Actuarial – Page 4 – We Know Zero

If providing risk information is ineffective in changing behaviour, why do we do so much of it?

22. July 2017 · Write a comment · Categories: Actuarial, Regulation, Risk

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from https://simple.wikipedia.org/w/index.php?title=Oceanic_whitetip_shark&oldid=4875771.

Changing people’s behaviour is hard. Even if we have agreed that it needs to change, actually acting on this new knowledge is hard enough, but getting that agreement in the first place by shifting our beliefs is even harder.

It gets worse. The research suggests that providing risk information is ineffective in changing behaviour. You might need to read that again before it sinks in: risk information is ineffective in changing behaviour.

Professor Theresa Marteau, Director of the Behaviour and Health Research Unit at the University of Cambridge, and her team have been looking at the four behaviours responsible for the majority of premature deaths worldwide: smoking, eating too much, drinking too much (alcohol) and moving too little. The original focus of their work concerned how people responded to genetic test results indicating a greater predisposition to diabetes, cancer and other diseases. What they found is that the genetic test may get someone past the first barrier, ie agreeing that they need to change their behaviour, but not the second part, ie actually doing it.

As Marteau says: Few of us would swim in waters signed as shark-infested. On the other hand, when the risk of future disease is up against the pleasures of current consumption, it doesn’t tend to compete very well. Marteau summarises their findings as follows:

Put simply, we overestimate how much our behaviour is under intentional control and underestimate how much is cued by environment.

In my view, this research is directly applicable to the financial services industry and explains a lot of behaviours which have up until now often been considered as separate rather than related problems, eg:

The failure of consumers to shop around adequately in the annuities and investment markets (we know we should but get easily discouraged by the difficulty of the process);
The stampede to take transfer values out of defined benefit pension schemes (the possibility of immediate consumption trumping deferred gains); and
The surge in the tax take at HMRC caused by people removing all of their cash from defined contribution pension schemes (same again).

Turning to my own profession for a moment, and looking on the Become an actuary part of the Institute and Faculty of Actuaries website, we find: Actuaries use their skills to help measure the probability and risk of future events. A little further on we find: It is essential that actuaries have excellent communication skills to enable them to communicate actuarial ideas to non-specialists in a way that meets the needs of the audience.

So, in a nutshell, producing risk information and then communicating it.

As a pensions actuary, I spent most of my time overseeing calculations which underpinned reports to clients which I would then summarise in presentations in order to get them to move a little bit further towards fully funding their pension schemes than where they were starting from. And then we had to condense the whole of that process into a single meeting where we tried to persuade the people who were actually doing the funding as part of the negotiation of the final deal. While, unconsciously, I am sure that just my presence was having some kind of placebo or nocebo effect, all of my conscious effort was directed on providing risk information and communicating it.

And actuaries are not alone in focusing on the provision of risk information as the most important element in guiding consumer behaviour. From the Financial Conduct Authority’s Retail Distribution Review, to the Pensions Advisory Service and Pension Wise, we are obsessed with it.

However if we are going to really change behaviour in response to the many risks these consumers face, we need to be spending much less time on producing risk information (which coincidentally may be done for us in the future by increasing capable machines anyway)and much more time focusing on the design of the financial environment we all operate within.

But if changing the environment is so much more effective for changing behaviour, perhaps what we need is a framework of standardised definitions to characterise any interventions we make. Fortunately the social scientists are way ahead of us on this and have produced just such a framework. TIPPME (typology of interventions in proximal physical micro-environments) has been developed and demonstrated by applying it to the selection, purchase and consumption of food, alcohol and tobacco. As the authors state: This provides a framework to reliably classify and describe, and enable more systematic design, reporting and analysis of, an important class of interventions. This then allows evidence to be collected into what works and what doesn’t in changing behaviour across populations.

Our physical health and what interventions cause us to look after it better are thought sufficiently important for a coordinated approach to designing the risk environment, rather than the piecemeal legislation and partial solutions offered by commercial providers we have had to date, to be worthwhile. I would suggest that our financial health needs to be given similar consideration. This looks like a promising way forward that could result in truly evidence-based financial regulation, with the prospect of lasting change to the way we help consumers navigate a path through the financial seas. Far away from the sharks.

The future for actuaries

20. May 2017 · Write a comment · Categories: Actuarial, Prediction, Regulation

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This work is licensed under a Creative Commons Attribution-NonCommercial 2.5 License.

