Some background: From about 2008 to 2012 I spent a lot of time carrying out research on the economics of pensions as well as advising privatised companies and their regulators on managing their pension schemes.
Thank you Gordon - another masterful article. I have arrived at the position of free-market Classical Liberal, not from any prior and certainly no partisan political leanings, but by observation that everything run by government ends up as a wasteful mess. Your article has shone a light on pensions, which hadn't been prominent in my thinking, and has done nothing to persuade me to take a more benign view of government: as it expands and bloats, so does its deceit.
As a former actuary (never directly involved in pensions, though I benefit from one), I'd add to the list of problems that have caused the demise of defined benefit schemes: worker mobility. DB schemes worked brilliantly in the days when you could start your working career in a large well-run business and imagine "I fit in well here, I can envisage working here until I retire on ½ or ⅔ of final salary".
But nobody thinks that way today (except, perhaps, in parts of the public sector): companies don't last, jobs don't last, and loyalty between employee and employer has vanished. People expect to change jobs every few years, so there's no way to build up the necessary entitlement for a final salary pension. If you're lucky, maybe you could transfer already-earned benefits to your new job, but the actuaries involved on both sides both have a duty to minimise the cost to the existing schemes, so there would normally be a significant loss incurred each time you moved.
Even if all the government fiddling (started by Gordon Brown) were removed, DB schemes couldn't return, sadly.
Fair point, but I think that there is an element of self-selection about this. There are sectors of the economy which offer collective industry-wide DB schemes - local government & universities/higher education. Others, like the NHS & teachers, are collective but not funded. In countries like Canada collective funded pension schemes are very important. Such arrangements offer economies of scale and movement within the sector need not jeopardise the viability of the schemes.
Pensions are a form of compensation, so most private companies wanted to control them as a part of broader employment policies. However, once companies stopped growing and wanted to move or downsize their labour forces, the emphasis on worker retention and investment in skills disappeared. It wasn't just workers wanting to move, but even more companies wanting to shed workers. And DB schemes never worked well in small and medium companies except in the few cases where there were collective schemes.
DB pensions worked relatively well in sectors of the economy that are stable, often dominated by the public sector (even universities) and not subject to large market pressures. This was never more than 30% to 40% of total employment, but it was the part with which politicians and bureaucrats were familiar. Hence, policies neglected everyone else and continued to assume an employment model that was disappearing from the 1980s onwards.
Thanks Gordon - I agree, and did note that parts of the public sector were an exception, it's still not unreasonable to start work as a teacher or a doctor and expect to retire in the 'same' job (or, at least, the same pension scheme) 40 years later. I can't think of anywhere in the private sector where this would be a reasonable expectation - maybe a pilot for a major airline (though BA closed their 'gold standard' scheme several years ago)?
In the 1980s many company schemes were in surplus. They were required by the Inland Revenue to reduce these surpluses by writing them into profits. It was a rare CEO who objected but with falling interest rates, inflation and Gordon Brown’s tax raid these very surpluses were not there just when they were needed.
Correct. I had that, among other things, in mind when I referred to adverse tax changes. It wasn't so much a requirement to account the surpluses as profits as the pressure to cease making further contributions to pension funds when they were in surplus by disqualifying such contributions as allowable costs.
The method of valuing pension surpluses and deficits also changed radically - in effect from treating a pension fund as being supported by a viable ongoing business to a standalone basis with potentially no sponsor support.
I think the larger problem was that the government saw large pension funds as pots of money over which the government had little control and which weren't accountable to anyone. Pensioners had very limited rights and some pension funds were abused by their corporate sponsors - most obviously Maxwell - so that public sympathy for company sponsors was very limited.
What company is BT? It is not stated, at least not where I can see it?
At one point BT’s unfunded pension liabilities were more than double the market value of the company. Ofcom refused to acknowledge this while BT’s senior management stuck their heads in the sand. Eventually, for complex legal reasons, the government was forced to guarantee the liabilities of the BT pension fund.
Sorry - an acronym that may mean nothing to non-Brit readers. BT plc is the current company name of what used to be British Telecom, the privatised and former monopoly telephone company. In its current manifestation its primary operating subsidiaries are (a) BT Openreach, which runs its physical copper and fibre network, (b) BT Wholesale, which sells telephone and broadband network services to companies, and (c) BT Retail, which operates in the competitive retail market for telephone & broadband services.
