A mixture of task & communication checks help manage the problem of proliferating complexity in the modern word – that’s the relatively simple premise of Atul Gawande‘s short, but excellent book on checklists – The Checklist Manifesto.
The book is driven mainly from a medical context, that being the author’s background, and centred around the astounding data from a study supported by the World Health Organisation into the power of checklists. Although the context is broadened to be applicable to many facets of modern life- examples and applications are also cited from construction, aviation and even finance. The humble checklist can dramatically improve baseline performance – perhaps more so than even the best new drugs or surgical technologies.
Gawande draws a key distinction between two types of error: (1) errors of ignorance (where we don’t know enough) and (2) errors of ineptitude (failing to correctly apply what we do know. Most of the failures in the modern world are of the second kind.
What were the key insights?
Well, here’s a checklist –
I was influenced in a lot of this thinking by Charles Duhigg‘s excellent book Smarter, Faster better which I discussed in more detail here. Mitesh Sheth also wrote up this excellent list of productivity hacks, which I contributed to.
2. Approach the world as it is, not as you’d like it to be
2016 was a year of surprises and shocks at a macro political level. Some of the events that took place challenged the world views of people – including myself. The result of the EU referendum left many people – myself included- feeling more than a little frustrated and angry.
3. Understand the Building Blocks of Change
Changing habits at work is hard. Rolling out new systems and processes and changing old ones. It’s so vital to keep operating efficiently, but the extra burden to individuals of change in the short term will also be resisted.
This great blog by Mckinsey helped me greatly in my understanding of the 4 key requirements for workplace change:
Making effective decisions therefore, involves getting beyond stories into data, asking the right questions, and seeking evidence (where it can be found). Testing theories, rejecting hypotheses, trying to assess against a counterfactual and learning as much from the trials that didn’t work as those that did.
My most-read blog posts of 2016 were:
This post, responding to the misguided (in my view) viewpoints of London Evening Standard journalist Anthony Hilton in September garnered by far the most views of any of my blogs this year (around 1400 views).
The article must have stuck a chord with readers in the pensions world. We do of course live in pretty challenging times for DB pension funds, with several strong macro-economic headwinds making it harder to deliver the benefits that have been promised. This year saw a vigorous debate around what should, or should not be done to the DB pensions system. This debate was further catalysed by the high-profile cases of BHS and British steel, and the debate looks set to run on into 2017.
Given the importance of the DB system to the retirement prospects of millions of members I believe a solid debate on some of these important issues is to be welcomed, and look forward to continuing the debate productively in 2017.
Powerful forces of change are at play in many industries, and asset management is certainly one of them. Technological and demographic shifts will shape the future of the asset management industry, in this piece (April 2016) I discussed some of the intersecting forces, drawing on a wide body of existing research on the future of work and finance.
Here are my six key takeaways:
In the wake of the BHS pensions story, the W&PSC issued a green paper calling for views on the future of the DB pensions system in the U.K. Given the prominence of this debate and the considerable air-time it’s received this year the responses from the main actuarial & investment consulting firms were considered and insightful. What was also interesting was the diversity of views. Will most schemes pay the benefits promised? Should the role of TPR change? Should there by wholesale change to the system? Will small changes be effective? Is consolidation feasible? These were all questions on which the consulting firms gave insightful, but often differing answers.
I hope you’ve enjoyed my blog posts this year. I look forward to sharing more in 2017. Sign up to receive updates on new posts.
The Work & Pensions Select Committee (WPSC) Pension Protection Fund and Pensions Regulator inquiry consultation certainly attracted a good number of responses. I count almost a hundred in that list and presumably not all are yet published!
Most of the major investment & actuarial advisory firms are represented there, as well as PPF and The Pensions Regulator.
Reading through the submissions of all the investment advisory firms (yes, I really did!) I must admit was struck by the quality of the submissions, the level of thought that had clearly gone into them and the ordered and lucid way in which arguments were presented. I didn’t agree with everything that was said by our competitors (you’d expect that) but I was impressed with the quality.
I’ve tried to summarise each of them below, naturally these are through the lens of my own reading and interpretation. If you think I’ve got any of them wrong, please let me know!
At the end I’ve tried to draw out the questions on which that group of respondents are clearly divided.
I’ve ordered the summaries below on an approximate scale of suggested change level, from those that argued for least >> most
Big picture Hymans believe that the current regime is fine, there is not an issue with affordability subject to giving schemes and sponsors “time to heal”.