Daniel and Richard Susskind in their book “The Future of the Professions” set out two possible futures for the professions. Either:
• They carry on much as they have since the mid 19th century, but with the use of technology to streamline and optimise the way they work
• Increasingly capable machines will displace the work of current professionals

Their research suggests that, while these two futures will exist in parallel for some time, in the long run the second future will dominate. The actuarial profession is particularly vulnerable. As the Susskinds write:

Accountants and consultants, for example, are particularly effective at encroaching on the business of lawyers and actuaries.

Actuaries both here and in other countries are waking up to what is coming, but the response of the profession is a whole has been quite slow.

For the actuarial profession, we will see the extension of some trends which have already begun, eg:

Automation of processes not just leading to greater efficiencies but reconfiguring both what work is done and how it is done, eg propensity pricing and pensions valuations
Para professionalization, like CAA Global for instance
Globalisation
Specialisation
Mergers of businesses as markets consolidate
Flexible self employment

And the emergence of trends that have hardly started at all yet, eg:

The end of reserved roles for actuaries
Different ways of communicating advice (Richard Susskind got into trouble with the Law Society in the mid 1990s for suggesting that most legal communication between lawyers and their clients would be delivered via email in the future, which would strike us as an obvious observation now)
Online self-help for users of actuarial advice (ask discussed by the Pensions Policy Institute in their report last year)
The advance of roboactuaries and their assistants

Focusing on the last of these, a paper produced by Dodzi Attimu and Bryon Robidoux for the Society of Actuaries in July 2016 explored the theme of robo actuaries, by which they meant software that can perform the role of an actuary. They went on to elaborate as follows:

Though many actuaries would agree certain tasks can and should be automated, we are talking about more than that here. We mean a software system that can more or less autonomously perform the following activities: develop products, set assumptions, build models based on product and general risk specifications, develop and recommend investment and hedging strategies, generate memos to senior management, etc.

They then went on to define a robo actuarial analyst as:

A system that has limited cognitive abilities but can undertake specialized activities, e.g. perform the heavy lifting in model building (once the specification/configuration is created), perform portfolio optimization, generate reports including narratives (e.g. memos) based on data analysis, etc. When it comes to introducing AI to the actuarial profession, we believe the robo actuarial analyst would constitute the first wave and the robo actuary the second wave

They estimate that the first wave is 5 to 10 years away and the second 15 to 20 years away. We have been warned.

One of the implications of this would be far fewer actuarial students required and, in my view, a much smaller appetite amongst actuarial firms for employing students while they were sitting actuarial examinations, particularly the core rather than specialist ones. This in turn would suggest an expansion of the role of universities in supporting students through these stages of their actuarial education, massively increasing the IT and data analysis skills of the next generation of actuarial students and developing far more opportunities for students to develop skills more traditionally seen as “work-based”, such as presentation, project management and negotiation skills. Some universities, such as my own at the University of Leicester, are using the preparatory work in anticipation of the Institute and Faculty of Actuaries’ launch of Curriculum 2019 to do all of these things.

But universities and the education professionals in general face their own challenges from the rise of technology and increasingly capable machines:

The development of learning labs offering personalised learning systems
Online education networks, like Moodle, once used just to support traditional university teaching activities, but now starting to actively supplant them
Other online education platforms, like the Khan Academy
The rise of Massive Open Online Courses or MOOCs. For instance, more people have signed up to Harvard University’s MOOCs in one year than have enrolled at the University in its 377 year history

The actuarial profession and the higher education sector therefore need each other. We need to develop actuaries of the future coming into your firms to have:

great team working skills
highly developed presentation skills, both in writing and in speech
strong IT skills
clarity about why they are there and the desire to use their skills to solve problems

All within a system which is possible to regulate in a meaningful way. Developing such people for the actuarial profession will need to be a priority in the next few years.

Of course it is still possible to laugh at what Artificial Intelligence and Machine Learning (here and here) have not managed to do yet, despite their vast ambitions. But it should not blind us to the fact that those ambitions will be realised in our working lifetimes in many cases. And we need to start preparing now.

Actuaries and Climate Change

30. April 2017 · Write a comment · Categories: Actuarial, Climate Change, Demographics, Legal, Pensions, Prediction, Risk

The Institute and Faculty of Actuaries (IFoA), through its Actuarial Research Centre, is inviting research teams and organisations to submit proposals for a research project on modelling pension funds under climate change. The research is intended to address the need for pensions actuaries to understand the potential magnitude of climate change impacts, and hence if and when climate change might be relevant to the funding advice they give. What areas in particular might be useful to look at through the lens of a pension actuary?

