Junior doctors strike action – is it justified?

In short, my opinion is it’s not. I’ll explain why…

Why is a new contract being proposed?

A new contract is being proposed to replace the current one that has some oddities to reflect a transition from an old era and is no longer fit for purpose. The stated aims for the junior doctor contract were:


The government is also looking to use the new contract to reduce the cost impact of having more doctors working at the weekend.

Reviewing the current contract, whilst I can now understand how it came to pass, my initial reaction was one of surprise that: the current contract will allow someone working 41 hours a week to be paid the same as someone working 48 hours a week and anyone working illegal hours is paid more – an odd incentive system. Certainly there seemed good reason to consider something different.

Why doctors say they’re striking

This can be summed up simply as: “Patient safety”. Do they have a point?

Doctors state that the key safeguards in place under the existing contract are being removed and that this makes the new contract unsafe.

The existing safeguards that they refer to relate to the requirement to pay extra “penalty” pay if doctors work illegal hours. The NHS Employers’ submission to the DDRB commented that this was often adversarial:


It is easy to see how this could be the case as doctors are effectively “rewarded” or “compensated” for working illegal hours.

The proposed new contract has the stated intention of making working hours better:


But doctors said this was meaningless as effective safeguards to enforce this weren’t in place.

After reading the documents and original proposals, this didn’t seem to be the case to me. There was a specific section on safeguards and it seemed to put the power to raise issues with doctors themselves. This all sounded ok.

But talking to some junior doctors I could understand why there were still problems. There were significant conflicts of interest around raising issues with working hours. One I spoke to told me the following:

“the process of reporting would be in the first instance to your educational supervisor and this is a serious problem.”

“Educational Supervisor’s role is to oversee your learning objectives for that job and check you are achieving them…It is also their job to write all of the reports that decide whether or not you ‘pass’ that year of training and write 3 references per 6 months that stay on your portfolio for every future employer to see forever. This is not a person you want to piss off!”

“There will always be the fear that if you are a conscientious stay later, that you will be thought of as slow and inefficient and that will reflect badly on your training report so you’ll not mention it, even feel guilty about it.”

“It would be entirely feasible to ruin your training year or even your future job prospects by ‘exception reporting’ honestly.”

This is clearly an issue but it was only after discussing things in detail that I got to this. All the articles, posts etc. that I read just talk about removal of existing safeguards being bad without talking about what is being added.

However, the January negotiations have recognised this issue and added a “Guardian of safe working”:


The revised proposals also reinstate financial penalties. However, these penalties will now stay within the health service to help improve working conditions or provide further training rather than providing extra pay:


This all sounds positive. Is the new contract unsafe? If it is, it doesn’t appear to be any less safe than the current one.

Why doctors are really striking

It’s not about the money but…

…is the way a lot of conversations go. But money is important. I don’t mind it being about the money but I do mind misinformation about the money.

We’ve had this on both sides with doctors talking about 30% pay cuts and government talking about 11% pay rises. Both are talking nonsense.

One of the key principles of the design of the new contract was that the cost of pay afterwards would be the same as the cost before i.e. no average pay cut and no average pay rise.

Most junior doctors currently work 40 to 48 hours a week and are paid a banding payment of 40% or 50% of basic pay in addition to their basic pay. The average pay of all junior doctors is quoted in the NHS Employers’ submission as 143.5% of basic pay.

Under the new system basic pay is quoted as 11% higher on average and there are then additional payments for hours worked over 40 hours per week, hours worked at night, on Sundays and Saturday evenings, and for working on call. Finally, there are additional incentive payments for some roles such as A&E and General Practice.

Depending on hours worked, some doctors would find themselves better or worse off than under the current system. But…crucially:

  • These differences are not as significant as made out
  • The average doctor is no worse off
  • The difference in payments reflects some doctors doing greater number of hours and/or unsociable hours than others

Even more crucially, those who would be worse off under the new system will have their pay protected for 3 years. The nature of pay progression as a trainee means this should be enough to mean no “actual” pay falls.

