We Know Zero

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

Debt: one actuary’s view

11. July 2015 · Write a comment · Categories: Actuarial, Economics, Pensions

I was a pensions actuary for some years, and spent most of that time advising trustees of defined benefit (DB) pension schemes about what to do with their funding debts (we called them deficits or shortfalls, but so as not to confuse them with what the UK Government means by a deficit, ie spending greater than receipts in any given year, I will stick with the term debt here). It seems to me that there are many parallels between this kind of debt and the kind that governments run:

The debt has built up over many years, and the reasons it was built up are often no longer a priority for the sponsor trying to pay off the debt (whether this is former employees for companies, or bailed out banks for governments)
It is very sensitive to things which are not under the control of the sponsor (whether this is gilt yields or pensions legislation for companies, or the state of the world economy for governments)
The debt position can change very quickly
The sponsor usually has more attractive options for investing money than paying off the debt

Pension scheme debts fall broadly into three categories:

Small debts, where the company sponsoring the pension scheme can easily afford to service the debt and is relatively large financially compared to the debt. Think Norway, with their massive sovereign fund, or South Korea on the graph above. There are a wide range of ways of dealing with a debt like this: if the funding target was not to buy out the benefits with an insurance company at this point, I would generally try and encourage the trustees and sponsor in that direction because of point 3. However there are many other completely reasonable approaches here and the point is that, whichever is chosen, it is unlikely to seriously affect the ability of the company to implement its business plans.
Large but manageable debts. The company does need to put in place a proper funding plan here. How quickly it would be asked to pay off the debt would depend on what is called the employer covenant, which is the willingness and ability of the company (or sometimes group of connected companies, which is where the willingness comes in) to pay. Strong companies are allowed more options and longer repayment periods if they want them, although in some cases they may just want to fully fund and remove the ongoing costs of meeting the regulatory and administrative requirements of running a DB pension scheme. Think of the UK in this category. The paper from which the graph above is taken is concerned with the green zone cases like the UK, for which it concludes that reducing debt in the current circumstances of very low real interest rates (the same problem making pension debts so large) and demand shortfalls in the economies in question (the rather more important debt) is likely to be undesirable as the costs will outweigh the benefits.
Large and unmanageable debts. The company cannot afford a funding plan. In most cases the scheme does not have access to sufficient assets to buy policies to pay full pensions to its members with an insurer. An organisation called the Pension Protection Fund (PPF) then gets involved, which guarantees to pay full pensions to pensioners and 90% to non-pensioners, in exchange for all the assets it can get from the defaulting scheme and its sponsor. The sponsor usually needs to be insolvent for its scheme to enter the PPF, although sometimes it is allowed to return phoenix-like without the pension scheme but with the PPF as a stakeholder receiving a share of company profits over an agreed period.

I saw my role as to help trustees negotiate hard for a funding settlement with the sponsor, on the understanding that the sponsor would also negotiate hard. It was always clear to me that the sponsor’s responsibility was to grow its business and it would look to direct most of its profits to that end. The trustees were there to ensure that the (in the main) employees of the past who had been made a pension promise were not forgotten by the employees of the present and future and their employer when resources were being directed.

Imagine what the trustees’ role might be if this whole basis of funding was turned on its head: companies directing ever more of their profits into debt repayment at the expense of any sort of investment in the future of their businesses. To the extent that this threatened the future income stream to the scheme as the business fell apart, trustees and their actuaries might find themselves making very different arguments (perhaps along the lines of the flexibility the regulator promotes and the importance it stresses of trustees having a good understanding of the employer’s position and plans, including how any plans for sustainable growth enhance the employer covenant). But we would then be in a situation where what the company was expert in, ie running its business, had been subordinated to funding a pension scheme, while what the trustees and their advisers were expert in, ie funding the pension scheme, had become less important than protecting the long term health of the company. This would appear to be sub-optimal.

But it is not that different from having a government that makes its highest priority to reduce a debt which it does not fully understand and certainly cannot fully control, while cutting back on all the things that governments do which support the economic health of a country, from investing in infrastructure and housing to promoting real social security for the economic units, ie us, within it.

