Interim Interview: Alan Salamon
The pension industry – what are the challenges, what lies ahead and is Brexit affecting your pension?
Oli Templeton, Senior Consultant - Financial & Professional Services, interviews Alan Salamon. Alan is a recognised industry leading company pension and investment specialist with strategic, operational and commercial experience in both Defined Contribution (DC) and Defined Benefit (DB) regimes. Having managed a pension fund and having worked in both insurance and fund management, he has unique knowledge of the whole pension fund industry. He also holds the Award in Pension Trusteeship, the Investment Management Certificate and is PRINCE2 qualified.
Starting with Brexit, what do you see as the challenges ahead?
The most striking element in all the political and media contributions about Brexit is that although experts have a lot to say on the subject, none of them can know how the whole thing will pan out. They also ignore that without Brexit, the EU has a substantial number of similarly difficult and continuing problems. This is an important point because the only real Brexit issue currently affecting the UK is one of exchange rates and these will improve, and worsen, relative to any other currency, including the Euro, from time to time.
Anyway, specifically on pensions and investments. Soon after the Brexit vote, the mainstream press were saying …
“The Brexit vote is having “terrifying” effects on the pension schemes of millions of British workers, with 75% of people now expected to have a retirement income below the government’s recommended level, City experts warn.” (The Guardian)
The city experts were a major firm of Actuarial, Pensions and Investment consultants.
What they were referring to was the sudden increased costs of buying an annuity and valuing a pension scheme’s liabilities due to the significant fall in the value of the pound (£) and the Bank of England’s protective measure of lowering interest rates. The position has already improved from that week and it will continue to change. The pensions downside from that initial Brexit effect will probably be more than compensated for when interest rates normalise because of a removal of quantative easing which will happen at some time.
Pension vs Investment
Providing pensions is both about the pension scheme benefit, that is the pension or cash value to the individual investor, and the investment funds that manage the money that we rely on to improve our pension pot. Considering how these two elements are inextricably linked, it is interesting that from a Brexit point of view they have entirely different dependencies.
Pensions themselves are extremely national packages. Every country in the EU has their own social security system which is linked to their own tax system and there has been very little integration of any of these areas. Integration at EU level has been discussed and tentatively tried but because of the impact this would have on the individuals (who are also voters), with some nations losing and some winning, the initial regulatory requirements could never be agreed. Therefore there should be no effect on the calculation or regulation of pension benefits that can be blamed solely on Brexit.
However the investment funds themselves have become very EU oriented. As investment funds are like large financial accounts or huge wallets of money (underpinned by real assets) they are relatively simple entities, albeit with sometimes complex internal workings. Therefore investment managers want to sell their funds to investors and pension schemes across Europe taking advantage of the single market. This required a great deal of rule harmonisation between the European Union countries which is still continuing at pace. There has been so much agreement in this field, albeit slowly, that I expect on Brexit not much will change except the UK will reword the required laws and regulations to ensure they are able to develop and flex in accordance with UK law which will probably mirror the best of EU requirements and reject the worst.
One final point to make is that there will definitely be some investment jobs going to the EU from the UK because it makes sense for those that deal with EU business to be in the EU. However, I don’t think the overall numbers of investment jobs will be determined by Brexit alone. The UK is a more effective investment base given a worldwide context and the relevant infrastructure here cannot be replicated elsewhere in just a matter of a few years. Also the enormous rise in pension funds under management that will result from the still young pension’s auto enrolment regime will attract more players from the US and elsewhere once it becomes more profitable.
What are biggest challenges facing the pension industry at present?
There are many challenges facing the pension industry but two emerging themes are auto enrolment and investment governance.
A mega social and economic initiative requiring every eligible worker in the country to be enrolled into a pension scheme that their employer must also pay into. It will force us to save for our old age but it comes with significant immediate and longer-term challenges.
Firstly, the rules are complicated and there are tough decisions to make regarding the way that contributions are calculated and the type of funds you can invest in. For employers, the additional administrative overhead, which is continuously renewed in three year cycles, is expensive and adds risk to their business. The breadth and depth of the regulatory framework has resulted in pension providers, mostly insurance companies, spending tens of millions of pounds to enable their systems to cater for all the requirements, whether mainstream or niche. For employers, the larger or more diverse the workforce, the more auto enrolment adds to operational overhead and governance risks.
Although pension business and investment assets under management will grow exponentially in the long term, in the short and medium term, auto enrolment business will be loss-making for most providers. Some will be acquired by others with resulting job losses and reduced provider choice. Consolidation of insurance company pension providers has already started and this will continue as more and more pension providers, including master trusts, find themselves sub scale and with inflexible business models.