British Telecom found itself in huge difficulties because of the large scale of pension liabilities inherited from when it was a government monopoly and had a much larger number of employees.
Inflation indexing: are/were defined benefit pension funds obliged by law to provide indexed pensions? Could the pension not simply be a defined benefit, fixed at the moment of retirement, like a simple annuity. An annuity provides lifetime income and the basic non-increasing variant does lose value progressively to inflation. In Canada at least the disappearance of DB pensions came after the realization by companies that pensions could be a huge existential source of risk. Pensions are not a core activity of a company was the logic. Pass them off to someone else.
It's inflation - sustained, not one-time, rises in prices - that is the primary stealthy theft practised by government. Inflation is government policy everywhere and is created and sustained through the increase in the money supply. Governments reduce the real value of their enormous debt through inflation, central banks printing money. Unfortunately, people buy the "supply chain issues" baloney instead of blaming government. The solution to inflation for an individual without a pension is an annuity for assured income, combined with an equity portfolio (best in the form of low-fee broad passive index ETFs) that in the long term compensates for inflation.
The UK passed legislation which required that DB pensions must be adjusted annually - the standard rule is inflation or 2.5%, whichever is lower. Before that companies had discretion about adjustments to pensions in payment so there was a conflict between using nominal investment returns to inflation-adjust pensions or reduce company contributions. The consequence of the change was to push DB pensions to invest in what Americans call TIPS or index-linked gilts in the UK.
I accept your point about governments relying on inflation to reduce the real value of their debt, but that is systemic for all financial assets rather than being specific to pensions. Your comment on how best to protect retirement income against inflation is correct but relatively few people in the UK have the assets at retirement to follow it. In addition, for a long time people with defined contribution pension funds were required to use the money to purchase an annuity, which was usually not inflation-proofed because inflation-proofed annuities were very offered on very unfavourable terms.
In Canada, the federal government ended the new sale of real return bonds in 2022, citing low demand. But that was the very time when inflation spiked considerably, causing a similar jump for the government in interest payments. The government wants inflation to reduce its liabilities but doesn't want to pay for it!
There was objection from various pension funds about the only instrument that offered true inflation protection (and mutterings from individuals like myself who value them since inflation is a very significant retirement financial risk when retirement lasts 30+ years). I take your point that the dynamic of enforced purchase of index-linked gilts amounted to indirect appropriation by stealth.
I've only looked at Canadian annuities but it's true what you say that the inflation-proofed annuities (pseudo in Canada because you have to pick an annual "inflation" rate 1% 2% 3% in Canada by which the payment is adjusted; there's no automatic CPI tracking option - guess why!? there are no RRBs that the insurance companies who sell annuities can use to efficiently match the liability!) are not good value. It takes many years at the much-reduced payment amount to break even before compounding considerations are even taken into account.
People who receive index-adjusted pensions backed by the taxation power of government live a highly privileged retirement.
Anyway, I appreciate your fact-filled informative posts. Keep it up!
I am surprised that the Canadian government has stopped selling RRBs. In the UK these are the primary way of issuing government debt at very low (sometimes negative) yields. When there is persistent uncertainty about future inflation. there is a very high demand for such bonds.
There are very mixed motives in this context. A significant share of inflation is outside government control - world commodity and energy prices. But the UK has just experienced a large spike in inflation entirely due to policy-driven increases in taxes and regulated utility prices. By issuing long-dated index-linked bonds a government can offer insurance that will reduce resistance to such policies at very low cost to itself.
It would appear from your article that, as I suspected, the Treasury really consider that all wealth in the country should belong to the State for them to divvy out as they see fit.
It would appear that the Treasury has been captured by Marxists!
I think that it is slightly different. First, they are tax collectors for whom income is the core part of the tax base, so allowing people to defer taxes on income is (to their mind) fundamentally unfair. They wouldn't acknowledge that taxing earnings and then taxing the income that is generated by savings is inefficient - that is just what an income tax is. Second, I think that it is politicians rather than civil servants who are inclined to believe that they know better how to spend people's money than the recipients. After all no politician likes to believe that they, along with their fellows, are incompetent and dishonest.