And imagine what would happen if we treated schemes with large unmanageable debts like Greece. The current deal which looks like it might be agreed tomorrow involves asset sales, spending cuts, tax increases and reform of both its tax and pensions system in return for three year loans and debt restructuring and reprofiling. This would be the equivalent of not only putting the sponsor into administration and selling off all its assets but also immediately demanding pension contributions from the workers who had been kept on into a scheme which would never give them any benefits just before firing them with no pensions (pensioners left without pensions was a scenario which occasionally happened in the UK before the PPF and sometimes led to naked pensioners demonstrating on the beach). The sell off would, as it always does (and certainly has in the case of Greece) pay off the banks first before moving on to the unsecured creditors. Insolvency practitioners know that they can get more for a company by selling it as a going concern rather than as just a bunch of assets. The PPF similarly understand that a proportion of future profits can be in their best long term interests as a creditor rather than dancing around the flames of a fire sale. The Troika, the IMF and their enforcer, the ECB, appear to have lost sight of this.

The current austerity fixation is not bringing good private sector practice into the public sector. On the contrary it is removing the public sector foundation required for the private sector to flourish. And that is just bad business.

Does this meet the definition of democracy?

24. April 2015 · Write a comment · Categories: Prediction

The result of the forthcoming General Election is not in much doubt it would seem. Eight different polling organisations’ latest polls are shown above, and the similarities between them are so much more striking than the differences. It appears that we will be going through the motions of a process which is to a large extent predetermined on 7 May. The election result is not where the uncertainty lies.

However, the day afterwards, when the general public no longer has any say in what happens, is still deeply uncertain. Although the parties have all let us have their manifestos, details about how they would behave in the event of a distribution of seats which seems to be largely already decided in most cases (presumably because the parties think we might vote differently if we knew) are very sketchy. Does this meet the definition of democracy, ie a system of government by the whole population? The Electoral Reform Society would say not. I would argue it does.

If the election result is largely as expected what would it tell us about the views of the electorate? I think it would tell us:

They don’t want austerity on the scale of 2010-12 again (which is one reason why the Conservatives and Liberal Democrats together don’t appear likely to get a majority);
They are not as obsessed with immigration policy as the two main parties think they are (which is why they seem prepared to vote for a range of different approaches to managing immigration with no approach commanding majority support);
They don’t want a referendum on whether to stay in the EU (which is why the Conservatives and UKIP together will not be able to get a majority); and
They don’t support the current student fees system and don’t believe it is indistinguishable from a graduate tax (which is another reason why the Liberal Democrats and Conservatives together seem unlikely to get a majority).

There are probably several other attitudes amongst the electorate that can equally well be divined in the negative in a similar way (the BBC summaries of the parties’ positions on a range of issues can be found here), but the point is that a finely balanced pattern of parties of the type we look likely to end up with does not represent an inability to make a decision. It does however represent a determination not to allow any single party to make decisions. That seems to meet a reasonable definition of democracy to me.

Too much choice is no choice at all

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

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.

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.

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

How does this story end, I wonder?

Time to take a look outside?

16. February 2015 · Write a comment · Categories: Actuarial, Legal, Pensions, Regulation

The Institute and Faculty of Actuaries (IFoA) is introducing a new mandatory Actuarial Profession Standard (APS) in relation to review of actuarial work. The existing requirements in the APS applying to scheme actuaries will be withdrawn.

APS X2 Review of Actuarial Work will come into force on 1 July 2015 and is accompanied by a detailed, practical Guide. One of its key requirements is that actuaries, for any piece of work they wish to have reviewed, will need to consider the need for that review to be independently carried out, ie by someone not otherwise involved in the work in question.

I should declare straight away that I have a conflict of interest about this new standard, having set up a business because I felt scheme actuaries should have access to peer review services from an experienced scheme actuary outside their organisations. I am delighted that an idea which seemed a little odd to some when I first started offering these services in 2013 should now be regarded as sufficiently mainstream by the IFoA to prompt a revision of peer review guidelines.

Under APS X2, review processes are defined as either work review or independent peer review. Whereas work review is a general term covering all forms of review processes, the term independent peer review can only be applied to review processes involving reviewers not otherwise involved in the piece of work under review.

There are many reasons why you might want to have your work independently reviewed, for example:

Work reviewed within a firm might be influenced by the respective positions of the actuary and his/her reviewer within the management structure of the organisation;
Even if the work is reviewed by a colleague completely objectively, it might not be seen to have been;
There is a risk of group think in any organisation. Review from outside can significantly reduce this risk;
An independent reviewer may have a different range of experiences to draw on from those within your organisation. This can be particularly useful when reviewing work where there are potential conflicts of interest or concerns over how best to communicate a piece of work.

If this sounds of interest and you think it might be time to take a look outside for some of your peer review needs, my details can be found by following the link.

