The difficulties of looking forward

25. January 2014 · Write a comment · Categories: Economics, Prediction, Regulation

Unemployment

We are only six months into the Bank of England’s new regime of giving forward guidance about what circumstances might lead them to adjust the Base Rate and they are already in a bit of a mess with it. Whether forward guidance is abandoned or not is still in the balance, amid much confusion. However, much of this confusion seems to be due to the challenge that events have provided to the assumption that the Bank of England could make reasonably accurate economic predictions.

It turns out that not only did the Bank not know how fast unemployment would fall (not a surprise: the Monetary Policy Committee (MPC) minutes from August make clear that they suspected this might be the case), but neither did they know, when it did fall, what a 7% unemployed economy would look like. The Bank has been very surprised by how fragile it still is.

Back in August 2013, when unemployment was still at 7.7%, the MPC voted to embrace the forward guidance which has now fallen on its face. This said that: In particular, the MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%, subject to the conditions below.

The “conditions below” were that all bets would be off if any of three “knockouts” were breached:

1. that it would be more likely than not that CPI 18 to 24 months ahead would be at 2.5% or above (in fact it has just fallen to 2%);

2. medium-term inflation expectations no longer remained “sufficiently well anchored” (the gently sloping graph below would suggest it hasn’t slipped that anchor yet); or

3. the Financial Policy Committee (FPC) judged monetary policy posed “a significant threat to financial stability”. More difficult to give an opinion on that one but, looking beyond the incipient housing market bubble, it is difficult to see that monetary policy is causing any other instability currently. Certainly not compared to the instability which would be caused by jacking up interest rates and sending mortgage defaults through the roof.

Source: Bank of England implied spot inflation curve

Source: Bank of England implied spot inflation curve

So it seems that there has been no clear knock out on any of these three counts, but that the “threshold” (it was never a target after all) of 7% is no longer seen as significant a sign of economic recovery as it had been believed it would only last August.

Fun as it is to watch the illusion of mastery of the economy by the very serious people flounder yet again, as what is an intrinsically good piece of economic news is turned into a fiasco of indecision, I think the Bank is right to believe that it is far too early to raise interest rates. I say so because of two further graphs from the Office of National Statistics (ONS) latest labour market statistics, which were not included in their infographic on the left.

The first is the graph of regional unemployment, which shows very clearly that large areas of the UK are still nowhere near the magic 7% threshold: the variations are so wide and, in austerian times, the resources to address them are so limited that it makes sense not to be overly dazzled by the overall UK number.

Regional unemployment

The second is the graph of those not looking or not available for work in the 16-64 age group since the 1970s. As you can see, it has recently shown a very different pattern to that of the unemployment graph. In the past (and borne out by the data from 1973 to around 1993) the number not available to work has tended to mirror the unemployment rate as people who could manage without work withdrew from the job market when times got tough and came back in when things picked up. However in the early 90s something new started to happen: people withdrawing from the job market even when unemployment was falling. There has been a steady increase in their number until it finally started to fall only last year. So what is happening?

Not in labour force

One of the factors has been a big increase in the number of people registered as self employed, rising from 4.2 million in 1999 to 5.1 million in 2011. However, many of these people are earning very little and I suspect that at least some of them would have been categorised as unemployed in previous decades. There must therefore be some doubt about whether 7% unemployed means what it used to mean.

The Bank of England have shown with their difficulties over forward guidance that it is very hard to look forward with any degree of precision. It should be applauded for admitting that it doesn’t know enough at the moment to start pushing up interest rates.

When the levy breaks

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

For those people who are not pensions geeks, let me start by explaining what the Pension Protection Fund (PPF) is. Brought in by the Pensions Act 2004 in response to several examples of people getting to retirement and finding little or no funds left in their defined benefit (DB) pension schemes to pay them benefits, it is a quasi autonomous non-governmental (allegedly) organisation (QUANGO) charged with accepting pension schemes who have lost their sponsors and don’t have enough money to buy at least PPF level benefits from an insurance company. It is, as the PPF themselves appear to have acknowledged with several references to the schemes not yet in their clutches as the “insured” in a talk I attended last week, a statutory insurance scheme for defined benefit occupational pension schemes, paid for by statutory levies on those insured. As a scheme actuary I have always been very glad that it exists.