Thank you Gordon - another masterful article. I have arrived at the position of free-market Classical Liberal, not from any prior and certainly no partisan political leanings, but by observation that everything run by government ends up as a wasteful mess. Your article has shone a light on pensions, which hadn't been prominent in my thinking, and has done nothing to persuade me to take a more benign view of government: as it expands and bloats, so does its deceit.
As a former actuary (never directly involved in pensions, though I benefit from one), I'd add to the list of problems that have caused the demise of defined benefit schemes: worker mobility. DB schemes worked brilliantly in the days when you could start your working career in a large well-run business and imagine "I fit in well here, I can envisage working here until I retire on ½ or ⅔ of final salary".
But nobody thinks that way today (except, perhaps, in parts of the public sector): companies don't last, jobs don't last, and loyalty between employee and employer has vanished. People expect to change jobs every few years, so there's no way to build up the necessary entitlement for a final salary pension. If you're lucky, maybe you could transfer already-earned benefits to your new job, but the actuaries involved on both sides both have a duty to minimise the cost to the existing schemes, so there would normally be a significant loss incurred each time you moved.
Even if all the government fiddling (started by Gordon Brown) were removed, DB schemes couldn't return, sadly.
Fair point, but I think that there is an element of self-selection about this. There are sectors of the economy which offer collective industry-wide DB schemes - local government & universities/higher education. Others, like the NHS & teachers, are collective but not funded. In countries like Canada collective funded pension schemes are very important. Such arrangements offer economies of scale and movement within the sector need not jeopardise the viability of the schemes.
Pensions are a form of compensation, so most private companies wanted to control them as a part of broader employment policies. However, once companies stopped growing and wanted to move or downsize their labour forces, the emphasis on worker retention and investment in skills disappeared. It wasn't just workers wanting to move, but even more companies wanting to shed workers. And DB schemes never worked well in small and medium companies except in the few cases where there were collective schemes.
DB pensions worked relatively well in sectors of the economy that are stable, often dominated by the public sector (even universities) and not subject to large market pressures. This was never more than 30% to 40% of total employment, but it was the part with which politicians and bureaucrats were familiar. Hence, policies neglected everyone else and continued to assume an employment model that was disappearing from the 1980s onwards.
Thanks Gordon - I agree, and did note that parts of the public sector were an exception, it's still not unreasonable to start work as a teacher or a doctor and expect to retire in the 'same' job (or, at least, the same pension scheme) 40 years later. I can't think of anywhere in the private sector where this would be a reasonable expectation - maybe a pilot for a major airline (though BA closed their 'gold standard' scheme several years ago)?
In the 1980s many company schemes were in surplus. They were required by the Inland Revenue to reduce these surpluses by writing them into profits. It was a rare CEO who objected but with falling interest rates, inflation and Gordon Brown’s tax raid these very surpluses were not there just when they were needed.
Correct. I had that, among other things, in mind when I referred to adverse tax changes. It wasn't so much a requirement to account the surpluses as profits as the pressure to cease making further contributions to pension funds when they were in surplus by disqualifying such contributions as allowable costs.
The method of valuing pension surpluses and deficits also changed radically - in effect from treating a pension fund as being supported by a viable ongoing business to a standalone basis with potentially no sponsor support.
I think the larger problem was that the government saw large pension funds as pots of money over which the government had little control and which weren't accountable to anyone. Pensioners had very limited rights and some pension funds were abused by their corporate sponsors - most obviously Maxwell - so that public sympathy for company sponsors was very limited.
What company is BT? It is not stated, at least not where I can see it?
At one point BT’s unfunded pension liabilities were more than double the market value of the company. Ofcom refused to acknowledge this while BT’s senior management stuck their heads in the sand. Eventually, for complex legal reasons, the government was forced to guarantee the liabilities of the BT pension fund.
Sorry - an acronym that may mean nothing to non-Brit readers. BT plc is the current company name of what used to be British Telecom, the privatised and former monopoly telephone company. In its current manifestation its primary operating subsidiaries are (a) BT Openreach, which runs its physical copper and fibre network, (b) BT Wholesale, which sells telephone and broadband network services to companies, and (c) BT Retail, which operates in the competitive retail market for telephone & broadband services.