How will these changes affect the workers paying into these funds?
Contributions are relatively low as a percentage of earnings and are usually not based on total earnings. Also the usual default funds they are enrolled into, in an effort to not expose them to any unforeseeable investment risk, are not aiming for high growth either.
Therefore, the sums that will be available at the end of a worker’s career will be disappointing. This could result in claims of mis-selling where people expecting a living wage replacement at retirement will find they can only afford a derisory monthly pension after decades of enforced saving. Recognition of this, in my view, was the reason the Chancellor of the Exchequer in 2015 abolished the compulsory requirement to buy an annuity and legislated to allow full encashment as an alternative.
What can businesses do to offer a better pension solution?
It’s worth mentioning the huge pressure on the insurance companies, investment consultants and investment managers to improve their transparency and value for money to benefit the end investor. This is a prime theme for both the Pensions Regulator (tPR) and the Financial Conduct Authority (FCA).
Wrapped up in this is the active vs passive investment management debate. The active management fees, while being much higher than those for passive investment management, do not on average produce a better result for the investor. Contrary to the view of some commentators, this doesn’t mean active investment management is doomed, but there are changes that the industry has to make to meet modern governance and investor fairness expectations. Those who update their business models will thrive in a larger pool of pensions and investment business than they have had in the UK before.
These challenges will require strong and expert professionals, as there are many businesses and other institutions wedded to continuing their old ways either because they were so profitable or because that’s all they know. Unfortunately for businesses and their shareholders, change means expense and uncertainty. However the inability to change will prove more expensive in the end.
The complexity of these issues means it will take years to completely modernise and stabilise our pensions and investment landscape and really make it fit for purpose. Those companies that engage fully now will be the winners of the future. Those who don’t will slowly diminish and eventually disappear.
With all these challenges what are people’s retirement pensions going to look like in the future?
In the long term many more people will be saving for retirement. More financial education will be provided in our children’s schools and we will be exposed to more financial communication by various media throughout our working lives. This will raise awareness of the issues, however the solution will not be the same.
When you consider the format and affordability of the traditional pension you see that the historic retirement ages of 60 and 65 were set over 100 years ago based on our fitness to work – in mainly manual jobs – and our life expectancy. A large proportion of the population died within five years of retirement and a huge majority had died before reaching their nineties. This made pensions affordable in the way we know them.
Now, when people are living much longer, the same contributions and employee benefit models are not going to provide adequate levels of pension that may be needed to last three or four times as long as they used to. Also, when you think of today’s cost of living and higher consumption expectations most people just can’t afford the high level of pension contributions necessary. So what we will see is a very flexible working and retirement pattern.
Mandatory retirement has already been made illegal so people will continue to work, as long as they are fit to do so. In many cases older people are fitter and healthier than ever before and improving medical interventions will keep those less healthy employable and active for longer. We mustn’t forget also that many of us will want to continue working for much longer than our parents and grandparents could ever imagine. A typical model of older age working will look something like this...
At a time agreed with my employer I will begin to cut down my hours. Perhaps over 5 years I cut my working days from 5 to 2, and those 2 days last another 5 years. Meanwhile I take a part-time job somewhere else such as in a supermarket, or railway company. Perhaps I create my own small business, be it neighbourhood gardening or ironing, book keeping or minicab driving etc. Meanwhile I can also take my private and state pensions which will augment my now lower salary. So I continue to work at least 2 days a week into my eighties in one of those roles and my pension has proved to be adequate by this measure. This is the future.
Employers who organise their work patterns accordingly will have the most productive workforces and contrary to what you might think there is a route here to cost effectively improve the recruitment of younger workers as well.
Does this mean that pensions are not as valuable as they used to be?
No, that’s not the case. For most people a pension is the most effective investment they can make if it’s an eventual income they are aiming for. It’s just that the actual pension at the end is smaller than people expect. This is because most of us don’t understand the total pot of money needed to provide a wage-size pension for 20 or 30 years. This problem has been exacerbated by today’s historically low interest rates which result in pensions, also called annuities, to be the most expensive they have been. However an annuity is guaranteed to be paid for the rest of your life and most people value that certainty once it’s explained to them.
It’s worth mentioning that pensions are not the only way of investing for the future. Those employers who provide a wider choice of employee benefits may find their workforce appreciate different types of saving and investing at different times.
Oli Templeton is Senior Consultant - Financial & Professional Services