Ronnie Bowie, Sally Bridgeland and Chris Curry were proposed by UUK (two actuaries and the Director of the Pensions Policy Institute respectively). UCU proposed Saul Jacka (professor of statistics at the University of Warwick and a Turing fellow at the Alan Turing Institute), Deborah Mabbett  (professor of public policy at Birkbeck) and Catherine Donnelly (associate professor at Heriot-Watt University, where she heads up a unit focusing on pensions, investment and insurance research). The Chair is Joanne Segars, a well respected and very experienced former CEO of the Pensions and Lifetime Savings Association (PLSA) who had most recently been working with the Local Government Pension Scheme.

The Terms of Reference of the JEP were also published, which stated that the purpose of the panel was to:

  • make an assessment of the 2017 valuation;
  • focus in particular on reviewing the basis of the scheme valuation, assumptions and associated tests; and
  • agree key principles to underpin the future joint approach of UUK and UCU to the valuation of the USS fund.

They also stated that the panel would take into account:

  • the unique nature of the HE sector, intergenerational fairness and equality considerations;
  • the clear wish of staff to have a guaranteed pension comparable with current provision whilst meeting the affordability challenges for all parties; and
  • the current regulatory framework.

All of the bits relating to the 2017 valuation were reported on in September 2018, with recommendations from the JEP on ways of bringing the total contribution rate below 30% of pensionable pay.

In response to this, the USS Trustee made a proposal for concluding the 2017 valuation and preparing a 2018 valuation which could more fully take account of the JEP recommendations. This was accepted by UUK after a reduction in deficit reduction contributions from 6% to 5% was made and finally by the Pensions Regulator here, which noted that the proposal for the 2017 valuation is at the very limit of what TPR finds acceptable as it would see the Scheme carry higher levels of risk than we would consider manageable for a ‘tending to strong’ covenant.

The 2018 valuation process has been proceeding at pace, with the USS Trustee proposal following the consultation response from UUK of 3 options for future contribution patterns leading to indicative agreement from UUK for the third option of a total contribution rate of 30.7% from October 2019 and a further valuation in 2020. Following the September 2018 report, the JEP is working on a follow up report for September 2019 in relation to the USS valuation process in general. The second phase of work on the USS valuation has two parts; the first is concerned with the valuation process and governance, the second with the long-term sustainability of the scheme.

UCU have rejected all 3 options and set out a timetable for ballots on industrial action from 9 September in the event of any agreement which does not represent no detriment to members, ie no reduction in benefits or increase in employee contributions from the 8% level they were at before 1 April 2019. The JEP have suggested (while accepting that their numbers are indicative only, without detailed modelling) that, if all the measures they propose were adopted, the contribution rate could be reduced to 29.2%, split 20.1% employer and 9.1% employee in accordance with the cost sharing agreement. This compares with the USS Option 3 proposal of a split of 21.1% employer and 9.6% employee.

The UCU position looks a long way from the one that the Trustee and UUK appear to be edging towards, and I fear that a strike ballot may therefore be inevitable.

However, I think there is an equally important area mentioned in the JEP report where USS can radically improve how its members engage with a scheme which will be, for most, their major source of income in retirement.

How USS engages with its members

In their report the JEP, rightly I think, devoted several pages to member involvement in the valuation process, information and transparency and building trust and confidence, matters which will be a particular focus of their second report. They observed that:

  • longer consultation periods, initiated at an earlier stage, could facilitate member involvement via universities’ internal processes, which might help to build confidence in the valuation and a shared sense of ownership – helping to avoid future, damaging, industrial disputes.
  • there is no formal, scheme-wide mechanism for involving members in the valuation process or for assessing their appetite for changes to the Scheme
  • for future valuation cycles it will be important that the Trustee and Scheme Actuary interact more, at an earlier stage, with all stakeholders, particularly with regard to setting valuation assumptions and expectations
  • lack of understanding is likely to have contributed to falling levels of member confidence in the Scheme. It might be helpful for the Scheme to provide simple-to-understand guides which use clearly defined terminology to aid the understanding of the majority of Scheme members
  • the lack of trust in the valuation process and the Scheme has given rise to a view, albeit not a universal one, that USS is not being as open as it could be with stakeholders….whilst observing the need for confidentiality…the Panel suggests the Trustee may wish to consider how to share more of the information currently deemed confidential, eg on a redacted basis or in a summarised form. This would aid understanding of the valuation process…and, importantly, help rebuild confidence in the Scheme and its governance.