British Telecom found itself in huge difficulties because of the large scale of pension liabilities inherited from when it was a government monopoly and had a much larger number of employees.
Inflation indexing: are/were defined benefit pension funds obliged by law to provide indexed pensions? Could the pension not simply be a defined benefit, fixed at the moment of retirement, like a simple annuity. An annuity provides lifetime income and the basic non-increasing variant does lose value progressively to inflation. In Canada at least the disappearance of DB pensions came after the realization by companies that pensions could be a huge existential source of risk. Pensions are not a core activity of a company was the logic. Pass them off to someone else.
It's inflation - sustained, not one-time, rises in prices - that is the primary stealthy theft practised by government. Inflation is government policy everywhere and is created and sustained through the increase in the money supply. Governments reduce the real value of their enormous debt through inflation, central banks printing money. Unfortunately, people buy the "supply chain issues" baloney instead of blaming government. The solution to inflation for an individual without a pension is an annuity for assured income, combined with an equity portfolio (best in the form of low-fee broad passive index ETFs) that in the long term compensates for inflation.
The UK passed legislation which required that DB pensions must be adjusted annually - the standard rule is inflation or 2.5%, whichever is lower. Before that companies had discretion about adjustments to pensions in payment so there was a conflict between using nominal investment returns to inflation-adjust pensions or reduce company contributions. The consequence of the change was to push DB pensions to invest in what Americans call TIPS or index-linked gilts in the UK.
I accept your point about governments relying on inflation to reduce the real value of their debt, but that is systemic for all financial assets rather than being specific to pensions. Your comment on how best to protect retirement income against inflation is correct but relatively few people in the UK have the assets at retirement to follow it. In addition, for a long time people with defined contribution pension funds were required to use the money to purchase an annuity, which was usually not inflation-proofed because inflation-proofed annuities were very offered on very unfavourable terms.
Thanks for your reply.
In Canada, the federal government ended the new sale of real return bonds in 2022, citing low demand. But that was the very time when inflation spiked considerably, causing a similar jump for the government in interest payments. The government wants inflation to reduce its liabilities but doesn't want to pay for it!
There was objection from various pension funds about the only instrument that offered true inflation protection (and mutterings from individuals like myself who value them since inflation is a very significant retirement financial risk when retirement lasts 30+ years). I take your point that the dynamic of enforced purchase of index-linked gilts amounted to indirect appropriation by stealth.
I've only looked at Canadian annuities but it's true what you say that the inflation-proofed annuities (pseudo in Canada because you have to pick an annual "inflation" rate 1% 2% 3% in Canada by which the payment is adjusted; there's no automatic CPI tracking option - guess why!? there are no RRBs that the insurance companies who sell annuities can use to efficiently match the liability!) are not good value. It takes many years at the much-reduced payment amount to break even before compounding considerations are even taken into account.
People who receive index-adjusted pensions backed by the taxation power of government live a highly privileged retirement.
Anyway, I appreciate your fact-filled informative posts. Keep it up!
I am surprised that the Canadian government has stopped selling RRBs. In the UK these are the primary way of issuing government debt at very low (sometimes negative) yields. When there is persistent uncertainty about future inflation. there is a very high demand for such bonds.
There are very mixed motives in this context. A significant share of inflation is outside government control - world commodity and energy prices. But the UK has just experienced a large spike in inflation entirely due to policy-driven increases in taxes and regulated utility prices. By issuing long-dated index-linked bonds a government can offer insurance that will reduce resistance to such policies at very low cost to itself.
It would appear from your article that, as I suspected, the Treasury really consider that all wealth in the country should belong to the State for them to divvy out as they see fit.
It would appear that the Treasury has been captured by Marxists!
I think that it is slightly different. First, they are tax collectors for whom income is the core part of the tax base, so allowing people to defer taxes on income is (to their mind) fundamentally unfair. They wouldn't acknowledge that taxing earnings and then taxing the income that is generated by savings is inefficient - that is just what an income tax is. Second, I think that it is politicians rather than civil servants who are inclined to believe that they know better how to spend people's money than the recipients. After all no politician likes to believe that they, along with their fellows, are incompetent and dishonest.