My analysis of the proposed new pay structure based on the sample rotas is as follows (click to see larger image):


These are % changes so, taking into account that the £ amounts are much larger later on in a career, most are better off overall with the exceptions being rotas 3 and 4.

It is certainly not the case that the new contract is fundamentally offering pay cuts. And it is worth remembering that doctors are in the top 1.5% of earners in the country. Rightly so. But worth remembering.

There are some losers though. These are part-timers and those who don’t progress through training each year. This is because under the current contract pay progression is done purely on “time-served” rather than experience. This leads to the absurd position that under the current contract there are some levels of pay that can only be reached by those who progress more slowly!

Whilst this is a worse position for those affected, the new contract is a much fairer system. My only caveat would be that I think it would be reasonable to offer extended pay protection for part-time workers as part of the transition.

There is a lot of hot air about pay with politics being played on both sides. I also think there is a lot of misunderstanding because of this.

Unsociable hours

There is much misunderstanding on hours too and their interaction with pay. I’ve seen several comments talking about the extension of “plain-time hours” as if it was an increase in actual hours to be worked.

The rate of pay for any hours only really matters if the hours worked change. Otherwise the redistribution of pay is the same. For example, if I work Monday to Friday and am paid £10,000 a year for each day worked, it doesn’t really matter if I’m instead paid £14,000 a year for Mondays (because who likes Mondays?) and £9,000 a year for each of Tuesday to Friday. In both cases I would get £50,000 a year. It would only matter if I worked more or less Mondays.

The rise in basic pay compensates the loss of pay from the extension of plain-time hours. It will vary by individual rotas how well this works. However, the change in what hours attract a premium rate is only substantially important if shift patterns change.

The desire for a 7 day service means there is a presumption of more weekends being worked under the new contract. However, many doctors already work a lot of weekends. It would be good to see a clear question and answer for how many weekends it would be expected that junior doctors may work.

Potentially working more weekends is a valid concern. It is one that is also suggested as being part of why the new contract is unsafe. Of course, working Saturday instead of Monday is not less safe in itself. But doctors are concerned that extra weekend work will be covered by sacrificing cover Monday to Friday. On the presumption that there isn’t an oversupply of doctors in the week currently this concern is understandable. However, the government did make it clear in the parliamentary debate on this that the intention is to use the extra funding to recruit more doctors to provide this cover.

Doctors don’t trust government on this but it is very difficult to see how it can be addressed contractually.

Finally, whilst some doctors having to work more weekends is undoubtedly more inconvenient, it should perhaps be considered in the round with other measures that are being made to try and make life better and the trends in other jobs.

Politics, ideology, mistruths, misunderstanding and low morale

The handling of the contract dispute has been appalling. It has been appalling on both sides and I feel I should be able to expect more.

I’ve mentioned already the ridiculous claims on both sides about pay. But we’ve also had misrepresented statistics and childish name calling about who told who what via social media (again both sides!).

There are some clear underlying encamped views on each other’s ideologies and the poor handling by government has made it easy for a few that clearly have some political agenda to stoke the fire of a demoralised workforce. This is really why we have a strike today. There is no longer any trust.

When I talk to junior doctors about the issues they have they talk about the personal pressures they feel to work hours after their shift and through their breaks; because there are still sick people to treat and rotas aren’t adequate. They talk about the inability to get time off when they need it. Simple things that many of us take for granted like taking a day off for a family event or booking a holiday in advance before the best places are booked up. They talk about the problems of moving from one place to another and trying to have a relationship. They talk about not feeling valued with constant bad news stories in the press. They worry about the future and increased pressures as funding becomes more and more stretched.

They also talk about internal problems. Interestingly, in the same discussion I mentioned before I was also told:

“A lot of hierarchy and bullying still exists in medicine“
“some consultants are very aware of how working as a junior has changed and are very supportive, and others think we are lazy for not doing the 100+ hours that they used to do.”

