New report claims the whole UK pension system has been a giant bet on the stock market. Survey shows people now wish they hadn’t bothered with pensions.
by Dr. Ros Altmann
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20th May 2009
Ros Altmann’s report challenges standard investment thinking. She says:
‘Essentially, the entire UK pension system has been based on a bet that equities would always do well enough over the long term to reliably deliver good pensions’
‘The bottom line is that financial theory tells us nothing about whether any particular pension investors will actually benefit from the equity risk premium at all’
‘The idea that equity markets might not deliver over the long-term was never seriously entertained by policymakers’
‘Nobody explained to workers that they were effectively gambling their future security on the stock market’
Hardly a surprise, then, that a new MetLife Survey shows people disappointed with their pensions, lost faith in the stock market and will have to work longer. We all know we need to consider insuring our house against fire, flood or burglary, but pension investors did not realise they should consider insurance against being decimated by falling stock markets.
‘New approaches to pension planning are required. Most people want a measure of security and are not so worried about maximising investment returns.’
Ros Altmann was asked by US insurance company MetLife to write an independent report examining the reality facing millions of people in the UK who are struggling to plan for their retirement. The report attempts to sort out some of the muddled thinking and erroneous assumptions that have left UK pensions in crisis.
Credit crisis has damaged pensions: The report aims to offer some alternative thinking on long-term investing to inform the pensions debate. It highlights how people who have trusted our pension system, and wanted to provide for their futures, have been let down. Those coming up to retirement now, without a final salary pension, have seen their pension fund assets fall and the costs of buying an annuity rise, as a direct result of the credit crisis.
Damning Survey results: MetLife commissioned a survey which confirms what most of us probably already know – that many people wish they had never bothered with a pension at all, most now recognise they may have to work longer and their pension savings will not provide them with much in retirement as the stock market may not be a reliable long-term investment.
Too much ‘blind faith’ in the stock market: The report challenges the standard orthodoxy which says long-term investors will always do best by relying on the stock market. It suggests that financial theory has been both misunderstood and misrepresented. In reality, there has been far too much ‘blind faith’ in stock market returns and not enough emphasis on security of income for older members of society.
Pensions must provide two things: 1. secure income 2. high investment returns: The report outlines that pensions fulfil two functions – they are very different, in fact, but are called the same. Firstly, pensions need to provide security of income in old age – some social insurance which is normally a state role. However, continuous cuts in our state pension have left it inadequate, so that private pensions need to provide some minimum security too. Secondly, pensions are long-term savings from which investors can try to obtain strong returns. But, as the report explains, millions of British savers were led to believe that investing in the stock market would provide the minimum security they need as well as strong investment returns over time! This has not turned out to be true for current retirees – hundreds of thousands of people every year.
UK policy for both state and private pensions, relied on high equity returns: The traditional employer final salary scheme did actually provide both aspects of pensions – minimum social security and a private savings vehicle for workers’ own contributions. The report outlines how UK pension policy has, at its core, been based on assuming that pension investments in the stock market could be relied on to deliver good pensions in future! This led to state pensions being cut, extra burdens being placed on employer final salary schemes, and personal pensions being expected to provide strong long-term returns for those without employer schemes too. There was no ‘Plan B’. It was said to be axiomatic that all investors for the long-term would do best in the stock market.
Equity risk premium cannot be relied on: The credit crisis has confirmed that such over-reliance on the stock market has been a disaster. In the UK over the past 10 years, £10,000 invested in the stock market would be worth just £8,500 – a fall of 15% – whereas £10,000 invested in government bonds would now be worth £17,000, a rise of 70%. In Japan over the last 15 years, bonds have increased by 80%, while equities have fallen by 50%. So much for relying on the equity risk premium.
Policy must address pension security: If equities cannot be relied on, policymakers must urgently address the challenge of adequately supporting a rapidly ageing population. Those coming up to retirement now face an impoverished old age, which could damage growth even more than the credit crisis in the coming years.
A ‘pension fund’ is not a ‘pension’: There are some essential truths that people need to understand, when planning to provide later life income. For example, most people do not realise the difference between their ‘pension fund’ and their ‘pension’. They think they are saving ‘in a pension’ but they are not. Getting income out of their fund in later life is a completely separate issue, and the money being put in cannot predict what pension income they will get out later, because there are so many risks that can affect the outcome. Annuities are little understood and the FSA has failed to regulate them in the consumer interest. Alternatives to standard annuities are not widely offered. This has left millions of people with inadequate retirement provision.
Final salary schemes caused confusion: Confusion has arisen because, with final salary schemes, workers’ contributions did allow them to predict what pension they would receive later. However, the reason for that was that employers had to step in to make up any shortfall. Without that employer obligation, people cannot predict what income they will get at all.
Final salary scheme assets were not insured against pension risks: In reality, falling stock markets, falling interest rates, rising life expectancy and high charges can all mean that even apparently large contributions to a private pension scheme may deliver disappointing pensions. Employer final salary schemes failed to protect their investments against these risks and most have now had to close. But individuals have not been told that their pensions are so exposed to huge risks. Anyone who invests in a property knows their house might be damaged by fire, flood or burglary and they may need some insurance. However, people contributing to a pension scheme were led to believe that equities would not let them down over the long-term, so they did not even realise they needed to consider insurance. This has been a significant policy failure.
We need a new approach – can we provide some affordable insurance protection? We have to re-think our whole approach to pension saving and be honest with people so they can understand the need to differentiate between the minimum security aspects of pensions and aiming for high investment returns, to understand the difference between a pension ‘fund’ and pension ‘income’ and to know the vital questions they should ask themselves along the way. This report aims to explore these important issues and I hope it will be a useful addition to the wider debate about how individuals can plan for their retirement. They are on their own, facing huge risks and do not always even understand the basics. In our rapidly ageing population, failure to grasp this issue could lead to millions of impoverished pensioners and long-term economic decline. The sooner we wake up to reality, the better for all of us. I hope you will enjoy the report.
The report (it’s 5.7 megabytes) can be accessed at: http://www.rosaltmann.com/Planning_for_Retirement.pdf
Dr. Ros Altmann