We know zero about 2015

10. January 2015 · Write a comment · Categories: Antifragility, Economics, Prediction

There have been a lot of predictions already for 2015. The Chartered Institute for Personnel and Development predicts employment in the UK increasing by half a million, GDP growth of 2.4% and earnings growth of between 1% and 2%, ie keeping its predictions reasonably close to what happened in 2014 and/or what the OBR, OECD and IMF are predicting. The annual FT economists’ survey resulted in an average conclusion amongst 90 economists that GDP growth would increase from 2.4% pa to 2.5% pa around election time and then on to 2.6% pa soon after. I could go on but I think you get the general idea – small changes around current economic statistics with a remarkable level of agreement amongst the experts. It’s enough to make you want to use these predictions to populate your models with, which is of course the general idea.

But before you get any idea that these people know more about 2015 than you do, consider what was being said about the oil price only 6 months ago in the Office for Budget Responsibility’s Fiscal sustainability report. Here is the graph:

Once again, there was a trend of projecting a price rather similar to the current one and a remarkable level of agreement amongst the experts. Here is what has actually happened subsequently:

Now I don’t want to pick on these forecasters in particular, after all the futures prices indicated that these views were the overwhelming consensus. But the oil price is a fundamental indicator in most economic models – Gavyn Davies details how the latest fall in oil prices has changed his economic forecasts here – with implications for inflation and GDP growth, and dependent upon predictions about many other areas of the political economy of the world which impact supply (eg OPEC activity, war in oil-producing areas) and demand (eg global economic activity). So an ability to see a big move in oil prices coming would seem to be a clear prerequisite for being able to make accurate economic forecasts. It seems equally clear that that ability does not exist.

Economic forecasts generally tell us that things are not going to change very much, which is fine as long as things are not changing very much but catastrophic over the short periods when they are. Despite the sensitivity testing that goes on in the background, most economic and business decisions are taken on the basis that things are not going to change very much. This puts most business leaders in the individualist camp described here, ie a philosophical position which encourages risk taking. Indeed even if some of the people advising business leaders are in the hierarchist camp, ie believing that the world is not predictable but manageable, to anyone with little mathematical education this is indistinguishable from an individualist position.

The early shots of the election campaign have so far been dominated by the Conservative Party branding Labour’s spending plans (which to the extent they are known appear to involve quite severe fiscal tightening, although not as drastically severe as Conservative ones) as likely to cause “chaos”, while the Labour Party wants to wrap itself in the supposed respectability of OBR endorsement of their economic policies. Neither of them has a plan for another economic crisis, which concerns me.

What are desperately needed are policies which are aimed at reducing our vulnerability to the sudden movements in economic variables which we never see coming. We should stop trying to predict them because we can’t. We should stop employing our brightest and best in positions which implicitly endorse the assumption that things won’t change very much because they will.

What sort of an economy would it have to be for us not to care about the oil price? That’s what we need to start thinking about.

Measuring the immeasurable more and more accurately

14. September 2014 · Write a comment · Categories: Regulation

The announcement by the Office of Qualifications and Examinations Regulation (Ofqual), the UK schools examination regulator, of the new grade structure for GCSEs is explained on their website by their Chief Regulator Glenys Stacey as follows:

For many people, the move away from traditional grades, A, B,C and so on, may be hard to understand. But it is important. The new qualifications will be significantly different and we need to signal this clearly. It will be fairer to all students that users of the qualification will be able to see immediately whether they did the new or a previous version of the GCSE. The new scale will also allow better discrimination between the higher performing students.

This is a big claim, which is not supported by any evidence I have seen. As Dylan Wiliam pointed out as long ago as 2001, the available data suggest that a student receives the grade that their achievement would merit only around 65% of the time. This is very close to the proportion of the time a random variable (which I think is how an examination mark needs to be treated) with a Normal Distribution falls within one standard deviation either side of its expected value. For mathematics, grade boundaries in 2014 were about 15% apart (80% A*, 65% A, 50% B, etc).

Therefore the narrowing of the grade boundaries the new system ushers in, now helpfully illustrated by Ofqual, will merely introduce more randomness to the grading process amongst higher performing students.

If the distribution of marks really is normal, a replacement of a 15% grade width by one closer to 10% would be expected to reduce that 65% accuracy to closer to 50%, ie you will be as likely to get the wrong grade as the right grade. This does not look like progress to me. Ofqual are, however, undaunted:

We realise introducing the new GCSEs alongside other changes will be challenging for schools, teachers and students. But the prize – qualifications that are better to teach, better to study, better assessed and more respected – will be worth it.

I remain to be convinced.

Do pensions make inequality better or worse?