This is an environment in which it is no surprise that they are demoralised and it is no wonder doctors feel the need to strike. But these issues exist under the current contract. They aren’t the reasons put forward for the strike action and they aren’t really part of the contract dispute.

In fact, if anything the proposed new contract is trying to address some of these things. Better yet talks are ongoing. There is time for more of these issues to be addressed. The contract dispute is a cover the real problems faced by junior doctors.

We should all support junior doctors but strikes about the new proposed contract are not the answer!!

Some Background reading…

Original paper submitted by NHS Employers to DDRB: http://www.nhsemployers.org/~/media/Employers/Publications/NHSE-DDRB-submission-Dec-2014.pdf
DDRB recommendations: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/445742/50576_DDRB_report_2015_WEB_book.pdf
Offer made in November: http://www.nhsemployers.org/~/media/Employers/Documents/Need%20to%20know/JD%20A4%20booklet%20FINAL%20amends%2027%20Nov.pdf
Update on discussions in January: http://www.nhsemployers.org/~/media/Employers/Documents/Need%20to%20know/Letter%20from%20Danny%20Mortimer%20to%20SofS%20040116-Final.pdf
Letter to doctors setting out progress of discussions: http://www.nhsemployers.org/~/media/Employers/Publications/Junior%20doctors%20letter%2007%2001%2016%20final.pdf

Political football with pensions tax relief

Today’s FT Westminster blog states pensions tax relief is once gain going to be kicked around and become a key battleground as part of the election. Labour are proposing to reduce the relief to 20% for those paying 45% tax.

To me the whole concept of removing such relief is crazy. It will mean people are taxed twice on their money, 25% on the way into the pension and at least 15%, but for those in question likely 30%+, on the way out. This results in an overall tax rate of 55%! Of course the result should just be that no pension savings are made but this is an odd message to give. We already have both an annual and lifetime allowance for tax relief. Do we really need any more restrictions?

My tweet response to this was quickly followed up by Greg Kingston (@GregKingston) who summarised the political landscape well with:

@markjrowlinson @JosephineCumbo @ftwestminster always good to campaign on something most people don't understand. Lowest number will win.

It is this kind of politics that leads to division and the desire, from those that can, to look into ever more complicated tax avoidance schemes. I’m all for a progressive taxation system buts let’s keep it simple and be honest about it – that way we are all in it together.

It also reminded me of this little story who I have no idea who to credit to. There are many variants around but they are worth remembering from time to time. In particular the first part shows why it is only reasonable for the those paying more to gain more out of cuts and reliefs and the second why we should always avoid being too envious of those who earn more than us.

Let’s suppose 10 people who work together go to a restaurant after every payday, and at the end of the meal the bill comes to £100. They agree to cover the bill according to how much they earn.

The manager pays £55
The two supervisors pay £11 each
The four file staff pay £5 each
And the three junior staff pay £1 each


The regular meals continue for a few months and eventually they manage to convince the restaurant’s owner that, as they’ve been frequent and loyal customers and the restaurant is doing very well, he could give them a 20% discount. This leaves them with a £20 windfall to divide between them.

The first idea the restaurant owner proposed was to split the savings evenly between them, so each gets £2 – leading to:

The manager paying £53
The two supervisors pay £9 each
The four file staff pay £3 each
And the three junior staff receive £1 on top of their (now) free meal

Obviously the 7 paying colleagues weren’t very happy with this arrangement – so the restaurant owner said “Fair enough, we’ll divide the windfall among you, proportional to how much you contributed to the original bill.”, leading to:

The manager paying £44
The two supervisors pay £8.80 each
The four file staff pay £4 each
And the three trainees pay 80p each

The trainees then complain that their share of the £20 windfall is 20p while the manager’s is £11 – how is this fair?!


