Pensions, property and politicians

So last week we had suggestions that the flagship £140 a week state pension reform might not go ahead after all and this week we have the announcement of a policy that will allow pensions to be used as guarantees for mortgages. The calls are for the politicians to “stop using pensions as a political football” and those in the industry seem to wholeheartedly disagree with this latest suggestion. So is it really a bad idea?

What’s good about it?

From my perspective the basic idea of putting more flexibility into what you do with pension saving is a good one. Certainly when you think about defined contribution (DC)/money purchase pensions; these aren’t pensions so much as tax advantaged savings schemes with strings attached. Loosening one of those strings is therefore a good thing.

On the basis that the idea is the pension pot is used to provide a guarantee rather than actually provide cash, it also seems like good economics as it’s allowing money to be worked harder.

What’s bad about it?

The biggest thing that is wrong about this is what it is trying to achieve. The idea is to help house buyers get on the ladder at a time when house prices and deposits are high. Is it desirable to increase housing demand at a time when house prices are still vastly over valued and being propped up by artificially low interest rates? Policy should certainly try to ensure there isn’t a complete collapse of the property market but it certainly doesn’t need stimulating past this.

Another key criticism is that, at a time when we are talking about a pensions crisis, this scheme is likely to mean at least some people end up with lower pension benefits if the guarantee is called in.

As Ros Altman has said, those who have pensions pots large enough to take part in the scheme, almost certainly have better guarantees they could use such as their own property. Also, the scheme would need the buy in of lenders to accept such pension guarantees, and on what terms would it be offered? The money won’t be available until retirement and that date is unknown.

Looking at DC schemes the main other flaw is the potential complexity introduced for so little benefit. Comments on the Guardian’s Reality Check yesterday suggested that it is expected only 12,500 people would use the scheme. For this number the complexity really isn’t worthwhile.

For DB schemes the complexities are huge. For example, cash in DB schemes is often not taken at fair value and the benefit won’t be available on early death etc.


I think for DC only pensions the scheme could work in the future when there are more and bigger DC pots around and when the economy & property prices are more stable. However, introducing it now is bad timing and really not worth the complexity.

For DB schemes I cannot see how the policy could ever be workable. But then they’re being legislated out of existence anyway…

Shrödinger’s Pension Fund

I’ve been planning to write a blog on this topic for some time. It was the title of my session at the 2011 Actuarial Profession Pensions Conference and a topic that I am passionate about. I guess the place to start is with some quantum mechanics and Shrödinger’s cat…

Shrödinger’s Cat

Shrödinger’s cat is a reasonably famous thought experiment from 1935 (NB: as it was just a thought experiment no cats were actually injured!). The idea is as follows:

– get a box
– add some poison released by an atomic timer (such that the time of its release is random)
– put a cat inside
– seal the box

Then ask the question “Is the cat dead or alive?”

The quantum mechanics answer is that the cat is both dead and alive at the same time. It is only when you open the box that its actual state is determined.Zombie cat

This is of course nonsense as a cat cannot be dead and alive. And in fact Schrödinger agreed. It was a classic “reductio ad absurdum” (a reduction to the absurd) designed to show how bizarre applying quantum mechanics principles to real world objects is.

So how does this relate to pensions?

Well, if we modify the experiment slightly and put an employer in a box we can then ask the question “is the employer solvent or insolvent?”. In the same way as a cat can’t be dead and alive, an employer cannot be both solvent and insolvent at the same time.

A further modification. What if we put an employer with a defined benefit pension scheme in the box and ask the question “what level should we fund the scheme to?”. We know there are 2 states that the employer could be in so these are the 2 states we should consider when funding a scheme.

This is unfortunately not how UK pensions regulation works. The Pensions Regulator lives in a quantum mechanical world of scheme funding and sees a continuum of schemes from those with strong employers to those with weak employers. Trustees are told1 to set their funding target taking into account this strength with higher targets required for weaker employers.

There are two key problems with this. Firstly, what happens when a strong employer becomes weaker? In this sort of scenario it is unlikely it suddenly has more money available to increase the funding level. Such demands could even make the employer weaker still and be a catalyst for its demise. Secondly, and related to this, strong employers can fail too! Who predicted the fall of Lehman Brothers and failure of Woolworths? Is it acceptable for members to receive a lower proportion of their benefits because we thought the employer was stronger than others?

Taking this approach to pension scheme funding is as nonsensical as a dead and alive cat!

So what approach should be used? To answer this we need to go back to the 2 possible outcomes for the employer and look at what this implies for the pension scheme…

Assume the employer is insolvent

In this case there is no additional money available to fund the pension scheme and, to wind it up and secure benefits with an insurance company, the full buy-out insurance liability will be required. On the assumption that the employer will be insolvent, we need to ensure the scheme is funded to this buy-out level.


If this was the approach taken for funding defined benefit pension schemes then no schemes would ever be setup. The cost of funding the benefits at this level would significantly outweigh the perceived benefits from employees. An employer may as well just pay extra salary.