22. August 2014 · Write a comment · Categories: Actuarial, Demographics, Economics, Pensions, Regulation

I ask this question because:

I have just read The Spirit Level by Richard Wilkinson and Kate Pickett, and am convinced by their arguments and evidence that inequality lies at the root of most of the social problems we have in the UK; and
As a scheme actuary, I persuaded myself that I was facilitating a common good, namely the provision of good pensions to people who might not otherwise have them to as high a level and for as long as possible given the economic conditions of the sponsors. The introduction of the Pension Protection Fund reduced the importance of the scheme actuary role, by mitigating the impact of sponsors not meeting their obligations, but still left a job I felt was worth doing. However, it now seems to me that, if pensions are not tackling inequality or even exacerbating it, they might be doing more harm than good.

First of all, I strongly recommend the Equality Trust website, which has a number of graphs showing the links between inequality and various social ills. One example, showing the relationship between inequality and mental illness, is set out below.

So what is the evidence on inequality and pensions? Certainly inequality, as measured by the Gini coefficient, in this case after a reduction for housing costs, has increased markedly in the UK since the 1960s.

While the proportion of private pension provision since 1997 as a percentage of the workforce has fallen (courtesy of the Office for National Statistics).

But is there much of a correlation between them? Well there is a weak negative correlation between the Gini coefficient and the percentage in workplace pensions as a whole.

And a rather stronger one when we just look at defined benefit (DB) pension scheme membership.

Neither of these are particularly strong correlations. Any impact by workplace pensions on inequality is likely to be limited of course, because they are in general structured (via final salary formulae in the case of DB, and employer and employee contributions as a percentage of salary in the case of defined contribution (DC)) to preserve relative incomes in retirement, even if not absolute differentials. However, moving now to the OECD statistics website, we can look at the retirement age community as a whole and compare their relative inequality with that of the working age population.

Turning to the working age population first, we can see below that the UK is a very unequal society compared to a range of rich countries, although less so than the US.

data extracted on 15 Aug 2014 15:52 UTC (GMT) from OECD.Stat

On the other hand, we get a very different picture if we consider the UK’s over 65 population, where the level of inequality is well below that of the US, and broadly comparable with the other major EU states.

data extracted on 15 Aug 2014 15:52 UTC (GMT) from OECD.Stat

Clearly this is not primarily down to private pension provision, but the more redistributive state pension and other benefits. However, at least the weak correlations we saw previously suggest that private pensions have not made inequality any worse and possibly slightly mitigated against it.

I think we can do better than this: after all we had inequality levels equivalent to current Norwegian levels back in the early 60s (which is why I included them in the international comparisons above). So the news that pensions tax relief is likely to be provided at a 30% rate for all after the election rather than reflecting the current tax bands is not, in my view, the cause for gnashing of teeth as the Telegraph and others believe but actually a good thing. After all, the Pensions Policy Institute have shown that 2/3rds of all tax relief is going to those earning over £45,000 pa.

One of the clear conclusions of the research carried out in The Spirit Level and elsewhere is that reducing inequality in society benefits every group in it, including those who are redistributed away from. Pension provision has its part to play in this.

And 30% tax relief does not seem like too high a price to me.

We still know zero

19. August 2014 · Write a comment · Categories: Economics, Prediction, Risk

From time to time I get asked about my banner header showing successive Office of Budget Responsibility (OBR) forecasts for GDP growth against actual GDP growth and, in particular, what has happened since. The OBR produces its forecasts twice a year, in March and December, and the latest one is here. However I have resisted updating my banner to date for a number of reasons:

The statement that economic forecasts are wildly inaccurate has become a truism that, in my view, no longer needs additional evidence in support; and
To be completely honest, once actual GDP growth started to increase (as was inevitable eventually, and particularly once the Government’s austerity boot’s grip on the economy’s neck started to weaken), the graph no longer looked quite as amusing.

However, I have recently started to question the first of these assumptions so here is an updated graph:

Notice how the point at which growth peaks and starts to fall is moving closer with each new forecast. This is as much a part of their models as putting back the upward path a quarter or two with each successive forecast was while that path was still actually falling. Be assured that the OBR will not forecast the next fall before it actually happens.

What concerns me is the forecast consensus which is starting to build around 2014-2018 of GDP growth between 2% and 3% pa (currently narrowing as a forecast to 2.5% – 2.8% pa). This is despite the OBR themselves making no more than a claim of 20% probability of growth staying in this range, as the following fan chart shows:

However I don’t see this fan chart turning up in many news reports and therefore my concern is of an election campaign fought under the illusion of a relatively benign economic future. I think it is likely to be anything but, particularly as the Government is likely to stick the boot back in post election whoever wins.

