The Threat of a Good Example

09. May 2013 · Write a comment · Categories: Actuarial, Economics, Pensions, Regulation

The interests of the UK’s private sector defined benefit (DB) pension scheme members, and the security of their vested benefits (ie the ones they are entitled to keep), were weakened this week. The Pensions Regulator, slow to act in many cases, bureaucratic and inconsistent in others, did at least have a coherent set of objectives which allowed it to focus on reducing the fragility of the pensions system overall. However this is not an example of how the Government wants its regulators to behave it seems. The announcement in the Budget in March that the Regulator is to get an additional statutory objective to encourage “sustainable growth” amongst scheme sponsors, following sustained lobbying from the National Association of Pension Funds and the Confederation of British Industry, led to a swift consultation on, and acceptance of, the proposals. It also appears to have led to an equally swift exit for the Regulator’s chief executive Bill Galvin (he leaves next month) who had had dared to reject calls for such an objective, pointing out reasonably that the existing arrangements required the Regulator and trustees to balance the interests of business, the pension scheme and the Pension Protection Fund.

So here it is, the Pensions Regulator’s first statement on DB pension schemes since the new objective was announced. The Regulator looks to have been very mindful of the not-yet-quite-existing objective in framing this statement and, although the precise wording of the objective is not expected until later in the year, has obviously already decided which way the wind is blowing. The key word that jumps out at you on a first skim is “flexibility”, which seems to be the new code for weakening regulation now that “light touch” has been discredited. This contrasts with last year’s statement, when the use of the word was accompanied by a warning that “we will consider whether the flexibility in the funding framework has been used appropriately”, ie emphasising the limits of flexibility rather than its possibilities.

There are also a number of areas where the position taken by the Regulator on funding appears to have noticeably weakened since 12 months ago. Here, in my view, are some of the main ones (italics are mine):

Section

Pension scheme funding in the current environment – April 2012

Section

Defined benefit annual funding statement – May 2013

17

In the regulator’s view, investment outperformance should be measured relative to the kind of near-risk free return that would be assumed were the scheme to adopt a substantially hedged investment strategy.

7

Trustees can use the flexibility available in setting the discount rates for technical provisions…to adopt an approach that best suits the individual characteristics of their scheme and employer.

19, 14

The regulator views any increase in the asset outperformance assumed in the discount rate to reflect perceived market conditions as an increase in the reliance on the employer’s covenant. Therefore, we will expect trustees to have examined the additional risk implications for members and be convinced that the employer could realistically support any higher level of contributions required if the actual investment return falls short of that assumed.

…Where appropriate the use of actual post valuation experience is acceptable.

 

8

The assumptions made for the relative returns of different asset classes may rise or fall from preceding valuations reflecting changes in market conditions and the outlook for future returns. Trustees should ensure that they document their reasons for change and have due consideration to any increase in risk this might bring.

2

As a starting point, we expect the current level of de­ficit repair contributions to be maintained in real terms, unless there is a demonstrable change in the employer’s ability to meet them.

 

12

Where there are significant affordability issues trustees may need to consider whether it is appropriate to agree lower contributions and this may also include a longer recovery plan. Trustees should ensure that they document the reasons for any change and indicated that they have had due consideration of the risks.

Finally, under the heading what you can expect from us, the Regulator also mentions that it has discarded any triggers it had for subjecting schemes to further scrutiny “on individual items such as technical provisions”.

Unfortunately the combined impact of the changes in emphasis, specific wording and the ditching of the triggers would appear to directly conflict with two of the Pensions Regulator’s definitely-still-existing objectives, namely:

  • to protect the benefits under occupational pension schemes of, or in respect of, members of such schemes; and
  • to reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund.

The House of Lords Select Committee on Regulators in 2007 concluded that:

  • Independent regulators’ statutory remits should be comprised of limited, clearly set out duties and that the statutes should give a clear steer to the regulators on how those duties should be prioritised.
  • Government should be careful not to offload political policy issues onto unelected regulators.

We will have to wait and see exactly where this new objective is to be pitched, but, on the evidence of this funding statement from the Regulator, there must now be considerable doubt that either of the select committee principles will be met.

Set any organisation conflicting objectives and no clear way of prioritising between them and the chances are they won’t achieve any of them. The Pensions Regulator has already started to run this risk.

Spreadsheets and the Under Toad

29. April 2013 · Write a comment · Categories: Actuarial, Economics

In The World According to Garp, John Irving describes how Garp’s son mishears the word “undertow” as a source of danger at the seaside as a child, and spends the rest of his life in fear of the “Under Toad”.  This word now appears in dictionaries as referring to a general fear and anxiety about the unknown and mortality. It sounds like a word almost designed for actuaries, and never more so than when dealing with spreadsheets.

Spreadsheets are of course currently in the news because Thomas Herndon, a graduate student at the University of Massachusetts, was set an exercise to choose an economics paper and replicate its results. He chose Growth in a Time of Debt, a paper by Professors Reinhart and Rogoff, which had been cited by George Osborne more than any other in defence of his policy of austerity.

He couldn’t replicate any of it, and when the professors sent him the spreadsheet they had used, the reasons why became apparent. Only 15 of the 20 countries with high public debt in the analysis had been included in the calculation of average GDP growth. The As to Ds had been missed off. The paper had not been peer reviewed.

This particular error, when combined with other criticisms Herndon and his professors had of the methodology used in the paper, provided considerable challenge to the original conclusions of the analysis and was therefore widely reported due to its implications for UK economic policy in particular. However errors of this kind in Excel spreadsheets are very common.