The current concentration of carbon dioxide in the Earth’s atmosphere is around 400 parts per million by volume (ppmv), or a little over 140% of the generally accepted pre-industrial level of 280 ppmv. What level we can cap this at depends on how we respond in every country in the world. There are therefore many opinions about it:

Source: IPCC AR5: Fig 2.08-01

Here RCPs stand for Representative Concentration Pathways, and are meant to be consistent with a wide range of possible changes in future anthropogenic (i.e. human) greenhouse gas emissions. RCP 2.6 assumes that emissions peak between 2010-2020, with emissions declining substantially thereafter. Emissions in RCP 4.5 peak around 2040, then decline. In RCP 6.0, emissions peak around 2080, then decline. In RCP 8.5, emissions continue to rise throughout the 21st century. What this means is that the best we can hope for now is a scenario somewhere between RCP 2.6 and RCP 4.5, with the US Government’s Environmental Protection Agency appearing to believe that RCP 6.0 is the most realistic scenario. As you can see, RCP 4.5 assumes an eventual equilibrium at around 500 ppm, or about 180% of pre-industrial levels and RCP 6.0 an equilibrium at around 700 ppmv, or about 250% ppmv.

Equilibrium climate sensitivity is defined as the change in global mean near-surface air temperature that would result from a doubling of carbon dioxide concentration. A doubling of the pre-industrial level to 560 ppmv (ie between the RCP 4.5 and RCP 6.0 assumption) has been projected to result in a range of possible outcomes:

Source: IPCC 2007 4th Assessment Report, Working Group 1 (Figure 9-20-1)

This is certainly a bit of a we know zero kind of graph, but has worryingly fat tails indicating reasonable chances of 10 degrees plus added to average global temperatures. To put this in context, let’s use the approach taken in Mark Lynas’ excellent “Six Degrees“, where the combined research into the effects of each additional degree above pre-industrial global temperatures is collated to allow us to view them as distinct possible futures. Some examples are as follows:

One degree

We are nearly here (around 0.8ᵒ so far):

Return of the “Mid-west American dust bowl” but with greater vengeance
Increase in hurricane activity
Loss of low lying islands, eg Tuvalu

Two degrees

The “safe” level we are trying to limit increases to:

Release of greenhouse gases begin to alter the oceans. May render some parts of southern oceans toxic to Ca CO3 and thus to one of life’s essential building blocks, plankton.
Heatwaves like 2003 which killed 35,000 people in Europe and led to crop losses of $12 billion and forest fires costing $1.5 billion will occur almost every other summer.
Crippling droughts can be anticipated in Los Angeles and California
From Nebraska to Texas the anticipated drought would be many times worse than the 1930s “dust bowl” phenomenon.
Polar bears would probably become rapidly extinct.
Mediterranean countries will become drier and hotter with significant water shortages.
IPCC estimate sea level rise of 18 to 59 cms.
Monsoons would increase in India and Bangladesh leading to mass migration of its populations.
International food price stability will have to be agreed to prevent widespread starvation.

Three degrees

Africa will be split between the north which will see a recovery of rainfall and the south which becomes drier. This drier southern phase will be beyond human adaptation. Wind speeds will double leading to serious erosion of the Kalahari desert.
Indian monsoon rains will fail. ·
The Himalayan glaciers provide the waters of the Indus, Ganges and Brahmaputra, the Mekong, Yangtze and Yellow rivers. In the early stages of global warming these glaciers will release more water but eventually decreasing by up to 90%. Pakistan will suffer most, as will China’s hydro-electric industry.
Amazonian rain forest basin will dry our completely with consequent bio-diversity disasters
Australia will become the world’s driest nation.
New York will be subject to storm surges. At 3° sea levels will rise to up to 1 metre above present levels.
In London, a 1 in 150 year storm will occur every 7 or 8 years by 2080.
Hurricanes will devastate places as far removed as Texas, the Caribbean and Shanghai.
A 3° rise will see more extreme cyclones tracking across the Atlantic and striking the UK, Spain, France and Germany. Holland will become very vulnerable.
By 2070 northern Europe will have 20% more rainfall and at the same time the Mediterranean will be slowly turning to a desert.
More than half Europe’s plant species will be on the “red list”
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. US southern states worst affected, Canada may benefit. The IPCC reckons that a 2.5° temperature rise will see food prices soar.
Population transfers will be bigger than anything ever seen in the history of mankind.