Let’s see what happens if the situation was to be reversed: the restaurant hits on hard times and raises the prices by 20%, but nobody wants to simply order less food. The manager proposes everyone contributes an extra £2 each so:

The manager pays £57
The two supervisors pay £13 each
The four file staff pay £7 each
And the three junior staff pay £3 each

The junior staff are not happy at all – the cost of their meal has tripled! So, they suggest everyone just contributes 20% more than what they used to for the original bill:

The manager pays £66
The two supervisors pay £13.20 each
The four file staff pay £6 each
And the three junior staff pay £1.20 each

To which the manager says “Sorry, I’m not going to pay £66 for a meal – I’m already paying for much more than I get. In fact, if you’re going to insist, I’ll find some less demanding friends and go to a different restaurant with them.” – leaving the remaining colleagues to cover the (now £108) bill between the 9 of them.

The moral of the story?
Don’t go to restaurants you can’t afford… And if you do, don’t get greedy with other people’s money!

The new code of practice is good, but it’s still a flawed funding regime

I’ve blogged before about how putting employer covenant into establishing a funding target is as sensible a concept as zombie cats. Therefore, whilst the new code of practice published last week is markedly better than the first draft, it is disappointing from my perspective that such a flawed concept continues to have such high billing.

Probability and binary outcomes

To briefly summarise my thinking on this again we need to consider binary outcomes.

A binary outcome is one where there are only 2 possible results. A great, albeit morbid example, is that this year I will either be alive at the end of the year or dead.

Now I might want to think about the impact of those scenarios. If I am alive then (hopefully) things will be good and I’ll continue to earn money to provide for my family. However, if I’m not then my family could be in real difficulty. What should I do?

Well I could look to try and save up enough money to make sure my family is ok if I died (let’s say this is £500,000 for arguments sake). However, this is utterly impractical, it would take years and how would we eat in the meantime?!

The probability of me dying this year is quite low though (about 0.06% based on current tables) so really all I need is 0.06% of £500,000 which is £300. I can manage that. Now if I die my family will be protected.

Oh wait no they won’t. They’ll just have £300!!!

The probability of my death is irrelevant as it will either happen or it won’t. Saving the average amount needed doesn’t help in either scenario. If I survive I’ve put aside £300 I could have spent and if I die it is woefully inadequate to provide for my family.

Applying a probability for an individual event like this therefore doesn’t make any sense.


Of course the solution to my problem is simple. I should buy some life insurance.

By using insurance I can pay my £300 (plus an expense/profit allowance) and know my family is protected in the event of my death.

This works because the insurer is taking lots of £300 premiums. Let’s say they have 10,000 policies. It would now be reasonable to expect that 6 of those policies would involve a pay-out which should be covered by the £3m of premium income.

Insurance is an efficient way of covering such risks.

Pension scheme risks

Much is made in the new code of practice on funding of the significant risks involved in funding a pension scheme. From the member (and hence trustee) perspective though, there really is only 1 risk, the risk that the employer sponsor runs out of money. Provided the employer is around the benefits will get paid no matter what the current funding level.

This risk is again binary. Either the employer will survive and continue to make profits or it won’t. We might be able to make judgements on how likely it is but this is just a probability. The actual outcome is still binary.

So what is the solution? Well as is the case for managing my own mortality risk the solution is insurance. To fund schemes to the worst case scenario is (like me saving £500,000) completely impractical.

The government introduced such insurance in a compulsory format in the form of the PPF and PPF levies.

However, at the same time the Pensions Regulator introduced the concept of employer covenant strength.

Employer covenant

Employer covenant strength is akin to the probability of insolvency.

An employer with a good covenant is like a person that eats well and goes to the gym a lot. An employer with a bad covenant is like a person that eats too much junk food and drinks too much. It changes the probability of outcome but not the range of outcome.

