The collective pension plan in its various iterations is probably one of the most significant, and undersung, financial and policy innovations of the 20th century. Workplace pensions represent one of the most important, if not the most important financial assets for millions of people.
The Netherlands consistently tops international pension system rankings like the Melbourne-Mercer Global Pensions Index. But the country seems stuck in an extended debate about the precise constellation of its future system. In a 2018 international survey by State Street Global Advisors, Dutch respondents were the least optimistic about their own financial future, with just 8% responding positively.
And in the UK, the high-profile Universities Superannuation Scheme (USS, the country’s largest) is again under pressure as trade unions repeatedly clash with employers over the future of the scheme. Unions were set to take industrial action over contribution levels at the end of February. Other issues, such as the valuation methodology and risk tolerance of the scheme are subject to reappraisal.
Ageing populations and low interest rates are facts, and most people can grasp the simple reality that lower returns and longer lives mean people today either have to work longer, pay more or make do with less, at least compared with previous generations.
Keith Ambachtsheer, Toronto-based director emeritus of the Rothman Institute, refers in a recent Ambachtsheer Letter to research stating that an inflation indexed pension based on a 70% final salary accrual rate costs 40% of pay when the risk risk-free return is 1% (Hamilton and Cross, 2018).
Yet the cost falls to 20% if the return is 3.5% above the risk free, which only highlights the need for clear thinking and consensus about the right level of risk.
However, determining the right risk level is complex and intractable when rates are low, returns subdued and much regulation favours short-term risk reduction at the cost, of prudent long-term risk taking.
Ambachtsheer articulates the wisdom of a two-pot approach to long-term investing, combining a risk-taking portfolio with an LDI strategy and allocating from one to the other over time.
A similar concept, individual pensions accrual combined with collective benefits, is one of two approaches being considered in the Netherlands. Another approach, favoured by unions, involves conditional pension rights in a more explicit form of collective DC.
The stakeholders of USS might do well to consider a more ambitious long-term compromise. In the UK the abandonment of private sector DB pension accrual was accompanied by remarkably little public debate. While they may be relatively easy to abolish, DB pensions appear very difficult to reform.
Liam Kennedy, Editor