Regulation – Page 6 – We Know Zero

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.

National annuities and small pots

20. February 2014 · Write a comment · Categories: Pensions, Regulation

Source: Flikr Creative Commons by Thomas Galvez under license

Patrick Collinson’s article about bringing in auto-annuitisation and a national annuity service has prompted some discussion.

As he said:

It won’t solve the problem of overcharging by the City while workers are saving to build up their pension pot. It won’t solve stockmarket underperformance. It won’t solve the biggest issue for annuities – that we are continuing to live longer and longer. But a National Annuity Service could at least make sure that one of the biggest financial decisions anybody faces isn’t a case of pension pot luck.

Peter Kane, Corporate Relationship Director at Standard Life, felt that the biggest challenge was that most employees in the UK are not saving enough and the average level of fund at retirement (before an annuity is even considered) is insufficient. He’ll get no argument from anyone about that being a big challenge, but there has been a great deal of discussion about it and there will continue to be so. It does not in any way diminish the importance of what he refers to as “the annuity issue”.

Matt Dorrington, Pension Consultant at Capita Employee Benefits, thinks what we need to consider is who will hand hold these people and how are they remunerated for their services. The reason a national annuity service would be set up of course is if the Government decided that the pensions industry was not hand holding enough and requiring to be remunerated too much.

Joe Robertson, Member Nominated Director at The Pensions Trust, was concerned about the computerisation required to process the information to allow enhanced annuities for the masses. Is that why there has been so little encouragement to people to access the much better value annuities their personal information could buy them for so many years (up to 24% of annuities were enhanced in some way in 2012, but only 2% were in 2003)?

If the Government were to step in with a cheaper annuity advice and broking service, would this lead to commercial annuity brokers leaving the market, or to their charges coming down to closer to the state broker’s rates? Commercial brokers might well still offer a wider range of options, justifying higher fees. If auto-annuitisation only applied for pension funds up to a certain level, with funds above this level not needing to be surrendered to the national service, might there still be a market for advising high net worth individuals?

These are just some of the many questions which would need to be answered, but such a service could potentially significantly improve outcomes for many. If nothing else it could reduce the current very wide variation in outcomes, although this may of course lead to those who currently navigate their way around the system quite cannily ultimately being worse off.

I would like to see an additional service provided by the new broker if it ever came into existence: to index market annuity rates against the relative cost of annuities under the Pension Protection Fund’s (PPF’s) Section 143 basis in any given month (this gives the amount of money the PPF currently requires schemes to have to purchase an annuity when their sponsor has failed so as to avoid entry into the PPF). Obviously even standard annuity rates vary by postcode, but it would provide a check on market prices increasing beyond what movements in the underlying investments used by annuity providers would justify.

But of course the real problems are at the bottom end. According to the Association of British Insurers (ABI), 30% of annuities were purchased with less than £10,000 in 2012. For annuities purchased with £20,000 or less, this percentage increases to nearly 40% for external annuities (ie when people “shop around”, as apparently they now do in 48% of cases) and nearly 60% for internal annuities (when they don’t).

Why is this, when legislation allows people to take the first £18,000 of pensions savings as cash (the so-called “trivial commutation” rules)? Part of the answer may lie in the latest report from the Pensions Institute entitled How do savers think about and respond to risk?. Of particular relevance I think is this finding:

One clear preference stands out: the reluctance to dip into long-term savings to meet a shortfall in short-term savings goals and vice versa. This provides support for the idea from behavioural finance that people have different “mental accounts” for their savings goals and are reluctant to “borrow from” them for other purposes (ie the mental accounts are not fungible). This holds very strongly for the long-term fund: only as a last resort are most people prepared to dip into this to meet short-term savings goals. A slightly bigger percentage of people are, however, prepared to use their short-term fund if they face the risk of a shortfall in their long-term savings goals.

I think at least part of the reason for the high demand for small annuities is this unwillingness to convert money which has always been seen as long term savings (and for which, as another part of the report makes clear, most people are generally more willing to accept a lower, but more stable, income than to risk significant falls in the asset value) into a form which could end up meeting short term needs instead. Of course, part of the reason might also be lack of awareness that the option not to buy an annuity exists. A state broking service may therefore help here too.

In view of the particularly poor value offered in the market at the lower end (£5,000 buys you around £5 a week, not increasing and which does not include anything for your spouse) and the persistent demand in spite of this, I would like to propose one further step. I think the Government might want to consider creating a section of the PPF for small pots. Say, those up to £18,000?

It is in no way what the PPF was set up to do. And yet. The administration expertise with handling large volumes of small pensions is already in place there. And, if the terms offered were on a S143 basis, it should not create any additional funding burden. What ever they make think of it, employers with pension schemes have become accustomed to dealing with the PPF.

If the PPF were able to take small pots on similar terms to those currently only available to larger annuities in the market, and the market were then left to provide annuities for everyone else, outcomes might be improved at all levels.

The PPF as an annuity provider of last resort? Perhaps this is an idea whose time has come.