Three degrees obviously needs to be avoided, let alone ten, but the problem is that business as usual for the finance industry may not be the way to get there. As some recent research has suggested, financial market solutions to environmental problems, such as carbon trading, may be ineffective. As the authors state: By highlighting the tenuous and conflicting relation between finance and production that shaped the early history of the photovoltaics industry, the article raises doubts about the prevailing approach to mitigate climate change through carbon pricing. Given the uncertainty of innovation and the ease of speculation, it will do little to spur low-carbon technology development without financial structures supporting patient capital.

Patient capital is something developed economies have been seeking for some time, whether it is for infrastructure investment, development projects or new energy sources, and no good way to create it within the UK private sector has been found yet, including various initiatives to try and get an increase in pension scheme investment in infrastructure projects. It therefore seems to me to be the wrong question to ask what impacts climate change are likely to have on the assumptions used for pension scheme funding, when it is the impact of the speculation which pension scheme funding encourages which is one of the main drivers of our economies towards the worst possible climate change outcomes.

A more productive research question in my view would be to bring in legislators and pensions lawyers as well as environmental scientists and others researching and thinking in this area alongside actuaries to look at how we could change the regulatory framework within which pension scheme funding and investment within other financial institutions where actuaries are central takes place. There is already research into what changes may be necessary to international law to reflect the new Anthropocene era the planet has entered, where the dominant feature is the impact of human activity on the environment. In my view this should be extended to the UK legislative and regulatory landscape too.

Pensions and the Zombie Apocalypse

12. March 2017 · Write a comment · Categories: Actuarial, Demographics, Economics, Pensions

If the models are correct we are heading for a Zombie Apocalypse

Let’s forget the strapline of this blog for a moment and assume that the models are correct. The Pension Protection Fund (PPF) is targeting “self-sufficiency” by 2030, ie no more levies from sponsors of pension schemes required for it to independently fund all the future benefits of every scheme member whether they are already in the PPF or going to end up in it with only the insufficient assets their former employers allocated to their former pension schemes for company. BHS has concluded a very high profile deal in the last couple of weeks to set up a new self-sufficient scheme for its former employees. The Universities Superannuation Scheme (USS) has proposed a funding plan which targets self-sufficiency less a “covenant” (ie amount of money feasible to get out of the university sector in the future) by 2031. John Ralfe mentioned a few other examples in his article from 2015.
These are schemes which have been dubbed “zombie” schemes on the basis that they are basically dead, with no new money or new members coming in, but nevertheless dragging themselves along the floor year after year until all of their members have stopped twitching.
What does the UK pensions world look like in 2030? Well according to various sources:
• UK population will have increased to 70.6 million (assuming Scotland and Northern Ireland are still in it) with 21.4% of them over the age of 65 (S&P)
• Credit rating of UK will have fallen to A, with a further fall to BBB by 2035 assuming no change in economic policy (also S&P)
• Average life expectancies at birth in UK would be over 85 for women and 82.5 for men (Imperial College and WHO)
• Benefit outgo from defined benefit pension schemes is £100 billion more than contribution income pa (Hymans Robertson)

This does not sound like a happy place for our zombies to be negotiating with the occasional limb getting torn off as multiple doors are slammed in their faces. Although the self-sufficiency route is now a common approach amongst large schemes, it is largely untested. No scheme as far as I am aware has actually managed to run in a self-sufficient manner for any appreciable length of time, whereas the more expensive buy out route (where the benefits for members are purchased in the form of contracts with an insurer) is by comparison well established.

So off into this volatile landscape our zombies will be let loose, trying to run themselves like little insurance companies, but without the scale or diversification or experience which makes insurers (mostly) survive for long periods. However that better track record comes at a price which schemes are currently reluctant to pay. There is a good chance that this experiment will not end well.

My guess for 2030? That the volatile landscape will have claimed some casualties amongst the self-sufficient zombies and put them into the PPF with much bigger deficits than if they had gone there straight away. And then all the other zombies will T-U-R-N A-R-O-U-N-D V-E-R-Y S-L-O-W-L-Y and follow them there. At which point the PPF will realise that they are undead no longer.