As I showed before, trying to use such a probability to manage a binary outcome does not make sense. Yet the code of practice says:

It (employer covenant) should help the trustees decide how much risk it may be appropriate to take (ie when they set their technical provision assumptions and investment strategy

With the intention that technical provisions should be higher for a weak covenant and lower for a strong one clear from some of the examples:

a low value for technical provisions based on a strong employer covenant assessment

But this is just like me putting £300 aside to cover the likelihood of my death. In fact worse, it’s like me doing it twice, once put aside and once as insurance (levy).

It won’t be enough if the employer fails and is too much if it doesn’t. It just doesn’t make sense.

The code actually acknowledges the impossibility of knowing whether an employer will be around in the long-term:

It is unlikely that trustees will be able (with any degree of certainty) to assess the employer covenant too far into the future

So surely in the majority of cases it is not relevant?? There is a bar to cross perhaps that some could fail, reasonable expectation to be around maybe, but after that, and for the majority of employers, a long-term view should be taken that doesn’t differ by employer.

Funding allowing for the PPF

Acknowledge the existence of the PPF and the single risk faced by members and trustees is largely managed.

There is perhaps some debate around the level coverage of benefits and I certainly wouldn’t be averse to increases in compensation but agree this and the possibility of employer insolvency can be ignored.

Schemes can then focus on running for the long-term on the assumption that employer support will always be there. Funding can be set at a level to broadly reflect the expected cost of providing benefits. Risk management becomes about managing risks for the employer rather than to protect members. Prudence used to allow an employer to reduce the volatility of its contributions rather than build a capital reserve.

In fact, as the reason for funding in the first place was to provide some level of security there is a reasonable argument to not require funding at all. (I don’t quite subscribe to this as I think there is merit in paying contributions at the time of accrual so cash cost and services gained are aligned somewhat and intergenerational issues mitigated.)

Can we allow for the PPF in decision making?

Acknowledging the existence of the PPF is an interesting concept. There is no law to state that the PPF should not be considered in scheme funding decisions but this is the common view propagated and believed by tPR due to its objectives. The reason for this is a court judgement Independent Trustee Services Limited v Hope and others in 2009. However, if you read the actual judgement the position is much more nuanced.

In particular, Mr Justice Henderson states that:

there is no single all-purpose answer to the question whether the PPF is a relevant consideration for trustees to take into account.

The judgement really states that the existence of the PPF cannot be used to justify something that would otherwise be “improper”. Additionally, a large part of the discussion of why this is the case relates to it being against public policy and not in the public interest.

In the context of scheme funding though, given the obvious efficiency and need to avoid double counting of capital and insurance, allowing for the PPF in the context of what it is there for would seem, to me, to be a very reasonable position to take and in line with the judgment made.


The current position is one that encourages excessive and often meaningless prudence which in turn often leads to excessively prudent investment strategies (if you’re funding to it then why take the risk – employer’s don’t generally think long-term enough to wait for money to come back).

There is much to like about the revised draft code of practice but the concept of employer covenant driving technical provisions doesn’t work. If the law allowed trustees to take account of the PPF it would be of great help. But even without this the funding code does not need to bring in employer covenant which is not mentioned in the law on funding.

Once insolvency risk is managed lower funding targets that are more reflective of actual expected costs can be used. The approach to funding can also be used to reduce the volatility of contributions (funding doesn’t impact on cost, just pace of funding don’t forget). In this sort of environment a highly valued benefit could be provided efficiently with members having reasonable levels of security in outcome. Isn’t this what we should be aiming for?

The annuity is dead, long live the deferred annuity!

There has been lots of discussion post budget about the new freedom in DC pensions and whether this is a good thing.

There are broadly 2 camps of people. Those who think the changes are a good thing and those who think they are a disaster.

There’s good reason for this. Even if you trust people to manage their money well, none of us know how long we will live, so how can anyone pay their own pension? Steve Webb suggested people should be informed of how long they might live but a life expectancy is just an average rate. I built the following modeller to show this:

How long will you live?