The number of insured schemes has dwindled since it was named the 7800 index in 2007 (with not quite 7,800 members at the time) to the 6,300 left standing today. As you can imagine, the ever smaller number of schemes whose levies are keeping the PPF ship afloat are very nervous about how that cost is going to vary in the future. They have seen how volatile the funding of their own schemes is, and seemingly always in the worst case direction, and worry that, when their numbers get small enough, funding the variations in PPF deficits could become overwhelming. Particularly as the current Government says whenever it is asked (although no one completely believes it) they will never ever bail out the PPF.

So there has been keen interest in the PPF explanations of how those levies are going to change next year.

PPF levies are in two parts. The scheme-based levy, which is a flat rate levy based on the liability of a scheme, and the normally-much-bigger-as-it-has-to-raise-around-90%-of-the-total-and-some-schemes-don’t-pay-it-if-they-are-well-funded-enough risk-based levy. The risk-based levy depends on how well funded you are, how risky your investment strategy is and the risk your sponsor will become insolvent over the next 12 months.

It is this last one, the insolvency risk, which is about to change. Dun and Bradstreet have lost the contract to work out these insolvency probabilities after eight years in favour of Experian. However, unfortunately and for reasons not divulged, the PPF has struggled to finalise exactly what they want Experian to do.

The choices are fairly fundamental:

  • The model used. This will either be something called commercial Delphi (similar to the approach D&B currently use) or a more PPF-specific version which takes account of how different companies which run DB schemes are from companies which don’t. The PPF-specific version looks like it was originally the front runner but has taken longer to develop than expected.
  • The number of risk levels. Currently there are 10, ie there are 10 different probabilities of insolvency you can have based on the average risk of the bucket you have landed in. One possibility still being considered at this late stage is not grouping schemes at all and basing the probability on what falls out of the as yet to be announced risk model directly. This could result in considerable uncertainty about the eventual levy. Even currently, being in bucket 10 means a levy 22 times bigger than being in bucket 1.

So reason for nervousness amongst the 6,300 perhaps? The delay will mean that it won’t be known by 1 April (an appropriate date perhaps) when data starts to be collected for the first levies under the new system next year. Insolvency risk is supposed to be based on the average insolvency probability over the 12 months to the following March, but the PPF will either have to average over a smaller number of months now or go back and adjust the “failure scores” (as the scale numbers which allocate you to a bucket are endearingly called) to the new system at a later date. Again, the decision has yet to be made.

All of this suggests an organisation where making models is much easier than making decisions. And that is in no one’s interest.

Perhaps surprisingly in the audience I was in, the greatest concern expressed was about the fact that the model the PPF uses to assess the overall risk to their future funding (and therefore used to set the total levy they are trying to collect each year) was different from either the current D&B approach, or either of the two possible future approaches, to setting failure scores, ie the levies they pay are not really based on the risk they pose to the PPF at all.

There are obviously reasons why this should be the case. Many of the risk factors to the PPF’s funding as a whole would be hard to attribute, and therefore charge, to individual sponsors. For instance the PPF’s Long-Term Risk Model runs 1,000 different economic scenarios (leading to 500,000 different scenarios in total) to assess the amount of levy required to ensure at least an 80% chance of the PPF meeting its funding objective of no longer needing levies by 2030. Plus it plays to sponsors’ basic sense of fairness that things like their credit history and items in their accounts (although perhaps not including, as now, the number of directors) should affect where they stand on the insolvency scale, rather than things that would impact more on PPF funding, like the robustness of their scheme deficit recovery plans for instance.

It is rather like the no claims discount system for car insurance. This has been shown to be an inefficient method for reallocating premiums to where the risk lies in the car driving population, and this fact has been a standard exam question staple for actuarial students for many years. However it is widely seen as fair by that car driving population and would therefore be commercial madness for any insurer to abandon.

So there we have it. The new PPF levy system. Late. Not allocating levies in accordance with risk. And coming to a pension scheme near you soon.