Camps, acronyms and other small stuff

08. February 2014 · Write a comment · Categories: Actuarial, Defined Ambition, Pensions, Regulation, Risk

The Defined Ambition consultation ended on 19 December but the lobbying has continued. Camps have now formed around the various options.

Steve Webb, the Pensions Minister, and Alan Rubinstein, Chief Executive of the Pension Protection Fund, have been enthusiastic supporters of something called the pension income builder, which increases the guaranteed pension accrued each year with part of the annual contribution, with the remaining contributions invested in a collective defined contribution (DC) arrangement.

The Collective DC more generally, where returns are smoothed between members in an attempt to reduce the volatility of returns on individual DC, has also had some very vocal proponents. Considering it was originally ruled out as an option by the Department of Work and Pensions (DWP), has had 10 objections to it raised by the Association of British Insurers (ABI) and has been accused of not reducing risk so much as moving it around between members by Lord Hutton, this is a little bit of a surprise.

Lord Hutton, former Secretary of State for Work and Pensions and chair of the Commission on Public Service Pensions Commission, is dismissive of the whole defined ambition idea. Recently he said that the Government should stop “banging on” about defined ambition and let the pensions industry focus on applying defined benefit (DB) investment strategies to DC schemes. He is a particular fan of the Liability Driven Investment (LDI) approach, common in DB schemes protecting their funding position, being applied more consistently to DC. Hutton has recently joined Redington, an investment consultancy, so I imagine we can expect to hear a lot more from him on this subject.

Much has been made of the Dutch system, which has a “second pillar” of large industry-wide pension schemes. This has suffered from the same economic pressures which have dogged the UK system since the turn of the century, but has arguably retreated from straight final salary benefits – first to career average retirement earnings (CARE), then to risk sharing via variable contributions for employers balanced by variable benefits for employees, and currently renegotiating again in the wake of the 2008 crash – in a more orderly manner. I tend to feel that the main reason the Dutch system is better than ours is the same reason that their flood defence system is better: they put a lot more money into it. Nine times as much in the case of flood defences, and contributions into their second pillar average 20% of salary compared to the current average into DC schemes in the UK of under 8%. They also make you buy an annuity, make you join and don’t let you opt out. Despite this it remains remarkably popular with the public.

As you can see, there are a lot of acronyms flying around, and relatively little discussion with the people who these schemes are likely to end up getting foisted on. The Association of Consulting Actuaries (ACA) carried out a survey of smaller firms which revealed that what they wanted was:

Members to receive more from their savings;
Increased transparency and trust in the companies who provided pensions;
No collective schemes; and
More tax concessions.

This last point is unlikely to be conceded, with the Institute of Fiscal Studies joining the increasing clamour this week to limit the generous tax exemptions to employers and members with occupational pension arrangements.

But has anyone asked members of pension schemes? Very few, as far as I can see. The most notable being the Pension Regulator’s survey of DC pension members in 2012. When those still actively contributing to these schemes were asked which of a long list of things would encourage them to take more interest in their pension, the three things they wanted overwhelmingly 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.

Notice how concerns about guaranteed benefits did not feature here. When asked, 85% had some understanding that their pension income was not guaranteed, and even more (94%) had an understanding that contribution levels were a key factor in determining that income. While 78% thought their company or personal pension would be one of their main sources of income in retirement (the next highest was the state pension with 22%), only 24% were confident that their current level of contributions was going to provide an adequate income. So they know they have a problem.

What they are asking for is a step change in financial education so that they can begin to tackle that problem. So could it be that all of the groups we have heard from above are trying to solve the wrong thing entirely?

As far as the regulatory environment is concerned, I think the document Defining Ambition produced by the National Association of Pension Funds (NAPF) before the consultation probably summarised the situation best. Joanne Segars stopped short of supporting any particular solution and instead laid out some of the main options and where they sat on the scale of risk (which I have reproduced above) to the member.

Segars suggested that we shouldn’t “sweat the small stuff”, and should instead concentrate on providing a flexible continuum of regulation to cover the whole scale of risk, otherwise any new approaches would be snuffed out by HMRC’s and TPR’s lack of flexibility and overly complex approach before they even got going, much as cash balance schemes have been over the last 20 years. I felt that this was just fence-sitting at the time, but have since realised that she was right. We have all been “banging on” for too long about things about which prospective members simply don’t care.

Assuming a relaxation of the regulations which doesn’t yet exist, we actuaries have piled enthusiastically into debating slight differences between our different pet schemes, standing toe to toe and swapping model results like punches, while seemingly forgetting all about the member.

Suddenly the most important contribution in Defining Ambitions seems clear to me: that of Morrisons’ HR Director about how they introduced a three year financial education and advice programme (called Save Your Dough) throughout their workforce ahead of their auto-enrolment date. They realised that they needed to help their employees understand their finances first before they would understand that they could make a difference to their long-term finances by saving into a pension. They involved Alvin Hall to add some celebrity glitter to the process, but also involved their main union USDAW. And they used a lot of different communication tools, from booklets to podcasts to online modellers to short films and video diaries in addition to the more traditional information sources and face to face sessions. They trusted that they had good people who would make reasonable decisions given sufficient accessible information.