I would take such suggestions a step further, as I believe much of this communication would be wasted within the current adversarial environment, and indeed would be likely to be “spun” by one side or the other. It is clear that there is little trust in the USS Trustee on the part of the UCU officers. However, the ability of the 21,685 (out of 24,707 total votes) who voted to strike and then the 21,683 (out of 33,973 total votes) who voted to end the strike to determine what could or could not happen to a scheme with 396,278 members (as at  31 March 2017, 190,546 of them active) was, I think, unhelpful to the process of achieving a consensus more generally. Engagement needs to go much further than negotiations between UUK and UCU during valuation processes. USS does need to do far far more, in conjunction with the UCU and others, to engage members to help them understand their finances first before launching into what can be fairly abstract pensions discussions even for university professors.

The good news is that the membership have become much more aware of their pension scheme, mainly as a result of last year’s industrial action, and, being the inquisitive people they are, will I am sure now be looking for a higher degree of information (and education) from their pension provider about their benefit provision in future.

As the Pensions Policy Institute and many others have been saying for years, the decisions we are asking people to make are complex and subject to many different influences and biases. These decisions can be helped enormously if more care is taken in the nature and timing of how members are communicated with. Members will not value benefits they don’t understand and ultimately this scheme is only going to work in the long term if the people in it are trusted to be part of the decisions about its future.

Dr Strangelove’s Pension

01. May 2019 · Write a comment · Categories: Actuarial, Climate Change, Economics, Pensions, Prediction, Regulation, Risk

The War Room with the Big Board from Stanley Kubrick’s 1964 film, ”Dr. Strangelove”. Source: ”Dr. Strangelove” trailer from 40th Anniversary Special Edition DVD, 2004 Directed by Stanley Kubrick

In 1960, Herman Kahn, a military strategist at the RAND Corporation, an influential think tank which continues to this day, wrote a book called On Thermonuclear War. It focused on the strategy of nuclear war and its effect on the international balance of power. Kahn introduced the Doomsday Machine (which Kubrick used in his film “Dr Strangelove” alongside many other references from the book) as a rhetorical device to show the limits of John von Neumann’s strategy of mutual assured destruction or MAD. It was particularly noteworthy for its views on how a country could “win” a nuclear war.

For some reason Kahn came to mind as I was looking through Resource and Environment Issues: A Practical Guide for Pensions Actuaries, from the Institute and Faculty of Actuaries’ Relevance of Resource and Environment Issues to Pension Actuaries working party, which summarises the latest thinking on the climate change-related issues scheme actuaries should be taking into consideration in their work. I will come back to why.

The section which particularly caught my attention was called How might pensions actuaries reflect R&E issues in financial assumptions? This section introduces two studies in particular. First, we have the University of Cambridge Sustainability Leadership (CISL) report on Unhedgeable risk: How climate change sentiment impacts investment. This posits three “sentiment” scenarios (paraphrased slightly for brevity – see the report for details of the models used):

