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

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

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

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

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

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

They also stated that the panel would take into account:

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

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

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

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

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

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

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

How USS engages with its members

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

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

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

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

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

The Time Has Come For Lecturers To Decide What They Want

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

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

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

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

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

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

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

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

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

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

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

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

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

Simplicity, transparency and personal responsibility

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

S&P sovereign credit ratings

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

Too much choice is no choice at all

10. April 2015 · Write a comment · Categories: Actuarial, Cartoons, Defined Ambition, Pensions, Regulation

Go on pick a card

Defined ambition has failed.

  • This was mainly because, tasked with suggesting a less onerous alternative to defined benefit (DB) schemes that gave more protection than defined contribution (DC) schemes, the pensions industry (including actuaries) did not get behind the least bad option, but instead presented a spectrum of options
  • The public and employers were unimpressed
  • And employers had enough on their plate anyway dealing with auto-enrolment
  • So they have now all (or nearly all) enrolled their employees into DC
  • And the reason they are in DC now is the same reason they were in DB before: because they were offered so many choices they lost sight of the fact that there was a choice.

DA options

The time to significantly influence corporate pension provision would appear to have passed until people realise how hard it is to make sufficient provision via a DC scheme. That may not be until the money actually runs out as the finance industry has a proven track record in keeping people in schemes (eg the early personal pensions and later endowment mortgages) long after they retain the capacity to do them any good.

In the meantime, people with DC pensions and madly transferring DB members now have freedom and choice. I predict that this too will fail.

  • This will mainly be because, tasked with providing cost-effective advice to people to empower them to make good decisions about their financial future, the pensions industry do not get their act together and just present a spectrum of options
  • The public will be unimpressed
  • And employers, who might have been persuaded to increase employee education and engagement in pensions, will have enough on their plate anyway dealing with auto-enrolment
  • So now most of them will be managing their own retirement with not enough money, vulnerable to pensions scammers and paying far more tax than they need to
  • And the reason they will not be in an annuity now is the same reason they were in one before: because they were offered so many choices (see the Pension Wise website, inexplicably still in an unfinished Beta state) they lost sight of the fact there was a choice.

Pension_Wise_Logo

The time to significantly influence individual pension provision appears to be rapidly running out.

How does this story end, I wonder?

Actuaries and Economics

20. June 2014 · Write a comment · Categories: Actuarial, Antifragility, Defined Ambition, Economics, Pensions, Regulation, Risk

I have been reading Ha-Joon Chang’s excellent book Economics: The User’s Guide after listening to him summarising its thrust at this year’s Hay-on-Wye Festival of Literature and the Arts. It is very disarming to meet an economist who immediately tells you never to trust an economist, and I will probably return to his thoughts on the limitations of expert judgement in a future article.

But today I want to focus on his summary of the major schools of thought in economics, and what the implications might be for actuaries. Chang’s approach is that he does not completely subscribe to any particular school but does not reject any either. He bemoans what he sees as the total domination of all economic discussion currently (and therefore also all political discussion about running the economy) by neoclassical economists. I think actuarial discussion may suffer from a similar problem.

So what is neoclassical economics? Well it has become almost invisible to us due to its omnipresence, in the way fish don’t see the water they swim in, but its assumptions may surprise you. It assumes that all economic decisions are at an individual level, with each individual seeking to maximise what is known as their utility (ie things and experiences they value). The idea is that we self-interested individuals will collectively make decisions which, within the competitive markets we have set up, result in a socially better outcome than trying to plan everything. This approach has become a very conservative outlook (ie interested in preserving the status quo) in Chang’s view ever since it was further developed to include the Pareto principle in the early 20th century, which says that no change in economic organisation should take place unless no one is made worse off. This limits the scope for redistribution within a society, which can lead to the levels of inequality we see now in parts of the developed world which many are becoming increasingly concerned about, Thomas Piketty included.