Actuaries and the New Manhattan Project

01. October 2016 · Write a comment · Categories: Actuarial, Regulation

Public.Resource.Org SI Neg. 2001-1900. Date: na…Oblique aerial view from approximately 12,000 feet, 50 miles from the detonation site, two minutes after the detonation of a hydrogen bomb during an unidentified US atomic weapons test, circa 1950s. At this point in time, the mushroom cloud rose to 40,000 feet…Credit: Unknown USAF photographer. (Smithsonian Institution)

I have just started reading an excellent new book by Cathy O’Neil, Weapons of Math Destruction, where she sets out the case against devolving important decisions to mathematical models without adequate feedback loops. The opening example she gives, of a teacher fired from her job in Washington because a school feeding students into her school was manipulating test scores, makes her general point very well. I am looking forward to the chapter on insurance.

However, the thought that this raised in my mind is how, increasingly, we don’t even need the algorithms and mathematical models to behave in a robotic fashion – we constantly follow rules set by others rather than using our own judgement. Indeed regulators push us more and more in this direction. They are nearly all under-staffed and over-tasked and need shortcuts to manage their workloads. And the most obvious shortcut is to focus on the very big and the very different. The very big are normally very much better staffed than the regulators and difficult to win arguments with. Regulators are therefore left with the very different. So regulators make life for the very different very difficult. And, before long, the very different no longer exist and the systemic risk in your population of banks, schools, hospitals or whatever it is has increased.

What O’Neill rightly focuses on as the main danger of widely used models is their lack of a feedback loop. If nothing tells you when your model is not reflecting the world it is modelling, it will not be long before it is doing a great deal more harm than good. And when a regulators uses a model which does not rely on inputs from the system it is regulating, then the model becomes the world it is regulating, often with bizarre consequences. One of the main reasons that the 2008 crash was so dramatic is that so little was done to prevent it even as warning signs grew. This was because, in the model used to regulate banks, these warning signs didn’t exist. Unfortunately and worryingly for us, the lessons learned, in the main, were not that model-led regulation was bad, but that the models used just needed to be more complicated.

Every call for what is being regulated to be simplified (by breaking them up into smaller units, in the case of banks, or simplifying the regulations themselves, rather than the regulatory arms race of measure and unintended loophole we seem doomed to keep repeating) has been resisted, resulting in a regulatory framework which becomes more bafflingly complex with every passing year. This is a process recognised in Government and there have been occasional attempts to reverse the tide. To date, with little effect.

And the regulators themselves? They are cash-strapped and at the mercy of inconsistent Government policy. So we have CQC inspectors (of NHS Trusts) and Ofsted inspectors (of schools and colleges) making short visits, producing reports based on anything anyone has said to them on these short visits, allowing for no factual corrections, subject to no cross examination, just to get through their caseloads without causing headaches for their political masters, but often resulting in inconsistent scrutiny or, in some cases, in abrupt reversals in conclusions in successive inspections. At the same time, it appears clear that you can evade your financial responsibilities almost completely if you are rich and unscrupulous enough. Our regulatory systems have proved unreliable in too many areas and have in my view lost credibility as a result.

So where do actuaries fit in to all this? They are one of the professions centrally involved in building, updating and interpreting models across a wide range of financial firms. Everything from the amount a firm makes in pension contributions, to the amount held in reserve by an insurer or a bank, to the detailed agreements in a corporate restructure, often involving staggering sums of money. This work cannot be carried out effectively by playing to an unreliable regulator.

Upon accepting the Army-Navy Excellence Award on November 16, 1945, Robert Oppenheimer, who ran the US Government’s Manhattan Project in Los Alamos to develop the world’s first nuclear weapons, proclaimed: “If atomic bombs are to be added as new weapons to the arsenals of a warring world, or to the arsenals of the nations preparing for war, then the time will come when mankind will curse the names of Los Alamos and Hiroshima.” He realised that responsibility for the use to which your work is put can never be wholly given away to someone else.

If mathematical models are to be the dominant regulatory tool of a financial world, and of the consultancies and financial firms competing in that world, then the time will come when mankind will curse the names of the highly paid professionals who followed inappropriate rules rather than exercising their own expert judgement when it mattered.

Democracy by numbers

23. July 2016 · Write a comment · Categories: Actuarial, Pensions

Today I am going to talk about politics and how we tend to approach it.

When I was working as an actuarial consultant we had a client who wanted to write to the local MP about how the Pension Protection Fund levy his company were paying on behalf of their admittedly poorly funded pension scheme was endangering the viability of the business itself. Our view was that it would do no harm and the letter was sent. Nothing came of the complaint, not that we had expected anything would, but the letter was responded to. And so have my letters both times I have written to my MP in a personal capacity, one of them even came back with a Minister’s letter enclosed with it.