£1,000 a year rise? Probably not

07. January 2014 · Write a comment · Categories: Economics, Pensions, Prediction, Regulation

There has been the usual flurry of misleading headlines around the Prime Minister’s pledge to maintain the so-called triple lock in place for the 2015-20 Parliament. The Daily Mail described it as a “bumper £1,000 a year rise”. Section 150A of the Social Security Administration Act 1992, as amended in 2010, already requires the Secretary of State to uprate the amount of the Basic State Pension (and the Standard Minimum Guarantee in Pension Credit) at least in line with the increase in the general level of earnings every year, so the “bumper” rise would only be as a result of earnings growth continuing to grind along at its current negative real rate.

However, the Office for Budget Responsibility (OBR) is currently predicting the various elements of the triple lock to develop up until 2018 as follows:

Triple lock

The OBR have of course not got a great track record on predicting such things, but all the same I was curious about where the Daily Mail’s number could have come from.

The Pensions Policy Institute’s (PPI’s) report on the impact of abandoning the triple lock in favour of just a link to earnings growth estimates the difference in pension in today’s money could be £20 per week, which might be the source of the Daily Mail figure, but not until 2065! I think if we maintain a consistent State Pensions policy for over 50 years into the future a rise of £20 per week in its level will be the least remarkable thing about it.

The PPI’s assumption is that the triple lock, as opposed to what is statutorily required, would make a difference to the State Pension increase of 0.26% a year on average. It is a measure of how small our politics has become that this should be headline news for several days.

Pugwash Economics

27. December 2013 · Write a comment · Categories: Cartoons, Economics, Regulation

Pirates colourImagine a ship tossed around in a rough sea. The waves throw the vessel in all directions, before the sea level plummets sharply. Whirlpools have formed to the south of them and there are fears these will spread north and swallow the ship. The only means of escape is a rope ladder dangled above the ship, from an airship desperately being inflated above their heads. However the only place on the ship where this can be reached is the ship’s bridge, which is reserved for the ship’s officers.

Strangely the crew do not attempt to storm the bridge but seem resigned to their fate. Instead the captain orders the airship to dump several tons of ballast into the ship, pulling it even further down into the water. To all pleas for mercy from the crew his reply is the same: row harder. The captain has had the sail removed and passed up to the airship crew, on the understanding that the material will be made into a tow rope that will pull the ship to safety. But that seems like a long time ago. The crew have been left with no choice but to row, their daily rations gradually dwindling.

Question: if the sea level rises again, as of course it will eventually, so that the rope ladder moves into reach for everyone on the ship not too weak to take advantage of it, despite everything the ship’s officers have done to make the crew’s lives more hopeless, should we congratulate the ship’s captain on his stewardship? I and many others think not.

Meanwhile the head of a pin is drawing perilously close to the fabric of the airship as the crew pile heedlessly up the rope ladder…..

State Pension Age and its discontents

10. December 2013 · Write a comment · Categories: Demographics, Economics, Pensions, Prediction, Regulation

When I started writing this blog in April, one of its main purposes was to highlight how poor we are at forecasting things, and suggest that our decision-making would improve if we acknowledged this fact. The best example I could find at the time to illustrate this point were the Office of Budget Responsibility (OBR) Gross Domestic Product (GDP) growth forecasts over the previous 3 years.

Eight months on it therefore feels like we have come full circle with the publication of the December 2013 OBR forecasts in conjunction with the Chancellor’s Autumn Statement. Little appears to have changed in the interim, the coloured lines on the chart below of their various forecasts now joined by the latest one all display similar shapes steadily moving to the right, advising extreme caution in framing any decision based on what the current crop of forecasts suggest.

OBR update

However, the worse the forecasts are revealed to be, the keener it seems politicians of all the three main parties are to base policy upon them. The Autumn Statement ran to 7,000 words, of which 18 were references to the OBR, with details of their forecasts taking up at least a quarter of the speech. In every area of economic policy, from economic growth to employment to government debt, it seemed that the starting point was what the OBR predicted on the subject. The Shadow Chancellor appears equally convinced that the OBR lends credibility to forecasting, pleading for Labour’s own tax and spending plans to be assessed by them in the run up to the next election.

I am a little mystified by all of this. The updated graph of the OBR’s performance since 2010 does not look any better than it did in April, the lines always go up in the future and so far they have always been wrong. If they turn out to be right (or, more likely, a bit less wrong) this time, then that does not seem to me to tell us anything much about their predictive skill. It takes great skill, as Les Dawson showed, to unerringly hit the wrong notes every time. It just takes average luck to hit them occasionally.

