NSFM opinion: Pensioned off

Michael Mainelli writes: Pension policies everywhere are being pensioned off – defined benefit schemes in the UK are closed to new members or closing down; private sector workers are outraged by public sector pension commitments; the young are outraged by obligations to the old; and accountants and actuaries around the world should be ashamed of their historical performance – and would be, if they weren’t so busy re-estimating future liabilities from minute to minute, and charging fees.

It’s nothing new.  The UK issued the first sovereign bond in 1693 in the form of a tontine to fund part of the Nine Year War against France.  In a tontine each investor pays a sum and receives annual dividends.  As each investor dies, his or her share is reallocated among the surviving investors, continuing until only one investor survives.  The principal is never paid back.  By the mid-18th century, investors knew how to play the system by buying tontines for young children.  The Government underestimated the longevity of the purchasers. Tontines were ruinous and abandoned.

Few financial institutions are more important than those providing for old age.  Pensions are a mainstay of financial services.  Sensible pension provision should be the major social benefit that the investment management system provides.  But in reality, net of fees and expenses, most old geezers would have been better to have placed their savings in some boring trackers as twenty year olds.  If it weren’t for governments’ distorting tax breaks, professional managers would be laughing stocks.

Every OECD country has significant pension problems.  The numbers are horrifying – a savings gap four times the GDP of the UK for example.  Despite this, Con Keating believes, “defined benefit pensions may be the best risk transfer mechanism we’ve ever stumbled across.”  He wrote in 2010 that defined benefit schemes can work, and work well, given appropriate regulation.  He challenges pensions professionals to rethink their methods by, for example, using more appropriate discount rates such as those of earnings, not bonds, and a few innovations, particularly pensions indemnity assurance (though do note he’s in the pensions indemnity assurance business).

One of the most interesting solutions to the longevity problem I’ve come across is to have an individual floating retirement age. Say that the pension guarantees 15 years of income, then people retire at 70 when the actuary says they’ll live to 85, or retire at 72 when the actuary says they’ll live to 87, and so on.  Basically a guaranteed, fixed-term, annuity for future delivery.

Underfunded pensions won’t go away and we need to start discussing what we’re going to do.  To start, I would encourage everyone in financial services to read Con Keating’s  “Don’t Stop Thinking About Tomorrow: The Future Of Pensions”.

Michael leads Z/Yen, the City of London’s leading commercial think tank, since co-founding it in 1994 in order to promote societal advance through better finance and technology.

This article is part of our NSFM opinion series, in which participants propose specific steps towards real and sustainable market reform. Contributors write in a personal capacity. NSFM participants are invited to contribute to the series. Please contact Ebba Schmidt or Frank Jan de Graaf for further information.