“Most schemes are well managed and should be able to pay benefits in full
Hymans would not propose any changes lest these have unintended consequences and damage the functioning of the majority of schemes. Floated the idea of conditional indexation in stressed situations but highlighted the need for “watertight safeguards”. On the regulator’s powers:
“The regulator has adequate power. It’s wrong to assume that committing more resource to the regulation of DB schemes will improve outcomes for pensioners. It might actually exacerbate the problem – because more onerous regulation could make DB provision more difficult for employers.
Hyman’s noted that the PPF has been managed in a sustainable way and indeed provides a good risk management model for all pension funds.
Provided a timely reminder that the PPF itself is both necessary and stable – with a growth in assets to £23bn but a funding level of 116%, and total benefits paid out to members of £2.4bn.
Much of the response concerned considerations regarding the future level of the levy, describing enhancements to the models used and refinements based on data gained, particularly in taking a different approach to small companies compared to large ones. Improving predictiveness of models, using different variables.
The PPF indicated a belief that sponsoring employers have sufficient cash and financial strength to shorten recovery periods, and discussed their aggregate modelling of the number of schemes predicted to enter the PPF:
“. Indeed our modelling projections would indicate that given the strength of employers in the median case the vast majority of schemes should be sufficiently funded to pose little risk of making a claim on the PPF by 2030 (with less than 700 schemes falling into the PPF in in the median case by that time as against around 850 to date).
The PPF would support a more interventionist role from TPR, for certain categories of scheme, with the goal of tackling risks to member benefits. In particular PPF believe that for stronger sponsors shorter recovery periods should be targeted (interesting, this is the one area where the PPF appear at odds with TPR, with TPR indicating their willingness for more flexible terms for strong sponsors). PPF believe restrictions on recovery periods and “back-end loading” of contributions would be appropriate.
For stressed schemes – the PPF suggests intensive scrutiny and consideration of the options for restructuring the scheme. They made a case for TPR to have the broad power to trigger the wind-up of schemes with request of PPF or the trustee. In transactions PPF believes avoidance powers could be enhanced by better targeting and faster implementation. Duties placed upon employers and trustees to engage with TPR would be appropriate.
PPF noted that options for scheme consolidation should be considered. Highlighted their concern at the suggestion of new business models that might allow a scheme to continue without a sponsor.
TPR believe the current regime is operating as intended and most pension schemes are affordable for the majority of employers (backed up by data on ratio of contributions to dividends). Made some suggestions on how TPR could be changed with the benefit of experience: more powers to compel individuals and organisations to give TPR information and submit to scrutiny (including civil powers). More timely actuarial valuation information (narrowing the 15 month window in acknowledgement of technological enhancements). Powers to be more prescriptive on the overall funding and investment outcome, rather than focusing on individual parameters such as length. Shifting the burden of proof to schemes to justify long recovery periods etc. Mandatory clearance of corporate transactions could be considered (the current system being voluntary), which could extend to all actions that potentially weaken the standing of a pension scheme (eg dividends, share buybacks). Suggested enhanced whistle-blowing procedures could also be considered.
We stressed the importance of considering all this from the member perspective, and emphasised the benefits to schemes of enhanced governance (which many UK schemes are of insufficient scale to deliver). We also highlighted the existence of a number of success stories around the industry that we believe through better knowledge-sharing of best practice. We acknowledged the tricky balance that regulation must strike between security for members and sustainability of firms, noting that it is usually in the best interests of pensioners to continue to have an ongoing firm backing the scheme. We argued for small-scale changes to existing regulation to strengthen the hand of trustees in funding negotiations, provide more guidance on parameters and shift the responsibility to sponsors to offer additional security in the case of lengthened recovery plans.
LCP’s response took things back to the highest context level, highlighting the key tensions and spelling out the fact that there aren’t any easy political choices. LCP believe a “significant minority” of schemes will be unable to pay full benefits. Resolution will require political change now which may be painful in the short term, but carry long term benefits for security of pensioners. Setting out the three different political options facing the government LCP described the broad choices as (1) leaving the balance between DB members and employers broadly the same (2) shifting the balance in favor of member security at the possible risk of “significant negative impact” on corporate sponsors and (3) shifting the balance to soften the pension promise, creating “welcome easement” to firms at the expense of reducing the value of pensions paid to members. Beyond that point LCP said they broadly agreed with the response of the ACA (summarised below). LCP believe that small changes (to regulation) are unlikely to have a positive impact:
“We think it unlikely that small changes to the current pension regulatory environment will have a major positive impact, and they may have negative unintended consequences. We strongly recommend that you do not propose changes to Government in order to be “seen to do something” in response to BHS.
LCP also commented that the exit from the European Union might present opportunities to change legislation.