For another bit of crystal ball gazing in his Statement, the Chancellor abandoned the OBR to talk about state pension ages. These were going to go up to 68 by 2046. Now they are going to go up to 68 by the mid 2030s and then to 69 by the late 2040s. There will still be people alive now who were born when the state retirement age (for the “Old Age Pension” as it was then called) was 70. It looks like we are heading back in that direction again.

The State Pension Age (SPA) was introduced in 1908 as 70 years for men and women, when life expectancy at birth was below 55 for both. In 1925 it was reduced to 65, at which time life expectancy at birth had increased to 60.4 for women and 56.5 for men. In 1940, a SPA below life expectancy at birth was introduced for the first time, with women allowed to retire from age 60 despite a life expectancy of 63.5. Men, with a life expectancy of 58.2 years were still expected to continue working until they were 65. Male life expectancy at birth did not exceed SPA until 1948 (source: Human Mortality Database).

In 1995 the transition arrangements to put the SPA for women back up to 65 began, at which stage male life expectancy was 73.9 and female 79.2 years. In 2007 we all started the transition to a new SPA of 68. In 2011 this was speeded up and last week the destination was extended to 69.

SPAs

Where might it go next? If the OBR had a SPA modeller anything like their GDP modeller it would probably say up, in about another 2 years (just look again at the forecasts in the first graph to see what I mean). Ministers have hit the airwaves to say that the increasing SPA is a good news story, reflecting our increasingly long lives. And the life expectancies bear this out, with the 2011 figures showing life expectancy at birth for males at 78.8 and for females at 82.7, with all pension schemes and insurers building in further big increases to those life expectancies into their assumptions over the decades ahead.

And yet. The ONS statistical bulletin in September on healthy life expectancy at birth tells a different story which is not good news at all. Healthy life expectancies for men and women (ie the maximum age at which respondents would be expected to regard themselves as in good or very good health) at birth are only 63.2 and 64.2 years respectively. If people are going to have to drag themselves to work for 5 or 6 years on average in poor health before reaching SPA under current plans, how much further do we really expect SPA to increase?

Some have questioned the one size fits all nature of SPA, suggesting regional differences be introduced. If that ever happened, would we expect to see the mobile better off becoming SPA tourists, pushing up house prices in currently unfashionable corners of the country just as they have with their second homes in Devon and Cornwall? Perhaps. I certainly find it hard to imagine any state pension system which could keep up with the constantly mutating socioeconomics of the UK’s regions.

Perhaps a better approach would be a SPA calculated by HMRC with your tax code. Or some form of ill health early retirement option might be introduced to the state pension. What seems likely to me is that the pressures on the Government to mitigate the impact of a steadily increasing SPA will become one of the key intergenerational battlegrounds in the years ahead. In the meantime, those lines on the chart are going to get harder and harder for some.

Time to define your ambition

03. December 2013 · Write a comment · Categories: Actuarial, Defined Ambition, Demographics, Legal, Pensions, Regulation, Risk

The consultation on the future shape of workplace pensions has been going on for nearly a month now and ends two weeks on Friday. It is littered with errors, from completely repeated questions (Q52 = Q54) to ones which are so similar as makes no difference (Qs 41 and 44 for example) and the thrust of a lot of the questions are quite hard to answer if you do not share some of the underlying assumptions of the DWP about the process, but come on! This is our chance to put a bit of definition into the rather blurry outline of a straw man which some of the newspapers have been tilting at so vigorously!

You don’t have to answer all of the questions, but just to goad you a bit I have done so here. Agree, disagree, I would love to hear from you. But not until you have responded to one of the following addresses:

How to respond to this consultation

Pleasesendyourconsultationresponses,preferablybye-mail,to:definedambition.pensionsconsultation@dwp.gsi.gov.uk

Or by post to:

Defined Ambition Team

Private Pensions Policy and Analysis

1st Floor, Caxton House

6-12 Tothill Street

London

SW1H 9NA

 

Feedback on the consultation process

There have only been 24 posts on the blog. I think the main reason for this was identified early in the process from a contributor referring to herself only as Hannah:

Hannah

I applaud the use of an open blog but it’s obvious that there’s a bit of a problem here! Perhaps, to avoid this becoming sidetracked, you could introduce a drop-down in the comment section so that people could select what aspect of DA reform or the consultation their comment relates to – and if their comment relates instead to concerns about their accrued benefits, you could redirect them to a separate specialised member queries page?