  • Two degrees. This is defined as being similar to RCP2.6 and SSP1 from the Intergovernmental Panel on Climate Change (IPCC) AR5. Resource intensity and dependence on fossil fuels are markedly reduced. There is rapid technological development, reduction of inequality both globally and within countries, and a high level of awareness regarding environmental degradation. It is believed that under this scenario global warming will not raise the average temperature by more than 2°C above pre-industrial temperatures.
  • Baseline. This is a world where past trends continue (i.e. the business-as-usual scenario), and there is no significant change in the willingness of governments to step up actions on climate change. However, the worst fears of climate change are also not expected to materialise and temperatures in 2100 are only expected to reach between 2°C and 2.5°C. This scenario is most similar to the IPCC’s RCP6.0 and SSP2. The economy slowly decreases its dependence on fossil fuel.
  • No Mitigation. In this scenario, the world is oriented towards economic growth without any special consideration for environmental challenges. This is most similar to the IPCC’s RCP8.0 and SSP5. In the absence of climate policy, the preference for rapid conventional development leads to higher energy demand dominated by fossil fuels, resulting in high greenhouse gas emissions. Investments in alternative renewable energy technologies are low but economic development is relatively rapid.

The modelled long-term performance for a range of typical investment portfolios is worrying:

CISL suggest quite different investor behaviour depending upon which climate change path they think the world is taking: moving into High Fixed Income if No Mitigation seems to be the direction we are heading, but adopting an Aggressive (ie 60% equities, 5% commodities) asset allocation if the Two Degrees scenario looks most likely.

Elsewhere the report suggests hedging via cross-industry diversification and investment in sectors with low climate risk. For example under No Mitigation, it is possible to cut the maximal loss potential by up to 47% by shifting from Real Estate (in developed markets) and Energy/ Oil & Gas (in emerging markets) towards Transport (in developed markets) and Health Care/ Pharma (in emerging markets). However over 50% of losses in all scenarios remain unhedgeable (ie unavoidable through clever asset allocation alone).

The second report (Investing in a time of climate change) from Mercer in 2015, focuses on the following investor questions:
• How big a risk/return impact could climate change have on a portfolio, and when might that happen?
• What are the key downside risks and upside opportunities, and how do we manage these considerations to fit within the current investment process?
• What plan of action can ensure an investor is best positioned for resilience to climate change?

The section I was drawn to here (it’s a long report) was Appendix 1 on climate models used, and particularly those estimating the physical damages and mitigation costs associated with climate change. The three most prominent models used for this are the FUND, DICE and PAGE models, apparently, and Mercer have opted for FUND. They have then produced some charts showing the difference between the damages exepcted for different levels of warming predicted by the FUND model compared to DICE:

The result of this comparison, showing lower damage estimates by the FUND model, led the modellers to “scale up” certain aspects of the output of their model to achieve greater consistency.

Both of these reports have been produced using complex models and a huge amount of data, carefully calibrated against the IPCC reports where appropriate and with full disclosure about the limitations of their work, and I am sure they will be of great help to pension scheme actuaries (although there does some to be some debate about this). However I do wonder whether as a profession we should be spending less time trying to find technical solutions in response to worse and worse options, and more time trying to head off the realisation of those sub-optimal scenarios in the first place. I also wonder whether the implicit underlying assumption about functioning financial markets and pension scheme funding is a meaningful problem to be grappled with at 3-4° above pre-industrial averages as some of this analysis suggests.

In the summary of Mark Lynas’ excellent book Six Degrees: Our Future on A Hotter Planet, the three degree increase for which damages are being estimated is expected to lead to Africa […] split between the north which will see a recovery of rainfall and the south which becomes drier […] beyond human adaptation. Indian monsoon rains will fail. The Himalayan glaciers providing the waters of the Indus, Ganges and Brahmaputra, the Mekong, Yangtze and Yellow rivers [will decrease] by up to 90%. The Amazonian rain forest basin will dry out completely. In Brazil, Venezuela, Columbia, East Peru and Bolivia life will become increasingly difficult due to wild fires which will cause intense air pollution and searing heat. The smoke will blot out the sun. Drought will be permanent in the sub-tropics and Central America. Australia will become the world’s driest nation. In the US Gulf of Mexico high sea temperatures will drive 180+ mph winds. Houston will be vulnerable to flooding by 2045. Galveston will be inundated. Many plant species will become extinct as they will be unable to adapt to such a sudden change in climate.