There seems to be no chance of stopping the OBR and others publishing their forecasts, too many people seem to value the power of the story-telling however implausible the plot, so the only course available seems to be to rubbish them as often as we can. That way it may just be possible, despite all the noise about predictions of economic recoveries and collapses we cannot possibly foretell being used to try and claim our political support more generally, to keep in mind that we know zero. And make better decisions as a result.

Never trust an actuary?

06. August 2014 · Write a comment · Categories: Actuarial, Cartoons, Pensions, Regulation, Risk

Trust me. I’M AN ACTUARY!

I commented on the Pensions Regulator’s new code of funding in a recent post. The reason I am returning to it so soon is that a good friend of mine has pointed out a rather important, but subtle, aspect of the new code which I had missed. It goes to the heart of what we should expect from a professional in any field.

Experts and the Problem of P2C2Es

In 1990, while still in hiding from would-be assassins keen to implement Ayatollah Khomeini’s fatwa, Salman Rushdie wrote a book for his son called Haroun and the Sea of Stories. This introduced the idea of P2C2Es or Processes Too Complicated To Explain. These were how awkward things, like the fact that the Earth had a second moon which held the source of all the world’s stories, were kept hidden from ordinary people. All the people who worked on P2C2Es were employed at P2C2E House in Gup City under a Grand Comptroller. When I read it to my son a few years later I enjoyed the story of very clever people conspiring against the general public as a fairy tale.

Since 2008, it has become increasingly clear that this is no fairy tale. Whether you are looking for the cheapest quote for insuring your life, house or your car; a medical opinion about your health; an investment that meets your needs: it is a P2C2E.

Malcolm Gladwell and others make the case that expert failure is what we should really fear, when important things rely on experts not making mistakes doing things that most people do not understand. The inability to challenge expert opinion has cost us all a lot of money in the last few years. We should stay clear of P2C2Es whenever we can in my view. Professionals should present evidence and the intuitions gained from their experience, but leave the decisions to people with skin in the game.

Other professionals disagree with this. There is, from time to time, a push to get rid of juries in cases where the evidence is thought too complicated (eg fraud) or too dangerous to make public in even a limited way (eg terrorism). Some of these succeed, others don’t. There are also frequent political arguments about what we should have a referendum on, from Scottish independence (got one if you’re Scottish) to membership of the EU (one is promised) to recalling your MP mid-term (so far no luck on this one).

There is a similar divergence of opinion amongst actuaries. Since the Pensions Regulator’s first code of practice for funding was launched, in 2006, the scheme actuary’s role has been clearly set out as one of adviser to the scheme trustees and not, other than in the rare cases it was cemented in the scheme rules, a decision maker. However there are actuaries who look back wistfully to the days when they effectively set the funding target for pension schemes and all parties deferred to their expertise. I am not one of them.

Because this was really no good at all if you were a trustee expected to take responsibility for a process you were never really let in on. The arrival at a contribution rate or a funding deficit for a scheme funding on a basis presented to them as a fait accompli was to many trustees a P2C2E. We risk returning to those days with the new code of funding.

What this has to do with pensions

Compare the wording of the new Code of Practice for pension scheme funding with the previous one:

2006 code

The actuary is not passing an opinion on the trustees’ choice of method and assumptions.

2014 code

Trustees should have good reasons if they decide not to follow the actuary’s advice. They should recognise that if they instruct their actuary to certify the technical provisions and/or schedule of contributions using an approach which the actuary considers would be a failure to comply with Part 3, the actuary would have to report that certification to the regulator as the regulator considers such certification to be materially significant.

Where Part 3 refers to the funding regulations for actuarial valuations. Previously actuaries who were unable to provide the required certification of the calculation of the technical provisions or of the adequacy of the schedule of contributions had to report the matter to the regulator only if a proper process had not been followed or the recovery plan didn’t add up to the deficit. It was thought that going any further would involve passing an opinion on the trustees’ choice of method and assumptions.

Will the new code make schemes better funded? In some cases perhaps, but at the cost of moving scheme trustees into a more passive role where they do not feel the same level of responsibility for the final outcome. It is the difference between roads where cars are driven by people concerned with road safety and the ones we have where drivers are primarily concerned with not setting off speed cameras. The general level of safety is reduced in both cases, with the further danger that this passivity will trickle into other areas of trustee responsibility. And the risk to the schemes of the group think of scheme actuaries (a relatively small group of professionals who tend to all cluster around the same schedule of continuing professional development (CPD) events) is massively increased.

Ha-Joon Chang famously said never trust an economist. Is it any less dangerous to trust an actuary under these circumstances?