On the issue of regulating the effect on pensions of corporate action, Mercer believed the onus could be moved to the other relevant regulators (such as the FRC, PRA or takeoever panel), to take into account pensions issues in the context of corporate activity, rather than the “single issue” pensions regulator becoming involved in corporate activity. Mercer suggested that advisers themselves could be an enhanced source of regulation by increased use of “whistleblowing” type activity and an enhanced focus on the need for members of professionally regulated bodies to do this.
On the question of TPR’s powers, Mercer made the point that before considering new powers the way TPR exercises it’s current powers should be evaluated, as it is possible the current powers are sufficient, but not being fully utilized. New powers would not necessarily reduce the risks faced by pension schemes. Making TPR more interventionist would not guarantee better outcomes, and might impose additional costs on trustees for no gain.
On the question of whether the current market conditions warranted an exceptional approach:
“Unfortunately, it is not possible to tell if the current environment is exceptional, and so difficult to say it warrants an exceptional approach.
“Our view is that the purpose of a valuation is to impose some controls over the future expected cost of providing the scheme and the pace at which that cost is met. The statutory funding regime achieves that. If a non-market related approach were introduced, the results might be different, but they would also have no context, be virtually meaningless (for example, they might not give appropriate signals to inform investment strategy), and inevitably short lived.
Made some very similar points to Mercer in the role that other regulators could play with regard to pensions, and much of the wording in other areas also bears a lot of similarity, suggesting there was a lot of common input.
In particular the ACA highlighted a possible role for other regulators:
“Consider the role of all regulators that could possibly have authority over actions that might affect pension scheme outcomes, and how they could use their powers to influence good governance in relation to decisions and advice affecting workplace pension provision.
Gave examples of the Takeover Panel, PRA and FRC, noting that the TPR itself does not regulate the way companies are run, and how they balance the demands of DB pension provision against other things.
“…corporate responsibility for balancing the security of company pension schemes with their other priorities seems a matter for other regulators, such as the FRC or PRA, with responsibility for good corporate management and governance.
Believe making TPR more interventionist, from it’s current supervisory and guidance stance is not a guarantee of better outcomes, not helped by the TPR’s internally inconsistent and conflicting objectives.
On the TPR’s powers the ACA response (again similarly to Mercer) emphasis the belief that existing powers have perhaps been underused or in practice are “illusory”
TPR has seldom used those of its powers that would directly impact company decisions, which has perhaps led many to view that its powers are illusory (for example, because the hurdles to cross before they can be used are too onerous). It is possible that the threat of using them has always proved sufficient, but that is not obvious to many in the industry. TPR has to produce reports about when it does use its powers; some clarification around situations where it chooses not to might also be helpful.
The ACA noted that TPR’s objective to minimize claims against the PPF skews it’s focus (towards larger schemes, even if they are at lower risk of default) in a way that is not necessarily optimal for the functioning of the system as a whole.
The ACA suggest a statutory override to RPI benefits (moving them to CPI) in the context of generating inter-generationally fair outcomes in relation to money purchase pension recipients. ACA note that the intention of trust law probably wasn’t to hardwire benefit increases to a particular index and also that mandatory indexation was enshrined by the Pensions Act 1995, suggesting that it is appropriate for the government to legislate to overcome problems created by previous legislation.
Mentions consolidation relatively briefly, makes the point that benefit complexity is one barrier to this happening, suggests that introduction of a facility whereby historic benefits can be converted to a single standard would facilitate this.
Aon believe that the inquiry into DB should be considered in the context of DC – money spent on DB can’t be spent on DC. Aon believe that an intermediate solution should be available to some schemes between full benefits and PPF levels. Focusing more on bigger regulatory changes rather than tweaks AON made some quite developed suggestions in regard to intermediate solutions, for workable changes to the existing regime. Broadly these suggetions were in favor of an intermediate benefit solution based on conditional indexation and moving to more of a “with-profits” style system with regard to pension increases (pay increases conditional on the performance of growth assets). Aon suggested that a change to a with-profits system (including within the PPF) might make it easier to push for consolidation of schemes without subsidy.
Of the consulting firms Aon came closest to advocating changes to the funding approach- articulating the benefits of a cashflow and probability of success measurement regime as opposed to a present value and funding level, however overall Aon reflected a balanced view here, arguing for a “wider range” of approaches, including both present value and cashflow approaches, rather than a replacement of the present value approach.
“A present value approach is not wrong. It encapsulates the valuation in a single figure, which probably does reflect where the scheme is trying to get to in the long-term. It also tends to encourage more immediate action in response to changing circumstances, although this means reducing deficit contributions when deficits reduce, as well as increasing deficit contributions when deficits increase. However, the present value approach does have a number of disadvantages which are becoming more apparent in the current low yielding and volatile environment
Aon suggest giving company directors a responsibility to consider the funding level of the pension scheme when deciding upon dividends.