Reply

Sam Gilbert

Thanks for this Hannah, we will look into this once the blog picks up pace.

DA Team, DWP

Of course the blog never did pick up pace because people soon realised that there comments would be lost in a stream of pension benefit queries. Not the way to encourage a consultation. If you want to comment on this or anything else about the process of the consultation, the contact details are as follows:

Elias Koufou

DWP Consultation Coordinator

2nd Floor

Caxton House

Tothill Street

London

SW1H 9NA

Phone: 020 7449 7439

Email:elias.koufou@dwp.gsi.gov.uk

Dollars and Census

22. November 2013 · Write a comment · Categories: Actuarial, Demographics, Economics, Regulation

November 2013 003The latest revelations from Edward Snowden that the US and UK agreed in 2007 to relax the rules governing the mobile phone and fax numbers, emails and IP addresses that the US National Security Agency (NSA) could hold onto (and extending the net to people not the original targets of their surveillance) has increased the pressure on the Government to tighten controls on the activities of the security services. This extension apparently allowed the NSA to venture up to three “hops” away from a person of interest, eg a friend of a friend of a friend on Facebook.

I have an issue with the Guardian analysis here. They say that three hops from a typical Facebook user would rope in 5 million people. However, using actual ratios from the network in their source (43 friends have 3,975 friends of friends have 1,328,361 friends of friends of friends) and the median number of friends of 99 from the original study, would lead to a number closer to 3 million. Still, it is clearly altogether too many people to be treated as guilty by association.

So it might seem like a strange time for me to be advocating that we give the Government more of our data.

The Office for National Statistics (ONS) is currently consulting on the form of the next census and the future of population statistics generally. The two options they have come down to are:

1. Keep the 2021 census pretty much as it was for 2011, although with perhaps slight changes to the questions and a greater push for people to complete them online; or
2. Using administrative data already held by the Government in its various departments to produce an annual estimate of the population in local areas. In addition there would be separate compulsory surveys of 1% and 4% of the population for checking the overall population figures and some of the sub-grouping respectively, and the ‘residents of “communal establishments” such as university halls of residence and military bases’ which are difficult to reach by other means.

In my response to the survey, I suggested that they do both, increase the compulsory surveys each year to 10% of the population and reduce the time between full censuses to 5 years. This is why.

First of all, everybody needs this data to be available. If the Government does not provide it, someone else will. Not by asking you overt questions, but by buying information about your buying preferences or search engine activities or any number of other transactions without your informed consent (eg you ticked agreement to their terms and conditions on their website) and without your knowledge. I would prefer to give my data to the ONS.

The ONS is part of the UK Statistics Authority, which is an independent body at arm’s length from government. It reports directly to Parliament rather than to Government Ministers and has a strong track record of challenging the Government’s misuse of statistics. With the exception of requests received for personal information (which are filtered off to become Subject Access Requests under the Data Protection Act), they have provided copies of all information disclosed by the ONS under the Freedom of Information Act on their website. In my view the ONS has demonstrated that it is a safe custodian of our data. They are everything the NSA is not: overt, apolitical and committed to the appropriate use of statistics.

But there are problems with the current data, which brings me onto my second point. Ten years is too long to wait for updated information. As the ONS points out in its consultation document, because of the ten year gap between censuses, the population growth resulting from expansion of the European Union in 2004 was not fully understood until 2012. There were other problems with the population data everyone had been working with before 2011, 30,000 fewer people in their 90s than expected for instance, which had serious implications for all involved in services to the elderly and those constructing mortality tables too.

So we do need more frequent census information. Five years seems about right to me, provided the annual updates can be made more rigorous. I think the ONS are right to suggest that they need to be compulsory to achieve this, but 5% of the population does not seem a large enough sample to be confident about this to me. I would prefer to see 10% completing annual surveys. This would allow 50% of the population to be covered over every 5 year census period, or 40% if the requirement was dropped in census year. There are many recent examples (see Schonberger and Cukier below) to suggest that the gains in accuracy due to increased coverage would be far greater than the losses due to the ‘messiness’ of incomplete responses.