Arguments between neoclassical economists in Chang’s view tend to be restricted to ones about how well the market actually works. The market failure argument says that there is a role to play for governments in using taxes and regulations (negative externalities) or in funding particular things like research (positive externalities) to mitigate the impacts of markets, particularly in areas where market prices do not fully reflect the social cost of particular activities (eg pollution on the environment). Another criticism made of neoclassical economics is that it does not allow properly for the fact that buyers and sellers do not have the same level of information available to them in many markets, and therefore the price struck is often not the one which would lead to the best outcome for society as a whole. So the more “left wing” neoclassicalism requires more market regulation to protect consumers and the environment they live in.

The more “right wing” neoclassical response to this is that people actually do know what they are doing, and even build in the likelihood that they are being conned due to asymmetric information in the decisions they make. The government should therefore reduce regulation and generally get out of the way of wealth-creating business. This form of neoclassicalism views the risk of government failure as much greater than that of market failure, ie even if we have market failure, the costs of government mistakes will inevitably be much greater.

And if you draw a line between those two forms of neoclassicalism, somewhere along that line you will find all of the main UK political parties and pretty much all economic discussion within the financial services industry.

And, on the whole, it tends to circumscribe the role that actuaries play in the UK.

One of the major drawbacks of neoclassical theory is that is assumes risks can be fully quantified if we only have a comprehensive enough model. Actuaries are predominantly hierarchists, who believe that they can manage the inequalities which flow from neoclassical theory via collectivist approaches, like insurance policies and pension schemes, and protect individuals and indeed whole financial systems from risk. Since Nicholas Nassim Taleb and others made so much money from realising that this was not the case in 2008, this has probably been neoclassicalism’s most obvious flaw, and the one which has given rise to the most discussion (although possibly not so much change to practice) amongst actuaries.

But there are others. Neoclassicalism assumes that individuals are selfish and rational, both of which have been persuasively called into question by the work of Kahneman and others, who have shown that we are only rational within bounds and make most of our decisions through “heuristics” or rules of thumb. Actuaries have tried to reflect these views, some of which were originally developed by Herbert Simon in the 40s and 50s, particularly in the way that information is communicated (eg the recent publication from the Defined Ambition working group), but have very much stayed at the microeconomic level (very much, according to Chang, like much of the Behaviouralist School themselves) rather than exploring the implications of this theory at a macroeconomic level.

Neoclassical theory is also much more focused on consumption than production, with its endless focus on markets of consumers. One alternative approach is that proposed by the Neo-Schumpeterian School, which rightly points out that, in many markets, technological innovation is considerably more important than price competition for economic development. The life-cycle of the iphone, from innovation to temporary market monopoly to the creation of a totally new market in android phones is a case in point. Actuaries have done relatively little work with technology firms.

Another school of economic thought which is much more focused on production is the Developmentalist Tradition, which believes governments can improve outcomes considerably by intervening in how economies operate: from promoting industries which are particularly well-linked to other industries; to the protection of industries which develop the productive capability of the economy, particularly infant industries which might get smothered at birth by the more established players in the market. This tradition clearly believes that the risk of government failure is less than the potential benefits of intervention. The failure of productivity to pick up in the UK since 2008 has been described as a “puzzle” by the Bank of England and other financial commentators. Perhaps some clues might lie outside a neoclassical viewpoint.

The Institutionalists have looked at market transaction costs themselves, pointing out that these extend way beyond the costs of production, and could theoretically encompass all the costs of running the economic system within which the transactions take place, from the courts to the police to the educational and political institutions. They have suggested that this may be why so much economic activity does not take place in markets at all, but within firms. I think actuaries have started to engage with failures in pricing mechanisms recently, particularly where these have environmental consequences such as in the case of carbon pollution and the implications for the long term valuations of fossil fuel reserves on stock markets.

The Keynesians I have written about before. They are probably the most opposed to the current austerity policies, pointing out how, if a whole economy stops spending and starts saving when in debt, as an individual would, the economy will stay in recession longer and recovery (and therefore the possibility of significant deficit reduction) will be slower. The coalition government in the UK have neatly proved this point since 2010.

I could go on, about the Classical or Marxist Schools which have been largely discredited by historical developments over the last 200 years, but which still have useful analysis of aspects of economics, or the spontaneous order of the markets believed in by the Austrian School. However my point is that I think Chang is right to highlight that there is a wider range of economic ideas out there. Actuaries need to engage with them all.