The European Spreadsheet Risks Interest Group, or EuSpRIG (“yewsprig”) for short, is an organisation sponsored by a group of heavy spreadsheet users which runs conferences and forums designed to pool users’ experiences and suggest best practice in spreadsheet use. EuSpRIG are therefore connoisseurs of the spreadsheet error. They helpfully include a list of spreadsheet horror stories on their website, including the GDP growth one.

Perhaps the most significant spreadsheet foul up on their list is described in the Report of JP Morgan’s Management Task Force regarding billions of losses in 2012 in its chief investment office, which cited a number of spreadsheet errors. However, my personal favourite is the one involving the London 2012 organising committee (Locog) confirming in January 2012 that an error in its ticketing process had led to four synchronised swimming sessions being oversold by 10,000 tickets. Locog said the error occurred when a member of staff made a single keystroke mistake and entered “20,000” into a spreadsheet rather than the correct figure of 10,000 remaining tickets.

It is tempting to think that our technological advancement and exponentially increasing computer power have made some kind of computational HD within our grasp, with every wart and blemish of the object of investigation now detectable by our ever more sophisticated tools. But EuSpRIG estimate that over 90% of spreadsheets contain errors. Most of these will never be found, but lurk beneath the surface threatening the accuracy of any calculations carried out by the spreadsheets concerned. In other words, the Under Toad.

Carveth Read once said (although only famously when it got attributed to Keynes): “It is better to be vaguely right than exactly wrong.” However, when most spreadsheets contain Under Toads, it is clear that a lot of the supposed precision with which information is provided to us is illusory. That exponential increase in computer power has made even the very measurement of precision in the more complicated spreadsheets virtually unknowable. We may never be more than vaguely right, but often have no real idea how wrong we are.

So we check, to ensure that the numbers coming out of the spreadsheets and other models we use are within a tolerable distance of what we would expect. Some of us use pen and paper. The GDP growth Under Toad might for instance happen when a formula which adds up a column in one worksheet is copied to another worksheet where the columns have a different number of rows in them, and the formula is not adjusted. I have certainly done that before now, and only found it when I checked it against a number of other sources. For this reason, I am always a bit nervous about model results being checked by spreadsheet. It doesn’t seem sufficiently unlikely to me that the two could be acceptably close to each other but, perhaps due to entirely different errors, many miles from the truth.

There is a generation of actuaries, of which I am one, that experience almost physical pain when we see students carrying out even the simplest calculations using spreadsheets, knowing that each new one on the block is almost certainly adding to the unknown unknowns of the Under Toad. I know there are just as many mistakes in my biro scrawls, but I also know it will be a lot easier to find them later.

A GDP increase of 0.3% on Thursday was greeted with relief at a triple dip averted, when a fall of just 0.1% would have been met with anguish. Tiny movements in the FTSE 100 are described as “up” and “down”, as if the direction were more important than the amount and when “broadly unchanged” would be a more informative description.

We are obsessed with tiny movements which contain no information and which, thanks to the Under Toad, we cannot meaningfully calculate. This obsession distracts us from seeing the bigger picture, the fuzzy connections that only become apparent when we look up from our HD sharp tiny piece of detail. And our spreadsheets won’t help us with that.

Hopes over Experience

19. April 2013 · Write a comment · Categories: Economics, Prediction

“IMF slashes UK growth forecast”. Does this sound familiar? It should. Every 9 or 10 months the headline seems to return to the newspapers in an almost identical form. September 2011, July 2012 and now “IMF slashes” is back this month. This occurs every time the IMF’s world economic output report (full reports every April, updates every October) happens to adjust down one of its predictions for UK growth.The latest is entitled Hopes, Realities, and Risks and is notable for its Oxford comma.

According to Stephanie Flanders, the BBC Economics Editor, the IMF rarely gives direct advice on the back of these reports, preferring to give discreet prompts. However this time the report says about the UK: “Greater near-term flexibility in the path of fiscal adjustment should be considered in the light of lacklustre private demand.”

Olivier Blanchard, the IMF’s chief economist, even singled out the UK in response to a question while launching the latest report: “There are a few countries where there is enough fiscal space to go further – one example is the UK. In the face of weak demand it is really time to consider an adjustment to the initial fiscal consolidation plans.”

So there you are, we are all doomed unless we change policy. You would imagine that an institution would have a fairly solid track record of understanding countries’ economies and making reasonably accurate predictions on the back of this expert knowledge for it to feel able to lecture us all quite so authoritatively. Unfortunately, they don’t.

As you can see, compared to the stacks of predictions the IMF have given us over the last 4 years on growth in world output alone, the actual growth figures are unfortunately fairly clearly outliers. The one thing we can take from the latest report with any confidence is that the current projections for 2013, 2014 and 2018 will not only be wrong, but probably by miles.

So it would be very difficult to justify a change in economic policy on the basis of a world economic output report. Which is a pity, because I agree that many of us will be doomed to a life of fewer opportunities and less economic independence if the current contractionary policies continue, scrabbling around for our share of a crumbling welfare state while the few of us already immunised from society by money feel very little pain at all. For a proper description of why austerity is a very bad idea, read Paul Krugman’s End This Depression Now or read his blog. Read the account of the Great Capitol Hill Baby Sitting Co-op crisis on page 26, which originally appeared in a 1977 article by Joan and Richard Sweeney. The means for ending the double dip, soon to be triple dip and probably ultimately corrugated recession are in our hands and have been known about for decades. Your spending is my income, and my spending is your income, so we need to stop contracting our economy.

And we also need to stop reading IMF reports.

 

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