What’s most important to show is how variable lifetimes are and how great a chance there is of living much longer than average. In fact by definition you have a 50% chance of living longer than average and average these days is pretty long!

Despite this though, I’m still in the first camp and think the changes are a good thing. Fundamentally I think it’s reasonable to let people spend their own money as they see fit. For some with little money at retirement this might well mean blowing what little they have in the first couple of years. But faced with poverty for life or a couple of good years followed by very similar poverty for life I know what I’d choose. Those with huge pots already do manage their money in retirement so we don’t need to worry about them. But it’s the people in the middle we do need to think about a bit more.

And with auto-enrolment in place many more will start to find that they have a sizable chunk of money in their pension pot when they get to retirement. That’s not to say it’s enough, but a sizable amount of money all the same. So what are they going to do with it in this new world of freedom and choice?

Annuitise like before

This seems unlikely, particularly at the moment. The fact that current annuity rates look so unattractive is partly why the changes have been made in the first place. Annuity providers were hit with significant share price falls on the budget announcement in the anticipation of a significant change in practice. Annuities are dead said some.

But annuities do still offer something. They are the only way of guaranteeing a pension income. Some may decide that, whilst they don’t want to annuitise their whole pot, using some to guarantee a level of income to cover their basic needs makes sense. The rest can then be invested and drawn down as and when required.

Why do current annuity rates look unattractive?

Many of those criticising the budget changes have been pointing out the benefits of risk pooling that annuities offer. This is a very valid point. Essentially those who live a long time are subsidised by those who don’t. Given none of us know when we will die this is a reasonable way of providing certainty to all. We can’t predict when an individual will die with any certainty but we can predict with some degree of confidence the number dying at each age for a large group of people. The same can be said of other risks in life such as crashing your car, being burgled etc. and it’s the principle of how insurance works.

However, an annuity also comes with some baggage. It can be regarded as not just an insurance product but an investment product as well. The underlying investment return of an annuity is very low, especially on inflation linked annuities, reflecting the low risk assets an insurer must invest in and their solvency and profit margins. As life expectancies are so long now, at typical retirement ages the chance of dying is still so small that this low investment return outweighs the benefits of risk pooling.

Now this isn’t the insurers fault1, the rate is low because insurance regulation requires such low risk assets and solvency margins to ensure certainty. But these low risk assets currently have minimal returns due to low interest rates and, in particular, quantitative easing. But just because it’s not their fault doesn’t make the rates look any more attractive.

Annuitise later

The solution to the problem is to annuitise much later, say 80 or 85, when the benefits of risk pooling outweigh the low investment return. Before this you can invest your money and pay yourself an income. If you die before you get to the point of annuitising then whatever funds you have left will be left to your next of kin. Having cash in your control also offers other flexibilities such as being able to use it to help pay for care costs if necessary.

In order to delay annuitisation and not be worse off you need to get a return on your money before you annuitise in line with the underlying investment return and also to cover the “cost of survival”. To understand this cost consider how the chance of making it to 85 changes between 65 and 84. At 84 you only have 1 year left and the chances of making it to 85 are high. However, at 65 there are 20 years in which you might die so the chance is much lower. A payment at 85 is therefore much more expensive if you’re already 84. The “cost of survival” each year is equivalent to your chance of death in that year.

Taking an annuity from Hargreaves Lansdown’s best annuity rates at 1 May 2014 for a single life inflation linked pension at 65 suggests you can get an income of £3,525 a year for £100,000 of capital. Or in other words it costs £28.37 for every £1 a year of starting pension. Using typical mortality tables for males this suggests an underlying real i.e. above inflation investment return of -1.7%. Current long-term inflation estimates are around 3.5% so this means a nominal return of just 1.8%! At 65 the chance of dying is around 0.8%. Therefore if you can earn more than 2.6% on your money after charges you’ll be better off by delaying annuitisation (assuming the same pricing basis). I’ve plotted how this breakeven investment return changes over time:

The return needed to beat the growth in annuity rate

The return needed to beat the growth in annuity rate

At 65 this it is 2.6%. It rises to 3.7% at 75 and 5% at 80. It then rises fairly quickly to 8% at 85. Given current AA rated long dated corporate bond yields of 4.2%, standing still, or in fact doing better than standing still, doesn’t seem that hard for several years. A 4% return each year would allow you to delay annuitisation until 87 and get the same pension.

