No Change in Pensions
After twenty years of ever-increasing volumes and complexity of pension regulation, a brief conversation this week with a member of the Visteon scheme brought home to me the fact that very little has really changed. After 38 years of service, this individual will lose 48% of his pension entitlement under the Pension Protection Fund rules – is this really the best that we can do twenty years after the Maxwell scandal?
One of the most pronounced movements in pension provision over this period has been the shift to defined contribution (DC) rather than defined benefit (DB) pension schemes. DC really does not deserve the epithet ‘pension’ as it is no more than a tax-advantaged savings scheme with no provision for the conversion of those savings to retirement income. Both the value of the pension pot at retirement and the cost of annuity purchase are highly uncertain. The substantial uncertainties associated with individual DC are reflected in their cost – while a two thirds final salary may be achieved with contributions, from employer and member, of twenty percent of income for DB, the same pension income will cost at least 30% of income using DC. In addition, there are significant cognitive and behavioural biases exhibited by individuals which will probably raise this cost further. Most of this difference in cost arises from the increased exposure of the individual alone to stock and bond market risks. Perhaps someone should inform the Treasury of this additional tax cost.
However, the most important difference has been in the purpose of regulation. Prior to Maxwell, regulation was concerned principally with increasing the quality of the pension payable; a transfer of responsibility for retirement income from the public to the private sector. Post Maxwell, the focus has shifted to improvements in the perception of pension security. The increased costs due to regulation in the pre-Maxwell period were predominantly reflected in savings and investment – larger pensions and higher funding amounts. Post Maxwell however, the increased costs are predominantly current expenditures – PPF contributions and compliance costs are a prime example. These regulatory compliance costs are now completely out of control – the Office for National Statistics reports scheme administration expenses as running at seven percent of pensions in payment versus just two to three percent in 1990.
Add to this pension accounting standards which are simply wrong, and it should be no surprise that employers are rushing to close DB schemes. Again this is a misplaced fixation upon markets; use of arbitrary market rates to discount pension liabilities. As these accounting issues can easily get tortuous, I shall use a simple analogy. When taking out a mortgage on our home, we ask the bank what their terms are and we ask ourselves, will we earn enough to pay that mortgage. The situation for a company is exactly the same; their ability to pay a pension liability is determined by their earnings, now and in the future.
The pensions world is now awash with investment bankers and others offering ‘solutions’–almost all are misconceived and extremely costly. Closing a scheme to new members may limit its future exposure, but it increases the cost of provision of existing pensions. Hedging spurious interest rate exposures, in liability driven investment strategies, is another. Now we are even being asked to believe that living longer is unequivocally bad and that we need to develop a financial market in longevity. The chorus of commentary is unceasingly negative; conventional wisdom abjectly despondent.
However, a new report, “Don’t stop thinking about tomorrow: The Future of Pensions” (available to download from www.futureofpensions.org), published this week takes a very different view; it contends that pensions broadly as we knew them are sustainable. The problems seem to lie principally with bad accounting and misguided and ill-concieved regulation.