Freedom and choice – a response to the Treasury pensions consultation

05. June 2014 · Write a comment · Categories: Defined Ambition, Legal, Pensions, Regulation, Risk

The consultation on the proposals for pensions announced in the Budget, and contained in yesterday’s Queen’s Speech, ends on 11 June. I have set out my response below. I hope that it will sufficiently incense one or two more people into making their views heard, before the chance disappears.

A.1
The government welcomes views on its proposed approach to reforming the pensions tax framework.

1 Should a statutory override be put in place to ensure that pension scheme rules do not prevent individuals from taking advantage of increased flexibility?

Yes. Otherwise you are just writing cheques to pensions lawyers.

2 How could the government design the new system such that it enables innovation in the retirement income market?

Reform preservation rules, the TPR code on funding, HMRC rules and the PPF levy framework so as not to penalise different arrangements across the defined ambition spectrum. Remove the annual allowance, controlling the level of tax relief offered through the lifetime allowance only (I got this the wrong way round in my first draft – the annual allowance assumes regular incomes, many people now have incomes which bounce up and down alarmingly from year to year. It is also ridiculously cumbersome to administer).

3 Do you agree that the age at which private pension wealth can be accessed should rise alongside the State Pension age?

No. There is already an issue around healthy life expectancy and the state pension age in some regions of the UK.

4 Should the change in the minimum pension age be applied to all pension schemes which qualify for tax relief?

Yes. The arrangements need simplification.

5 Should the minimum pension age be increased further, for example so that it is five years below State Pension age?

No (see answer to 3).

A.2
The government welcomes views on its proposed approach to supporting consumers in making retirement choices.

6 Is the prescription of standards enough to ensure the impartiality of guidance delivered by the pension provider? Should pension providers be required to outsource delivery of independent guidance to a trusted third party?

There needs to be more clarity about the charges which can be levied for guidance or if it is to be remunerated in some other way.

7 Should there be any difference between the requirements to offer guidance placed on contract-based pension providers and trust-based pension schemes?

No. In most cases the scheme members have not chosen to receive lower levels of service.

8 What more can be done to ensure that guidance is available at key decision points during retirement?

I think there needs to be a right (but not requirement) to it for everyone at 50, 60, 70 and 80 as a minimum, at an agreed national nominal charge. I imagine that the £20 million available to develop resources for this will need to be increased significantly to make an impact on the quality of guidance materials provided.

A.3
The government would welcome views on the options outlined in point 5.15, including their likely complexity, and the burdens they might place on scheme sponsors and HMRC.

9 Should the government continue to allow private sector defined benefit to defined contribution transfers and if so, in which circumstances?

Yes. In all circumstances.

10 How should the government assess the risks associated with allowing private sector defined benefit schemes to transfer to defined contribution under the proposed tax system?

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

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

All that would be required to extend the proposed freedoms would be to allow DB members to commute as much of their benefits at retirement, whether for cash or income drawdown, as they wanted, with the rest taken as pension as now. This could be applied to private and public sector schemes and would, I believe, at a stroke head off the rush to transfer.

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

A.4
The government would welcome views on any potential impact of the government’s proposals on investment and financial markets.

For private DB schemes, the Government says the decision is “finely balanced”. I think their fears are exaggerated and rather contradict the earlier declaration of trust in pensioners to make appropriate decisions about their retirement – after all appropriate investment in support of regular income in retirement (which would presumably be recommended by the “guaranteed guidance” to be offered to DC members) should not differ markedly from the equivalent investments in DB schemes. Whether DB schemes invest on a longer-term basis than individuals is, as the Kay Review made clear, uncertain.
The level of the Government’s concern about financial markets rather makes it look as if individuals can be trusted to look after themselves, with a slightly bigger safety net and a bit of advice, but financial markets cannot. This cannot be right.

Freedom for DBdom?

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

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

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

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

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

It then adds:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Nature of Risk and Pensions

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Camps, acronyms and other small stuff

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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