AON “called out” the practical challenges associated with consolidation – namely that it’s tricky to do it in a way that both avoids cross-subsidies between schemes AND achieves the enhanced governance objectives of consolidation. This is important as the concept of consolidation seems an easy one to agree upon, but much harder to find workable ways to achieve it in reality.
Cardano believe that the regime should be changed to engender (1) greater prevention – by focusing on the economic value of the liabilites (rather than the technical provisions basis which allows for asset returns) and (2) more flexibility – with the ability for trustees to negotiate with employer to get to an intermediate solution between full benefits and PPF benefits, in advance of a full corporate insolvency process. Cardano believe that there is a systemic affordability issue that government needs to address. Cardano believe that the current system of Technical Provisions gives a false sense of security, they also referred to the increased cashflow negativity of schemes and path dependency issues this creates as schemes pay out full benefits while being substantially underfunded on a full economic basis.
Cardano are critical of the Technical Provisions as a measure of scheme health and believe this has not fostered the best decision making:
“The recovery plans, approved by The Pensions Regulator (TPR), have also been sliding. As schemes have become more severely underfunded, longer recovery periods and higher future return expectations have been accepted. So a fuzzy measure of the health of the pension fund (Technical Provisions) contributed to poor risk management on behalf of trustees, which led to deteriorating funding positions, and that has been met, broadly, by TPR simply relaxing the parameters, and tacitly accepting the new status quo.
I think you can boil it down to the following subjective questions with the above respondents divided on pretty much all of these points
I think there was broad agreement on what the key challenges are – namely balancing security for members with sustainability for employers. This question seems to frame the debate at the right level for government consideration, rather than getting too absorbed in the particular details.
I think there was general agreement that changes to the funding regime, particularly moving the basis on which the liabilities away from one which references bond yields are not warranted.
Scheme consolidation and conditional benefit indexation were two frequently occurring suggestions that while not universally agreed upon, would appear in my view to have enough advocates for further investigation.
A considerable number of suggestions were made regarding smaller incremental improvements to current legislation, although there was disagreement on the question of whether incremental improvements is in itself worthwhile or beneficial or wholesale reform needed. Again that question seems framed at the right level for government consideration.
There seemed to be agreement that the current system is not set up to deliver inter-generationally fair outcomes, given that younger employees (particularly in the private sector) have no access to DB provision and are likely to receive lower pensions in relative terms than previous generations. There were several suggestions that the DB reforms should be considered in the context of/alongside the DC system in the knowledge that imposing increased costs on the DB side will impact DC.
So there you have my take on the consulting community responses to the WPSC BHS pensions inquiry. Do let me know your thoughts.
“Expected returns don’t pay benefits, cash does”
Anthony Hilton recently wrote a stinging attack on pension consultants -like myself- who advise defined benefit pension schemes to measure, and hedge, their liabilities with reference to gilt yields.
Here’s one (of several) reasons why he’s wrong.
His argument – that you could fund based on the much higher expected returns on risky investments – might perhaps be justifiable in a world where all corporate sponsors were rock solid and would last forever (clearly we do not live in this world – and even then it would expose companies to some needless nasty surprises along the way, but anyway).
However this completely misses the point that a major reason we fund pensions at all is precisely to provide security in a situation where the corporate sponsor ceases to be able to make payments itself. The reason we need to measure deficits is to get a picture of how secure the benefits might be in the absence of the employer, and to take corrective action (eg topping up contributions) if the situation is off-track, before it is too late.
And in those situations of sponsor company failure, we would hit a major snag under Mr Hilton’s approach: it’s hard cash that must be used to secure the benefits – Mr Hilton’s expected returns won’t cut it I’m afraid. Just ask the pensioners of BHS scheme, or indeed the allied steel and wire groups, still campaigning for their pensions over a decade later. This second example pre-dates the Pension Protection fund, so thankfully pensions today are better protected, but the conclusion for scheme funding – that you can’t rely on high future expected returns to discount liabilities – remains valid.
Pensions need to be paid to members in real cash, and it flies in the face of both accepted theory, and common sense, that the amount of money needed to provide these benefits can be reduced depending on the assets held to deliver them.
Today’s unfortunate reality is that the defined benefit system in the UK is on average chronically under funded compared to the benefits it has promised. Time and effort would be far better spent on considering the tough choices that might need to be taken, rather than on attempts to deny the existence of a problem in the first place.
Unfortunately Mr Hilton’s ill-judged remarks from an otherwise respected journalist damage the hard work that many of us in the industry have been doing for many years to try and secure the benefits and financial futures of those members dependent on defined benefit pensions for their retirement.