This sort of product could easily be provided as a collective to make it easy for individuals. However, there’s something even better in my opinion.

Step forward the deferred annuity

A deferred annuity is one that doesn’t pay you a pension immediately, it is deferred. For example you could purchase a deferred annuity at 65 that paid you a pension from 85, if you get there.

Why is this better than delaying annuitisation? There are 2 key reasons:

1. You get all the risk pooling benefits from 85 when the pension is paid but also get much of the benefit from 65 to 85 as well as the annuity only pays out if you make it to 85.
2. If you know you’re covered from 85, you still can’t predict when you might die but you do know exactly how long your money needs to last you!

Using the same assumptions as above the cost of such an annuity would be around 28% of the immediate annuity cost leaving 72% of your fund under your control to draw as you wish over the first 20 years. This isn’t going to give you life changing amounts of extra cash (you still need to save more for that!) but it keeps you in control of your money for longer without sacrificing on the need for some certainty.

The FT’s Josephine Cumbo wrote an excellent piece on Don Ezra, a pensions investment consultant living in the USA, this week. Don sets out why he has bought a deferred annuity and his strategy for managing his money. It’s well worth a read!

This solution could really work. So come on insurers, let’s start thinking deferred annuities.


1 – Other than those insurers who were no longer active market participants and only wrote annuities at rip off rates relying on lethargy for existing customers to purchase them.

Statutory nonsense

We had internal training this week on the latest bit of legal loophole nonsense threatening to cost pension schemes a lot of money in legal costs. The issue is that of the Statutory Employer and has come about following the Pilots case (and others).

Essentially it seems that depending on where you look in pensions legislation there is a different definition of “employer”. The differences are subtle but enough to keep lawyers entertained for a while. The result of this is the bizarre situation that a company could believe it is responsible for the scheme, pay deficit contributions and levies but actually not be liable for any section 75 debt. Worse still the members of such a scheme could end up not being entitled to compensation under either the PPF or FAS!

So obviously rather than quickly tidy up the legislation it appears instead that all pension schemes will need to go through the process of identifying their Statutory Employer – often at significant legal cost. Then when all that money has been spent consideration will be given to extending FAS to catch those falling down the cracks.

Luckily I’ve saved everyone this trouble and drafted some new legislation. I call it the MJR Pensions Act 2011:

“For the purposes of xxx (list relevant acts/regs) in place prior to the effective date of this Act (the “Acts and Regulations”) the definition of employer is extended to include the other definitions included in the Acts and Regulations.”

Why can’t it be this simple for a change?

Mark-to-Market, 24th November mallowstreet.com debate

A fantastic debate was held last night with the motion:

“This house believes that mark-to-market accounting is inappropriate for pension liabilities and should be abolished.”

My piece from the debate is reproduced below:

“I was sitting in Subway at the weekend thinking about what I might say today, staring at my “foot long” sandwich – yes I know I’d be better off with the 6 incher. It made think how bizarre the world would be if instead of having a universal measure for a foot we all put our own foot on the counter and demanded the sandwich was re-measured as 10 inches, 11 inches or 13 inches as appropriate. The length of that same sandwich would then be different depending on the last person to enter the shop and their view on what a “foot” constitutes.

But this is the bizarre world we live in when it comes to pension scheme liabilities. We regularly change our tape measure and value liabilities based on the opinion of the last person that day’s preference for bonds.