There is a lot in the consultation document about the relative costs of the different options, but nothing about the commercial value of the data being collected. Indeed the reduction of the consultation to these two, to my mind, inadequate options seems to be very greatly influenced by the question of costs and the current cuts in budgets seen throughout the public sector. This seems to me to be very short-sighted.

However, I think this displays a failure of imagination. According to Viktor Mayer-Schonberger and Kenneth Cukier in their book Big Data, data is set to be the greatest source of wealth and economic growth looking forward. Many others agree. By taking a fully accountable and carefully controlled approach to licensing the data in its care, the ONS should be able to finance its own activities, even at the level I am suggesting, at the very least.

The ONS is very nervous about becoming more intrusive in its collection methods, citing the 35% increase in cost of the 2011 census in achieving the same level of response. It also refers to the response rates to its voluntary surveys which have dropped from around 80% 30 years ago to around 60% today. The main reasons for this in my view are the incessant requests from companies’ marketing departments masquerading as surveys on everything from phone usage to our views on banking to the relentless demands for feedback on every online purchase making us all subject to survey fatigue. This makes it all the more necessary that an organisation which is not trying to sell you anything and which is scrupulous about the protection of your data should be attempting to increase its scope and maintaining its position as the go to place for statistical data rather than falling behind its commercial rivals.

So let’s not fall into the trap of conflating all official data with the mountains of bitty fragments collected by our intelligence agencies from their shady sources. That has nothing to do with the proper, accountable collection of information to allow government and governed alike access to what they need to make better decisions.

So take part in the consultation, it matters. And when the time comes give the ONS your data. You know it makes census.

Why TTIPing may be bad for us

13. November 2013 · Write a comment · Categories: Cartoons, EIOPA, Pensions, Regulation

Germany has surprised the European Commission (EC) by suddenly insisting that stiffer data protection controls are incorporated into the negotiations for the Transatlantic Trade and Investment Partnership (TTIP), which began earlier this year, and for which the second round has started this week. For those of you who have not heard of it before (understandable, as the negotiations so far have had a deliberately low profile), the purpose of the TTIP is to create a single transatlantic market, in which all regulatory differences between the United States US and the EU are gradually removed. The EC calls it “the biggest trade deal in the world”.

As the EC goes on to say:

On top of cutting tariffs across all sectors, the EU and the US want to tackle barriers behind the customs border – such as differences in technical regulations, standards and approval procedures. The TTIP negotiations will also look at opening both markets for services, investment, and public procurement. They could also shape global rules on trade.

Concerns have started to emerge about the massive transfer of power from governments to corporations that the final deal might allow. However Germany’s intervention on data protection is just the latest of a list of reasons that have been advanced for why the TTIP talks are unlikely to go anywhere. From the legislative schlerosis of the US, to protectionist instincts on both sides recently strengthened by austerity, to French paternalism towards their film industry, to European fears about an influx of GM foods, the TTIPing point will never be reached, they say. So nothing to worry about then.

Or is there? A document published last year by the US Chamber of Commerce and BusinessEurope explains how it would be able to overturn existing legislation which got in its way. And if the long tortuous progress of Solvency 2’s implementation date, the bureaucratic equivalent of the man with the end is nigh sandwich board on his back, endisnighhas taught us anything, it is that unimplemented regulatory frameworks can still have massive impacts. Just this month it was revealed that the best funded pension schemes in the FTSE 100 are insurers, precisely because of the impact of those schemes on insurers’ solvency capital requirements under Pillar 1 of Solvency 2. And the clear rebuff to EIOPA from exporting these requirements to occupational pension schemes has not prevented the work to develop a framework for imposing them from continuing.

So what would TTIP mean for defined benefit (DB) pension schemes? Well, at first sight, not very much. US DB schemes tend to have funding targets equivalent to FRS17 levels, which would be seen as at the weak end of UK funding targets. However, as we have seen with the process of market harmonisation in the EU, horse trading may lead to the US being stuck with stiffer requirements imported from the EU on pensions in order to maintain subsidies for US farmers, say.