One way of looking at this is that it is fantastic. It shows democracy working for individuals and businesses at a local level about the issues they care about. A kind of democracy service. This is certainly how we are encouraged to think of it.

However another way of thinking about it is that this is just bonkers. To understand this, consider some numbers.

There are not nearly enough GPs, according to the latest of many similar reports of a “looming health crisis”. How many full-time equivalent GPs are there per 1,000 patients per practice in England? 0.58, meaning that on average there is 1 GP for every 1,724 patients. GPs frequently complain that the standard 10 minute consultation this necessitates is not enough time to fully explore their health.

Compare this with the position of MPs, another profession which runs “surgeries”. There are 650 MPs to cover the whole of the UK. That’s one for every 92,000 people, or 68,000 voters. It is therefore faintly ludicrous to expect MPs to be able to:

write to a relevant department or official;
send a letter to an appropriate Minister;
make a personal appointment to discuss an issue;
make an issue public; or
speak at an event concerning an issue.

for each and every one of his or her constituents and their businesses, as the blurb suggests. “These steps can often go a long way to providing a solution” it adds helpfully.

If we were all to take up this suggestion of course, the system could not cope. And it cannot, by definition, be fair: a 92,000th of the power of an MP, even if it’s the PM, is probably not worth having in your corner, so the process MP’s use to decide who to help becomes a postcode (or, in reality, power) lottery on a much grander scale than anything we might be concerned about in the NHS. So beware of MPs who say that their minds have been made up on an issue by what can only ever be anecdotal contact with their constituents at best.

Even when most of us don’t bother our MPs, they are still inundated with a level of enquiries, most misdirected, that makes it very hard for them to keep up with their parliamentary work.

So it is perhaps not unreasonable to suggest that an entirely parliamentary approach to doing politics might not be the only option. And now the Labour Party are exploring this idea in the current leadership election. To the side now coalescing around Owen Smith, Corbyn’s policy-making on the hoof and lack of organisation and discipline at times makes him unfit to lead a party set up in 1906 to promote “socialism via parliamentary means”. To Corbyn’s supporters, the party needs to become a movement not confined to Parliament, and the sudden surge in party membership to 450,000 and £4.6 million collected in 48 hours from the £25 fee paid by registered supporters are signs that he is the person who can deliver this.

People cannot agree whether Jeremy Corbyn represents the past or the future, which certainly makes the present very exciting. But if MPs are too busy to represent us the way we want to be represented, we may all need to get more involved in politics from now on.

EU What?

04. June 2016 · Write a comment · Categories: Actuarial

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

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

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

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

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

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

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

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

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

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

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

Vote for Me!

22. May 2016 · Write a comment · Categories: Actuarial, Cartoons, Economics, Regulation

It is election time for the UK Actuarial Profession. The annual Council election is our chance to have our voices heard and to help in setting the strategic direction of the Institute and Faculty of Actuaries (IFoA). And this year I am running!

I think the next 10 years could be one of the most formative periods the profession has seen – with politics and economics at something of a turning point globally, and the place for actuaries and the finance industry more generally within that open to question as never before. I feel, as a former pensions actuary who now works with the actuaries of the future every day, that I have something to contribute to the process of actuaries finding their place in this new world.

So if you are a member of the IFoA please watch my video below and, if you share my priorities for the profession, I would greatly appreciate your vote.

Thinking in groups

26. February 2016 · Write a comment · Categories: Actuarial, Cartoons, Economics, Risk

Two women were fighting on my train the other morning. It was a packed train, with people standing the length of the carriage, so I didn’t see it so much as hear it. The first woman felt she had been pushed by the other one and complained very loudly and with much swearing. The second woman made some comment about the first woman’s mother and it escalated from there, getting louder and louder. Neither was prepared to let the other have the last word and, seeing the impact the mother comment had had, the second woman used it again. At which point the first woman hit her. The other passengers had been sitting and standing grim-faced up until this point, but now one or two intervened. One, who had the bearing of a lay preacher, attempted to assume sufficient authority to stop the argument. He was ignored. Another one stood and put the second woman in his seat and stood between them.

The second woman continued to make comments, but as much to herself as to the first woman. She kept stamping her feet in frustration. She was clearly in unbearable discomfort, but not from any physical pain. Finally she called the police and, as we pulled into New Street Station, started to give a physical description of her assailant. “Everyone on the train saw it” she said several times, while the passengers around her stared in any direction but hers.