How can this be classed as a “true and fair” way of measuring liabilities. Just as the measured length of an unchanged sandwich varies in this fantasy world, the expected cost of paying pension benefits as and when they fall due could be unchanged in the real world but the value disclosed dramatically different. It also means that at measurement dates just a few days apart, large differences can result in balance sheets making 2 companies difficult to compare.

As well as the overarching principle of accounts being true and fair, there are 2 other accounting principles that mark to market valuation does not follow: “continuity” and “consistency”.

Continuity relates to accounting on the assumption that a business is ongoing. For this reason, assets do not have to be valued at “disposable” value. Yet this is exactly the basis on which marking to market works. I watched an entertaining debate on mark-to-market and regulatory capital on you-tube a few weeks ago and one comment stood out: “how much would your house be worth if you had to sell it in the next 10 minutes?”. This is what mark-to-market does for you.

The reason for this principle of continuity is clear. It avoids almost immediate losses being realised when a capital investment is made in assets that are valuable and profit making to the company, but have limited resale value in the “market”.

Consistency is another important principle. It is quite clear that a company’s balance sheet does not give its market value so why apply this inconsistent approach to the pension scheme? It is also worth mentioning at this point that accounting was never designed to give a company valuation and has never stated that as its intention.

As Simon has already stated there is no market for occupational pensions and nor would it be desirable to have one. We have specific legislation in the form of Section 91 of the Pensions Act to guard against this.

However, if we were to accept that marking to market was the right approach, and to be clear I don’t, then what would such a market look like? There is much evidence to suggest that it would have little to do with government or AA rated bond yields.
We can get some idea on the average member of the public’s preference for cash now over cash later by looking at loan and credit card rates. Looking a bit closer to home there are 2 areas where there is clear evidence that pensions are not valued in line with current views of mark-to-market rates.

The first is by looking at potential opt-outs. Recent research by the Department for Work & Pensions, Hymans Robertson and the Office for National Statistics, revealed that 62% of those in the public sector earning less than £25,000 a year were unwilling to make pension contributions of more than 6% and that widespread opt-outs are likely. The key point here is that by opting-out if contributions are increased members are saying they value 6% of immediate cash salary equivalent to 20% of salary worth of pension benefits. And this is based on a 3.5% real discount rate that I have no doubt those opposing the motion tonight would like to see significantly reduced! By my calculations this means the implied member discount rate is nearer 10% above inflation!

The other area to look at is enhanced transfer value exercises. Looking at the substantial difference in take-up rates for exercises where the enhancement is given in pension or cash again shows the reduced value members place on pension compared with cash.

Now both of these examples reflect a significant mistrust and misunderstanding in occupational pensions and only apply to a proportion of the membership. A market, if one existed may actually improve this, but I still believe that it provides some clear evidence that pension benefits are not valued by members in line with traditional mark to market theory. It also highlights why a market is SO undesirable as information asymmetries would be rife.

In addition to the obvious reasons for this e.g. the need for cash now, living for today not tomorrow, concerns of dying before retirement etc. a key reason for the increase in discount rate is the risk of default. Despite how those on the other side may protest, pensions are still not guaranteed, and they certainly weren’t setup to be guaranteed. Employers can still default on their obligation. When talking about guarantees, RPI to CPI also adds an extra dimension to the debate. In the future it is unlikely that the pensions industry will ever be able to persuade members that accrued rights cannot be reduced.

I therefore suggest that it is difficult to take seriously the views of those opposing the motion when they can’t even apply their own approach correctly!

The effective discount rate at which members value their pension benefits is important. Unless this rate is lower than the rate underlying the cost to the sponsoring company, the pension scheme has no value to the company and it may as well pay additional salary instead. This combined with the volatility driven by mark-to-market leads to another great undesirable behavioural change, in addition to those already mentioned by Simon, the end of defined benefit pensions.

Taking a more holistic view. What mark-to-market is doing is stopping companies taking on, pooling and smoothing risk and instead forcing every ill-equipped individual to take on the risk themselves – this is wrong!”