The [IPCC] in its 2007 report concluded that all major planetary granaries will require adaptive measures at 2.5° temperature rise regardless of precipitation rates.[and] food prices [will] soar. Population transfers will be bigger than anything ever seen in the history of mankind. [The feedback effects from the] Amazon rain forests dry[ing] out and wild fires develop[ing] [will lead] to those fires [releasing] more CO2, global warming [intensifying] as a result, vegetation and soil begin[ning] to release CO2 rather than absorb[ing] it, all of which could push the 3° scenario to a 4°-5.5° [one].

The last time the world experienced a three degree temperature rise was during the geological Pliocene Age (3 million years ago). The historical period of the earth’s history was undoubtedly due to high CO2 levels (about 360 – 440ppm – almost exactly current levels). I would suggest that our biggest problem under these conditions is not that over 50% of losses on pension scheme investments remain unhedgeable.

In his recent article for Social Europe, the unbearable unrealism of the present, Paul Mason presents two graphs. The first is the projection by the United States’ Congressional Budget Office of the ratio of debt to gross domestic product until 2048 in the United States.

The second is a chart from the IPCC showing how dramatically we need to cut CO2 emissions to avoid catastrophic and uncontrollable breakdown.

Mason feels that capitalism is too indebted to go on as normal and too structurally addicted to carbon. In his view Those who are owed the debt, and those who own rights to burn the carbon, are going to go bankrupt or the world’s climate will collapse. This feeling is echoed by George Monbiot here, where he cites a paper by Hickel and Kallis casting doubt on the assumption that absolute decoupling of GDP growth from resource use and carbon emissions is feasible and summarises some alternative approaches to the capitalism he feels no longer has the solutions.

Others dispute this, claiming that the Green New Deal is the only chance we have (here, here and here) to prevent irreversible climate change.

Whether you agree with any of these predictions or none of them, agree that we face a climate emergency or feel that is too extreme a description, it all brings me back to Kahn and Dr Strangelove. We seem to have replaced the MAD of the cold war with the MAD of climate change, except that this time we do not even have two sides who can prevent it happening by threatening to unleash it on each other. It is just us.

What we really cannot afford to be doing, via ever more complex modelling and longer and longer reports, is giving the impression that the finance industry can somehow “win” against climate change rather than joining the efforts to avert it as far as possible.

The Time Has Come For Lecturers To Decide What They Want

17. March 2018 · Write a comment · Categories: Actuarial, Defined Ambition, Pensions, Regulation, Risk, Uncategorized

Since my last post on the strike, where I set out my reasons for not joining it, a lot has happened. The strike has forced UUK back to the negotiating table, overseen by ACAS, on a deal originally presented as done. The consultation period on the new arrangements has been postponed. University Vice Chancellors are scurrying to distance themselves from the UUK negotiating position and side with their own striking lecturers. As most observers admit, including most recently the Head of Public Sector Pensions at KPMG in the tweet below, the UCU have won the communications battle. Victory appears to be total.

However there remains a problem, which we seem to be facing increasingly in recent years from Trump to Brexit, and that is this: what to do when the victory you have won is based on campaign arguments which are fundamentally untrue, not backed by evidence or existing pensions legislation, and ultimately undeliverable? Just keep saying no to any workable option which is put to you?

How untrue? Well let’s go back to the now famous letter to the FT signed by many famous lecturers across the UK, including David Spiegelhalter, Ben Goldacre and Steven Haberman (notable as he is deputy director of the Actuarial Research Centre). This was itself a response to a FT story based on the audited accounts, where the pension deficits were merely being updated in line with what had previously been agreed and bore no relation to the negotiations about the March 2017 valuation. As the audited accounts state quite clearly:

The trustee regularly monitors the scheme’s funding position as part of the overall monitoring of FMP introduced followed the 2014 valuation. The monitoring is based on the assumptions used for the 2014 actuarial valuation (updated for changes in gilt yields and inflation expectations). The monitoring does not involve the same detailed review of the underlying assumptions (including the financial, economic, sectoral assumptions for example) that takes place as part of the full actuarial valuation, the next full actuarial valuation being due as at 31 March 2017. Therefore the amounts shown for liabilities in the funding position below are not indicative of the results of the 2017 valuation.