I don’t know what happened next in the lives of these two women, although an announcement was made a couple of days later on the same service that police were working their way through the train for witness statements about the incident. They never appeared in my carriage, and I am not sure what I would have said if they had. And I don’t know what your reaction to my story is – whether that the other passengers, including me, should have acted differently or some commentary on the behaviour of the two women. I am, however, reasonably confident that you will have a reaction, perhaps quite a strong one, despite my limitations as a narrator. The reason I am confident about this is that I found myself, involuntarily, completely absorbed in the dispute, upset when one of the women expressed upset, constructing back stories for each of them, questioning their strategic wisdom at various points and, by the time we arrived at New Street Station and I dispersed with all the other witnesses, emotionally drained. And a look at the faces around the carriage suggested to me that most of my fellow passengers reacted similarly.

Why am I telling you this? Because it is a clear example of our domesticated brains in action. The almost physical pain this argument caused me and most of my fellow passengers is the reason we can travel from Sutton Coldfield to Birmingham every day with rarely an incident. It is often referred to these days, in pejorative terms, as Group Think. The shared assumptions and behaviours which allow us to live alongside each other in peace. I then get on a second train each day from Birmingham to Leicester, which I tell everyone is a great train to work on. But this is only because I can trust the 80 or so other passengers not to start an argument. The police could not cope if everyone behaved like the two women in my story. When the police do make an appeal for witnesses, they do so secure in the knowledge that nothing they say or do will encourage more than a handful to come forward, so strong is our group instinct to stay out of each other’s lives if we can. It is not indifference but survival. You need very strong structures to counteract the very strong instinct for Group Think.

However the reason Group Think is used pejoratively is that we have had vivid demonstrations of its power to make large groups of people behave stupidly. For example, herding behaviour in financial markets often causing the very problems people are trying to protect themselves from by going with the crowd. Or regulatory regimes which seem to encourage monocultures to develop, whether in finance, health, education, politics or academia, based on shared assumptions rather than encouraging diversity, because monocultures are easier to regulate. Many professions, including the actuarial profession, have introduced specific professional guidance to encourage whistle-blowing where appropriate, ie standing up to the policies and practices of their own organisations in most cases, which often means doing battle with Group Think. How successful such initiatives prove to be remains to be seen.

Encouraging challenges to Group Think is hard. It normally means going out of your way to allow views to be expressed you don’t agree with. It makes getting your own way harder to achieve. It can seem to us like the opposite of strong leadership and decisiveness when we seek out opinions that will make decision-making more complex. But we have made our society so complex and organisationaly fragile that this is what we are going to need to do more of in the future to stop it all from crashing down around us.

Simplicity, transparency and personal responsibility

31. August 2015 · Write a comment · Categories: Actuarial, Defined Ambition, Demographics, Economics, Pensions, Prediction, Regulation, Risk

The Treasury is consulting on the tax relief that should be available in future for pension schemes and their members. The principles for any reform that it has set out are:

it should be simple and transparent;
it should allow individuals to take personal responsibility;
it should build on the success of automatic enrolment; and
it should be sustainable.

Simplicity, transparency, personal responsibility and sustainability mean different things to different people, which means that the precise meaning of these principles will depend on the politics of the people proposing them. However the words themselves are difficult to argue with, which is presumably why they have been chosen.

It has then set out 8 questions that it would like answered in response to its consultation. The consultation ends on 30 September. I have set out my responses below. I hope that they will sufficiently incense one or two more people into making their views heard, before the chance disappears.

1. To what extent does the complexity of the current system undermine the incentive for individuals to save into a pension?

On this question I think I agree with Henry Tapper at the Pension PlayPen. He says the following:

In summary, millions of pounds of tax relief is wasted by the Treasury helping wealthy people avoid tax…Incentives are available to those on low earnings who pay no tax, but this message is not getting through, we need a system that resonates with all workers, not just those with the means to take tax advice.

I then think I agree with the following:

The incentive should be linked to the payment of contributions and not be dependent on the tax or NI status of the contributor – if people are in – they get incentivised.

That would certainly make the incentive to the pension scheme member clearer and potentially easier to understand. The other simplification I would support would be the merging of income tax and national insurance contributions – many of the sources I have referenced below are trying to solve problems caused by the different ways these two taxes are collected. This simplification would be an essential part of any pension reforms in my view.

2. Do respondents believe that a simpler system is likely to result in greater engagement with pension saving? If so, how could the system be simplified to strengthen the incentive for individuals to save into a pension?

