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John Ralph is an independent pension consultant.
Is the answer to Britain’s chronic underinvestment problem really behind the pension couch?
Prime Minister Jeremy Hunt certainly thinks so, and his Lecture at Mansion House in July Defines how defined contribution plans invest 5 percent of their assets in private equity, venture capital and start-ups.
Pension experts have also chimed in, proposing various ways for corporate defined benefit pensions to invest more of their £1.7tn assets in equities.
Sadly, most of these ideas are half-baked and misunderstand how DB pensions work, how financial markets work, or how trustees’ decisions work. doing. Some people misunderstand all three.
Still, something is happening. The government said, “Assets held by the DB system may do more for members, employers and the economy.” Formal talks have just endedasking for opinions on two big ideas.
— get the DB scheme “invest for surplus”, By switching from boring bonds and gold coins to stocks etc. “productive assets”, Businesses can withdraw cash under strict conditions.
— set up a new one “Public Sector Integrator” To consider DB schemes and invest in stocks/“productive assets” It has economies of scale and expertise.
Only quoted and unquoted stocks are “productive assets” even though corporations use cash from bonds to invest in their businesses and gold is paid to pay for public goods of all kinds Let’s ignore the government’s explicit belief that the
Attempts to persuade the DB scheme or placate it back to stocks are utterly unsuccessful. The nature of DB pension promises has changed so radically in recent decades that we can’t rerun ‘fairness worship’ like an ’80s sitcom.
DB annuities were not guaranteed annual inflation increases and were once effectively ‘profitable’, with members sharing the risk and return of asset performance. If the performance is good, the pension will be increased, if the performance is bad, it will not be increased.
Corporations were lenient about holding stocks, as they were only charged deficit contributions if their assets fell below the modest value of the guaranteed annuity. The “discretionary” increase served as a safety valve.
Rising annual inflation rates with guaranteed caps, coupled with significant declines in real interest rates over the past 25 years, have fundamentally transformed DB pensions from ‘profitable’ to pensions. Members currently do not share any asset performance risks or returns.
Where equities were once the matching asset, now fixed bonds and inflation-linked bonds are the matching asset.
Matching pension assets and liabilities (holding bonds instead of stocks) has been standard in corporate finance going back 40 years. Great American economist Fisher Black. This is about actuaries applying these principles to the UK. in “Exley, Mehta, Smith”, 1997.
I am currently chairing the Pension Board and I am the chairman of a small plan, and I have no incentive to hold more stock. Our job is to keep our pension promises.
To convince trustees to hold more shares, companies need to start sharing their outperformance again, giving members, say, a quarter of their annual equity outperformance. But it doesn’t make sense to give up some of the upside in stocks and keep all of the downside while companies are struggling to cover their losses.
If companies really want to “excess investment,” they can cut out pensions entirely and just borrow directly from their own balance sheets to buy stocks. No company chooses this. So why should we do this indirectly through pension funds?
“Investing for surplus money” is just a form of leverage disguised and never yields good results.
If governments want to encourage investment in specific industries, they should continue with targeted tax cuts rather than wielding pension sledgehammers.
So what about the other proposal, that of allowing companies to withdraw cash from pension plans?
At present, there is no mechanism to allow companies to do this until pensions are bought up. This is to protect members and prevent pensions from being treated as (tax-exempt) piggy banks. We should be very suspicious of any changes.
What’s the deal with the members anyway? If the insurer’s takeover date is pushed back, they’re bound to lose money.
Persuading the trustee to agree will require both a bank guarantee for the cash drawn out in bankruptcy and the company providing compensation through pension increases. Businesses may be better off borrowing directly from banks.
The government’s other major initiative, “integration of the public sector,” is also riddled with holes. This is important. The only guarantor of the “public sector integrator” is the government. No one else.this is Huge Policy change. Why should taxpayers start guaranteeing hundreds of billions of pounds of private sector DB pensions?
If the government really wants a regulated pool of capital to invest in “productive finance” instead of guaranteeing private sector pensions, like the Royal Mail during privatization in 2012. Why not transfer all your assets and liabilities to a new public sector pension plan? Will the government then be able to invest as it pleases?
To put it more simply, wouldn’t it be better to issue gold and directly invest it?