So arguing about these assumptions was futile. The letter also showed an unexpected lack of understanding (particularly from Steven Haberman, who must have spent enough time in the company of pensions actuaries who carry out these kinds of negotiations all the time to know better) about what the assumptions shown in the accounts meant. In particular, there is a note saying that the general salary assumption is only being used for the recovery plan contributions rather than to calculate the scheme deficit. That means that, if you think the assumption is too large, it will be overstating the value of future contributions and therefore understating how large those contributions need to be. So rather than making the scheme seem more unaffordable, it would be making it seem less.

Then there is the mortality point – a massive misunderstanding. The assumptions do not say that life expectancy is increasing by 1.5% pa which would clearly be absurd. They are saying that mortality improvements (ie the percentage by which the expected probability of death of a 70 year old in 2020 is less than that of a 70 year old in 2019) are assumed to be 1.5% pa. Stuart McDonald gently put Ben Goldacre right on this point here.

However the bigger overall point is that individual assumptions are not the thing to focus on here anyway, but the overall level of prudence or otherwise in a basis. And the facts around this are considerably clearer.

  • We know that the initial valuation proposed by the USS Trustee to the Pensions Regulator and the covenant assessment on which it was based (ie the willingness and ability of the employers in UUK to continue paying contributions) were both rejected. As this initial valuation disclosed a deficit of just over £5 billion, then the proposal resulting in a £7.5 billion deficit which was finally presented to the Joint Negotiating Committee would appear to be as low as the Trustee could reasonably go and still get the valuation past the Regulator.
  • The S179 valuation of the scheme (this is the valuation all occupational pension schemes who pay levies to the Pension Protection Fund as insurance against the failure of their employer(s), which is done on the same valuation basis for all schemes) at the last valuation as at 31 March 2014 showed a deficit of £8.95 billion (compared to the £5.3 billion funding deficit disclosed). The latest “more prudent” valuation proposed is therefore still unlikely to be proposing a target which goes anywhere near 100% funding on this basis (the scheme was only 82% funded in March 2014 when, as you can see below, nearly 40% of schemes were in surplus on this measure). There is therefore no justification for the repeated assertion by the UCU that the scheme is not under-funded.

Source: Commons Work and Pensions Select Committee report on defined benefit pension schemes 20 December 2016

One last point on the campaign. Some of it seems to have been directed personally at the USS Trustee. This is the body with no other job than to protect the security of the pensions that lecturers have already built up. Why would anyone want to turn on them? Bill Galvin, the Group CEO at USS Ltd, the Trustee company, has set out responses to some of the other misconceptions here. I would urge anyone with an interest in this dispute to read them.

So, if the deficit is what it is and there is no scope for weakening the funding assumptions any further and maintaining current benefits on these funding assumptions involves contribution increases which are unacceptable to both scheme members and the employers, what is this dispute about now? The time has come for lecturers to decide what they want. Of course the basic premises of pension scheme funding can be argued about (and I direct anyone interested in the long history of actuarial debate in this area to read chapter 6 of Craig Turnbull’s A History of British Actuarial Thought which traces this from 1875 to 1997), and perhaps ultimately legislative change might be brought about if a new argument could be won in this area. But that is a long term objective and the funding of this scheme needs to be agreed now. If a £42,000 cap for 3 years while negotiations continue on a long term structure of the scheme which doesn’t leave all risk with scheme members is not acceptable, then we need to decide pretty quickly what is. Because once we move to a DC arrangement, the chances of us moving back to any form of risk sharing subsequently are in my view remote. There will always be other uses for that money.

However there are many possible alternative structures and many ways of sharing the risks between employers and scheme members. In particular let’s not get too obsessed with Collective Defined Contribution schemes, the enabling legislation for which has yet to materialise. Consider all the alternatives and let proper negotiations commence!

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