• Stuart Fowler

Pension risk sharing

This morning’s FT includes a letter from me reacting to the Department of Work and Pensions’ current initiative to encourage the innovation of pension-fund structures that combine features of Defined Benefit and Defined Contribution schemes. This initiative is based on policy-makers’ acceptance that it is not economically feasible for employers to bear all of the market, inflation and liability risks but equally it is unfair and offputting if individuals have to bear these risks to their retirement outcomes.

Followers of Fowler Drew will know we don’t believe these risks can be ‘managed’ away: that would imply extraordinary faith in individual skill and arrogant disrespect for the power and efficiency of public markets. In finance theory that implied belief is often referred to as a ‘free lunch’.

We do believe they can be managed, within limits, but it requires an accommodation with uncertainty about their retirement outcomes. Telling people that inconvenient truth is part of what policy makers need to do as we move from paternalistic but failed collective structures to acceptance of personal responsibility.

This is what I said.


A minister’s conversation with the FT (Pensions industry in line for shake-up, June 18) is not the best way to judge the direction the Department of Work and Pensions is going in following its November 2012 policy document, ‘Reinvigorating Workplace Pensions’. The focus then was partly uncontroversial: better outcomes for members stemming from the lower costs of very large, and not-for-profit, collective structures. But it was also controversial, flying in the face of both finance theory and the UK’s fraught history of risk transformation. It is the risk-sharing part of the proposed collective schemes that the interview casts little light on.

Steve Webb should be in no doubt that sharing investment risk, whether between different members or between all members and employers, is a dead end. Capital markets are not about fairness but they are also so unfair as to overwhelm any attempt to provide more equal pension outcomes between members of different ages. Since 1950, real total returns over rolling 10-year periods (equivalent to 10-year differences in retirement age) for the UK stock market have been as good as 15% pa and as bad as -5% pa. Diversification of equity-type risks has not done a lot to narrow that range which reflects changes in the inflation regime as well as in the ‘real economy’, internationally as well as in the UK.

Insuring or reserving (risk free) against such real-outcome variance will cost as much as the benefit, which is why ‘third-way’ annuities with guarantees have not turned out to be the answer. As an alternative to insurance, using discretionary judgement to engineer less variable payouts to members across time, as attempted by with-profits fund actuaries, nearly led to ruin. Logically, if either insurance or management were solutions, the problem of high variance would not now exist.

This is not a counsel of despair. Longevity risk can be lessened by large-scale pooling of lives assured. The uncertainty of investment outcomes can be reduced by changing the way members convert their own pension capital into real ‘income’.

We cannot afford, either individually or collectively, to live off inflation-protected annuity incomes for a retirement as long as it is. Annuities without inflation protection simply transform the risk from equities to inflation. Since we are forced to bear the inequity of risk assets, annuities needs to be phased over much of the expected drawdown period. Personal decisions about rates of income drawdown, as an alternative to buying annuities, need much better professional support, such as from modelling all the risks to sustainability.

This is what we in the industry should be talking to Whitehall about. It may not be radical but it is at least honest and that could just be what is needed to meet the Government’s objective of ‘increasing trust, confidence and engagement’.

Stuart Fowler

#investmentprocess #pensions #pressmentions #risk


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