And there are two features of the US DB landscape which would be an issue for many UK DB schemes.

The first is the recovery plan length, which typically does not exceed 7 years in the US. Possibly not too onerous in many cases, if coupled with a FRS17-type funding target, but the EIOPA caravan has surely travelled too far for any dilution of funding target to be allowed at this stage. A 7 year recovery plan would however represent a considerable increase in contribution requirements for many schemes within the UK’s current funding environment.

The second is the restrictions placed on US pension schemes which fall below prescribed funding levels. If the funding level falls below 80%, no scheme amendments are allowed which would increase benefits until the funding level has first been restored to 80% or above, and certain types of benefit payments are restricted. These restrictions become much more stringent below 60% funding, when benefit accrual must cease and the range of benefits which cannot be paid out is extended to cover “unpredictable” contingent events.

We may not be out of the woods of Solvency 2 yet as far as DB pension schemes are concerned. But even if we do manage to break out of EIOPA’s grip, it may be only to find ourselves surrounded by a larger forest.

Illustration by Emma J Hardy

Illustration by Emma J Hardy

Papers and Pensions

08. November 2013 · Write a comment · Categories: Actuarial, Defined Ambition, Pensions, Regulation, Risk

mobile pics Nov 2013 010Now that the Great and Good of the actuarial profession and pensions industry have launched their joint consultation with the DWP on defined ambition (DA) options, it is interesting to look at the initial response in the print media.

The first thing to note is how little of it there is. The Daily Mail, Daily Express and Daily Telegraph have it on the front page. The Financial Times, Guardian and Times do not. Nor do the red tops. All three headlines sit alongside photographs of the Duchess of Cambridge.

And the response varies. The Express have written what looks like a positive piece (“Bigger Better Pensions For All”) until you discover it has decided to present the launch of the consultation as an “industry shake-up” which will “spell the end of annuities”. I was a little puzzled about this at first, as the consultation is not really about annuities at all, until I realised that Steve Webb had made a speech the previous day and mentioned the FCA review of annuities. This clearly fed into the default Express editorial line better than the actual topic of the consultation. This became clearer on page 4, with the headline “’Poor value’ annuity payouts are axed in pensions shake-up” next to a big picture of a smiling Ros Altmann. There appears to be only one story possible in the Express on pensions, whatever the actual news event.

The Mail does at least focus on things that are in the consultation, concentrating on the proposals to allow final salary pensions to drop some currently guaranteed elements of benefits such as indexation and spouses’ pensions. “The Death Knell for Widows’ Pensions” is their headline, but the article beneath is fairly balanced on flexible defined benefit (DB), quoting both those highlighting the reductions to benefits the proposal would allow on the one hand, and the danger that all the remaining horses would bolt from the DB stable if changes were not made on the other.

Finally, the Telegraph. “Pensions face new blow from ministers” is their headline. The article is similarly balanced, and is the only one to make the important point that benefits already accrued would be unaffected.

The coverage of the alternatives put up for consultation is patchy. Strangely the Express does best here, despite its desperation to make it a story about the death of the annuity, it does mention in passing collective defined contribution (DC) and guaranteed DC. Otherwise the focus is exclusively on flexible DB in both the Mail and Telegraph, and what members currently accruing non-flexible DB might lose as a result. The comparison with public sector pensions is made several times, with the Telegraph pointing out that the recent settlement on public sector pensions, which would not be removing the requirement to provide indexation and spouses’ pensions, was promised by ministers to be the last for 25 years.

So what kind of start does this represent for engaging the UK public in the debate on the future on pension provision? Mixed, I think. There will clearly be much more scrutiny on any legislative easing to current benefit guarantees than there will be to any addition of guarantees on pensions which currently have none. Perhaps this is to be expected. I do worry that cash balance may get squashed out as an option between the two camps of flexible DB and guaranteed DC – it is barely mentioned in the consultation, and can work well when coupled with a strong commitment to employee education like Morrisons have attempted.

But these are early days and the first thing everybody needs to do is respond to the consultation. Most pensions actuaries and many others will have strong views on many elements of it. So don’t leave it to your firm to do it on your behalf. The deadline is 19 December.

RM = QE?