This is the invitation to support TEE (ie taxed-taxed-exempt, the same tax treatment as for ISAs). I have up until now been persuaded by Andrew Dilnot and Paul Johnson’s paper from over 20 years ago that this was not a good idea. This pointed out that the current EET system:

Avoids problems with working out what level of contributions are attributable to individuals in a DB system
Does not discourage consumption in the future relative to consumption now

I have changed my mind. The first point has already been addressed in order to assess people against the annual allowance, although this may need to be further refined. The second point is more interesting. As Paul Mason has pointed out in Postcapitalism, the OECD 2010 report on policy challenges, coupled with S&P’s report from the same year on the global economic impacts of ageing populations point to the scenario pensions actuaries tend to refer to when challenged on the safety of Government bonds, ie if they fail then the least of your problems will be your pension scheme. The projections from S&P (see bar chart above) are that 60% of government bonds across all countries will have a credit rating below what is currently called investment grade – in other words they will be junk bonds. In this scenario private defined benefit schemes become meaningless and the returns from defined contribution schemes very uncertain indeed. A taxation system which seeks to extract tax on the way in rather than on the way out then looks increasingly sensible.

I think that both the popularity of ISAs and the consistently high take up of the tax free cash option by pensioners, however poor the conversion terms are in terms of pension given up, suggest that tax exemptions on the way out rather than on the way in would be massively popular.
3 Would an alternative system allow individuals to take greater personal responsibility for saving an adequate amount for retirement, particularly in the context of the shift to defined contribution pensions?

Based on my comments above, I think the whole idea of personal responsibility for saving adding up to more than a hill of beans for people currently in their 20s may be illusory. People do take responsibility for things they can have some control over. Pension savings in the late twenty-first century are unlikely to be in that category.
4 Would an alternative system allow individuals to plan better for how they use their savings in retirement?

As I have said I favour a TEE system like ISAs. I think some form of incentive will be required to replace tax exemption, such as “for every two pounds you put in a pension, the Government will put in one” with tight upper limits. The previous pensions minister Steve Webb appears to broadly support this idea. Exemption from tax on the way out (including abolition of the tax charges for exceeding the Lifetime Allowance) would also aid planning.
5 Should the government consider differential treatment for defined benefit and defined contribution pensions? If so, how should each be treated?

I think this is inevitable due to the fact that defined contribution (DC) schemes receive cash whereas defined benefit (DB) schemes accrue promises with often a fairly indirect link to the contributions paid in a given year. In my view taxation will need to be based on the current Annual Allowance methodology, perhaps refined as suggested by David Robbins and Dave Roberts at Towers Watson. The problem with just taxing contributions in DB is that you end up taxing deficit contributions which would effectively amount to retrospective taxation.

A further option discussed in Robbins and Roberts is making all contributions into DB schemes into employee contributions. I would go further and apply this to both DC and DB schemes – a sort of “reverse salary sacrifice” which could be encouraged by making the incentives on contributions only available on employee contributions, which would then be paid out of net pay. Any remaining accrual contributions made by employers in a DB scheme would be taxed by an adjustment to the following year’s tax code.
6 What administrative barriers exist to reforming the system of pensions tax, particularly in the context of automatic enrolment? How could these best be overcome?

I think everything points to the need for the retirement of DB for all but the very largest schemes. It would be better to do this gradually starting soon through an accelerated Pension Protection Fund (PPF) process rather than having it forced upon us in a hurry later in the century when PPF deficits may well be considerably higher than the current £292.1 billion.
7 How should employer pension contributions be treated under any reform of pensions tax relief?

As I have said, I think they should be converted into employee contributions based on higher employee salaries. This would make it clearer to people how much was being invested on their behalf into pension schemes.
8 How can the government make sure that any reform of pensions tax relief is sustainable for the future.

They can’t, and any change now will almost certainly be revisited several times over the next 50 years. However, systems where people feel they can see what is going on and which are tax free at the end are currently very popular and I would expect them to remain so for the foreseeable future. That takes care of political sustainability in the short term. What about longer-term economic sustainability? Faced by an uncertain and turbulent next 50 years where I have argued that personal responsibility (rather than communal responsibility) for pensions will seem increasingly irrelevant, I think what I have proposed will allow us to transition to a system which can be sustained to a greater degree.

We are entering what may prove to be a traumatic time for the world economy if Postcapitalism is even half right. Pensions taxation seems a good place to try and start to move our financial institutions in a more sustainable direction.

Nick Foster is a former pensions actuary who now lectures at the University of Leicester

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