This approach to funding, although appealing from a security point of view, does not ultimately lead to an efficient way of providing pensions.

Assume the employer is solvent

If the employer is solvent until the last pension benefit is paid then (ignoring unfunded arrangements that would be even better!) it is most efficient for it to hold the best estimate of the amount of money it needs today to pay benefits in the future as and when they fall due i.e. taking into account best estimate expectations of returns on assets.

By doing this there is no opportunity cost of tying up capital. Benefits can also potentially be provided cost effectively meaning employees are able to access something they really value.


If the funding regime took this approach then if an employer did become insolvent, there would not be enough money to secure benefits for all members leading to reductions. We therefore need a mechanism to address this and provide protection to members.

Interestingly enough, at the same time as introducing the current funding regulations such a solution was also launched:

Pension Protection Fund


To sum up my conclusions:

– The way schemes are currently funded does not make sense
– There are only really 2 ways to tackle scheme funding as an employer can only be solvent or insolvent
– Working on an insolvency assumption leads to no pension schemes
– Assuming solvency and funding to a best estimate level is therefore the answer
– Security needs to be addressed and the PPF is perfect for this

I will write more on why the PPF is perfect for this (or at least why it should be) another day!

1 – Notably they are told this by the Pensions Regulator rather than UK pensions law – see more here: Taking things too far

Science vs Religion

Last night I watched a very enjoyable documentary put together by Chief Rabbi Lord Sacks on Science vs Religion and was inspired to explore some of the things raised in a blog post.

It’s great to see debate on such a controversial topic. It’s one that has always intrigued me and, this summer, I read Christopher Hitchens’ “God is Not Great”. This was a book so atheist that it challenged even my position as an agnostic!

I found much of the programme thoughtful and found myself agreeing with Lord Sacks a lot more than I had expected. However, the opening narrative made a comment that I simply can’t agree with:

for centuries religion and science stood happily side by side. But in the last few decades that relationship has broken down.

This is fundamentally not true. All that has changed in the last few decades is that now religion has to make its case rather than science. Numerous scientists were persecuted for making discoveries that went against religious teachings and much discovery was stifled by the shackles of religion. Lord Sacks says:

We’re living in an age of unprecedented scientific progress.

It is the freedom from religion in recent times that has helped such a period of discovery. These discoveries in turn have made religion have to defend itself more and it was great to see Lord Sacks make his case for religion in such a reasoned open manner.

How vs Why

The central theme of Lord Sacks’s argument was to “challenge the assumption that science and religion cannot coexist”. He suggested that this is because they answer different questions and should therefore work in partnership. Science answers the question of “How” things work but religion answers the question “Why”.
I think this is a nice way of thinking about things. It is difficult to see how science could ever answer the question “Why” to its full extent. As an example, how many parents have played this “Why” game with their children at some point? What starts as a straightforward question to answer, quickly becomes difficult when the child responds “Why” a few times!


Religion is also touted as being the answer to “how to live your life” providing a moral code and direction. The stories of the bible (and books of other religions) provide examples of such morals to lead your life by. I have no problem with this. However, the bible is not the only place to find good moral codes.
Many Hollywood movies have lessons of morality embedded within them (and in fact the moral is often the basis of the storyline). Recent Census collections found large numbers suggesting that their religion was Jedi. The Star Wars trilogy provides several examples of morality as the classic “good vs evil” set of films. So, if religion is a moral code, who can argue with Jedi as an option?!


It is the concept of literal stories vs symbolic stories that is where I felt Lord Sacks started to lose the argument with Richard Dawkins. Dawkins repeatedly asked whether Lord Sacks thought a particular event actually happened and he was not able to give a straight answer. It is this sort of true faith in events with little evidence that will always set apart the mind of a scientist that looks at evidence from the mind of a religious person. Indeed at this point of the programme Lord Sacks conceded that they would never agree on the point that children should choose their own beliefs and not be assumed to be part of the same religion as their parents.
It is my mathematical mind and the number of beliefs that exist that really make me the agnostic I am. I find it extremely difficult to understand how anyone can be so certain that their one small branch of faith is correct in every detail and not doubt whether maybe someone else has it right. There are 6 major religions. Ignoring all the branches of these and all the smaller religions, and also assuming one of them has it right, the odds are still 1 in 6.
How much money would you put on those odds? I certainly wouldn’t bet my life on it!

Can religion and science coexist?

I can absolutely accept that religious beliefs have a place in the world to answer those difficult “why” questions. But when you get into the detail of any religion it gets rather more difficult a proposition. It is then that certain aspects of religion like circumcision, not eating certain foods, wearing certain clothing etc. look more like outdated mechanisms of control rather than anything meaningful. And it is this control of the faithful and inherent trust of anything said that means all organised religions have the potential to be dangerous.
Why not live life by the common moral code underlying all religions and enjoy the numerous stories and rich history they bring without worrying about details that have no real basis in fact. Let’s embrace the new knowledge that science brings. And let’s also have faith but in our own way.