21. October 2013 · Write a comment · Categories: Economics, Regulation

A couple of days ago I received my statement from Royal Mail plc, confirming my allocation of 227 shares at the offer price of £3.30 each, therefore costing me £749.10. At the time of writing the share price is at £5.14 (although it was at £5.31 a few hours ago), equivalent to a value for my 227 shares of £1,166.78.

So I am sitting on a paper profit of over £400, and the Government is under fire for undervaluing Royal Mail, from everyone from the trades’ unions, to the Labour Party, to the Commons Business Select Committee to even some stockbrokers and to 51% of the general public. In response, Vince Cable, the Business Secretary, has suggested that everyone calms down a bit and waits to see what the price is in a couple of months.

But what if the issue was not mis-priced at all? What if the short-term profits were intended all along?
Remember that this is a Government still in the business of quantitative easing (QE). A process described by the Bank of England thus:

…the asset purchase programme is not about giving money to banks. Rather, the policy is designed to circumvent the banking system. The Bank of England electronically creates new money and uses it to purchase gilts from private investors such as pension funds and insurance companies. These investors typically do not want to hold on to this money, because it yields a low return. So they tend to use it to purchase other assets, such as corporate bonds and shares. That lowers longer-term borrowing costs and encourages the issuance of new equities and bonds to stimulate spending and keep inflation on track to meet the government’s target.

However, the critics of QE have become increasingly loud. It is untested, no one is quite sure what the long term consequences will be of the amounts that have been invested in this way and many of the short term benefits appear to have been benefitting the wrong people once the initial emergency receded. Perhaps partly as a result of these criticisms, there has been no new QE since July 2012.

Alternatives have increasingly been tossed around between economists and other commentators. One of which is the notion of helicopter money. Drop it from the skies, cut out the banks, and the effects will be more immediate, its supporters say.

If the target of QE is investors, and the aim of the policy is to make them invest in corporate bonds and shares rather than gilts, in order to encourage companies to raise more money in the markets to fund expansion, could the paper profit of £1.7 billion (compared to the £375 billion of QE so far) be a micro-experiment in a different type of QE?

There is other evidence to support this. At the end of 2011, Spencer Dale, the Bank’s chief economist, gave a speech about flaws in the QE approach:

I have considerable sympathy for the argument that the MPC’s asset purchase programme provides relatively limited direct support to SMEs (ie small and medium sized businesses). It will provide indirect support by stimulating spending and activity in our economy. But most SMEs are heavily dependent on bank credit and so not able to benefit directly from the increased demand for corporate debt and equity triggered by our asset purchases. But therein lies the problem. The majority of SMEs do not issue marketable securities that the MPC could purchase…..Instead, we need to find ways to incentivise the banks to lend more to SMEs.

So would a few hundred pounds each help SMEs? Well, some of the owners will have applied for shares and benefitted directly, as they are likely to be in the more financially aware section of the public. This may also explain the decision to set a minimum stake of £750 in the Royal Mail offer. Others may benefit from any increase in consumer spending that results from people spending their winnings. The longer term stimulus effect the Bank is trying to produce will depend more on the actions of the institutional investors who bought 70% of the offering.

One of the other criticisms of QE is the impact on interest rates, although the size of the impact is difficult to determine and those who complain about the implications on annuity rates, for instance, tend to ignore the stoking up of asset prices it is also likely to have achieved. However Charlie Bean, one of the Bank’s deputy governors, gave some support to this criticism in May 2012:

A long period of abnormal monetary policy strains social support for a central bank’s actions. Changes in policy always have distributional consequences, shifting income from savers to borrowers or vice versa. That is an unavoidable by-product, rather than the aim, of policy. Society usually accepts such consequences because they are transitory, and what one loses on the swings today, one may gain on the roundabouts tomorrow. But the sustained period of very low interest rates has, quite reasonably, prompted complaints from savers who feel they are bearing an unfair burden.

So any vehicle for putting money in people’s hands without affecting interest rates would, we assume, at least get a fair hearing at the Bank.

When QE appears to have run out of steam, and the “Help to Buy” home ownership schemes are causing increasing unease about the property bubble they seem almost certain to create, should we expect to see further privatisations on the Royal Mail model if the recovery stalls? It wouldn’t surprise me in the least.

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