I am sure there are other examples of such good practice out there, but we have not encouraged them with our endless debates about DC plus v CDC v DB minus and everything in between. The small stuff has been sweated quite enough. Let’s help firms talk to their members better instead.

Peering over the barricades

30. January 2014 · Write a comment · Categories: Actuarial, Cartoons, Legal, Pensions, Regulation

Have you, as a result of your frenetic activity since Christmas, got a bit of a peer review backlog? I can help. Let me be the scheme actuary you’re temporarily short of. With a 10% discount on the rates shown here until the end of the UK 2013/14 tax year, and a further 10% reduction for type 2 peer reviews.

It’s like deja-vu all over again

28. January 2014 · Write a comment · Categories: Actuarial, Pensions, Regulation, Risk

The Pensions Regulator has a consultation on the go. In fact they have two: regulating defined benefit pension schemes and regulating public service pension schemes. Both started in December and are due to wind up in February. The defined benefit pension schemes one alone runs to over 160 pages across the four documents published. All at the busiest time of the year for most pensions actuaries, caught between the 31 December 2013 accounting disclosures and the looming deadlines for submitting the 31 December 2012 scheme funding assessments. Could it be that they are rather hoping to limit the feedback they get?

Because the changes that are being proposed to the funding regime known as scheme specific funding which has run for 8 years are dramatic. Under the pretext of only making changes to allow the introduction of the Regulator’s new objective to “minimise any adverse impact on the sustainable growth of an employer” (see my previous post on this), they have effectively announced the death of scheme specific funding and proposed a system which looks very much like the Minimum Funding Requirement (or MFR – the previous discredited funding regulations) mark two to me, although the Regulator insists that it will be completely different this time.

The main problem with the MFR was that it was a one-size-fits-all approach (although it did vary in strength depending on how far on average members had to go until benefits were paid – known as the duration of the scheme), which encouraged an inappropriate level of contributions for many schemes (the minimum funding requirement effectively became a maximum funding requirement in many cases).

Fast forward to now, and the new proposed funding approach based around something called the Balanced Funding Outcome (BFO). This calculates a required level of assets for each scheme on an “objective liability measure, independent of the scheme’s funding assumptions”. The actual assets will be compared with the required amount and a recommended level of contributions to get up to the required level will then be calculated by the Regulator. The contributions the scheme trustees have agreed with the scheme’s employer will then be assessed to see if they measure up. Where MFR varied by duration, BFO will vary by duration and covenant (how likely the employer is to stick around to pay the last pensioner). So, as you can see, completely different!

At the end of Appendix G of the 50 page draft funding policy, we finally find the problem that I think the Pensions Regulator really wants to solve:

Look at all those dots. They’re all over the place. There is currently absolutely no correlation between the deficit reduction contributions (DRCs) employers are paying and the funding level in their schemes. The Regulator is determined to change that, by giving trustees and employers sight of their preferred contribution number during their negotiations. The contribution number won’t be compulsory of course, but if you use it then the Regulator will leave you alone. It is almost as if they have never heard of Daniel Kahneman or behavioural economics.

What will happen? Well who knows but here’s a guess. Schemes to the bottom left of the chart above (ie low assets and contributions) are already being subjected to extra scrutiny and generally have employers in such a poor financial state that there is very little they can do about it. But those in the top right will effectively have been given permission to swoop down to the blue line with a whoop of “Pensions Regulator’s new objective”. It will be like the 90s all over again when pension schemes took contribution holidays because they were measuring their funding in an unrealistic way. It will be seen as financially stupid to be in the top right of the Regulator’s graph. Group think will be in charge once more. But, to use another quote from Yogi Berra, the baseball icon, “If you don’t know where you are going, you might wind up someplace else”.

If we agree to this we will be making the pensions system more fragile. The model used by the Regulator will not anticipate the next defaulting economy or other Black Swan that throws currency and financial markets into meltdown (no one was suggesting Argentina would default a month ago) and reduces everyone’s level of funding, so when that happens everyone will be in trouble rather than just the proportion of schemes in difficulties we have now. The overall funding risk of defined benefit pension schemes will be inflated so much that the system may not easily recover.

It gets worse. There is a lot in this consultation about governance, and also references to asset liability modelling, due diligence, reverse stress testing, scenario testing and covenant advice. These are all things which are likely to be a problem for small schemes, which I pointed out previously when they were proposed by EIOPA (because, let’s be clear, it is compliance with prospective EU legislation which has driven many of these proposals). But guess which group are going to see an almost total reduction in the scrutiny they get from the Regulator under the new regime? That’s right: small schemes.

There is still time to register your opposition to reliving the last 15 years of defined benefit pensions all over again: the consultation runs until 7 February.

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