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The Actuary The magazine of the Institute & Faculty of Actuaries

Letters to the editor – May 2012

In which actuaries discuss disappearing DB and graduate grandads

The editorial team welcomes readers’ letters but reserves the right to edit them for publication. Please email
[email protected] The deadline for receiving letters for the June issue is 15 May.

Letter of the month: Disappearing act
“Are we being told that funding and assets are a good thing or a bad thing?” asks Peter Tompkins in his letter in the April edition of The Actuary.

I suggest that the answer is that funding of private-sector defined benefit (DB) pensions is essential since a private-sector employer may go out of business leaving behind benefit promises that cannot be fulfilled.

Governments, on the other hand, are not going out of business; more precisely, if they do we will have far more serious problems to worry about than pensions, so we can proceed on that assumption. Other things being equal, equity between the generations suggests level funding as far as the eye can see. This will produce a pool of assets, but much smaller than would be needed for a private plan. Other things, of course, are often not equal: Norway, I understand, is funding its public plans heavily, using the proceeds of the North Sea oil boom. This seems sensible, but it does raise the spectre of a large pool of investment capital slopping around the capital markets under the overall control of government.
In the past, there was an escape hatch for the private employer in an extreme situation: termination of the plan with at least partial loss of benefits. As ‘pension reform’ takes away that escape hatch around the world, it seems to me that the profession has failed to address the resulting problems; it has simply stood back as private-sector DB plans are allowed to wither.

If participants are to be protected and DB plans are not to become extinct, I believe that we should move toward a regime where the benefits in a DB plan are reworked as basic benefits with a non-guaranteed supplement. This would be similar to the non-guaranteed terminal dividends used to address a similar problem in British life insurance, where the underlying assets include a large proportion of equities. I have made this case in widely ignored papers at SIAS and the IAA, also in New Zealand. Should we not think again before the DB plan disappears in the private sector?
Brian A Jones, 5 April 2012
The writer of the letter of the month receives a £25 Amazon voucher

On the wrong foot?
In response to the letter from Professor Richard Verrall and Dr Peter England in the April edition of The Actuary regarding Jessica Leong’s bootstrapping article in the December edition, I have two comments to make.

First, I would have expected two gentlemen with such experience of public speaking to have a good grasp of rhetoric. If they did, they would be familiar with synecdoche; a rhetorical term describing where a part is used to refer to the whole (for example ‘wheels’ for ‘car’) or the whole is used for the part. In non-life actuarial circles, the (general) term bootstrap has become common shorthand for the (specific) over-dispersed Poisson model. While in a peer-reviewed paper in a scholarly journal, such ambiguity would not be acceptable, it seems to me that the more idiomatic and accessible language is appropriate for the target readership of The Actuary.

Second, England and Verrall suggest considering a wider range of models, which was the suggested approach I inferred from the article anyway. However, multiple models cannot offer a universal panacea: in essence, how can multiple wrong answers be the right thing to do?

What I took from Leong’s article was that the particular application of bootstrapping considered was unlikely to be appropriate, which is unfortunate, as it is in such wide use in the industry.
Andrew Cox, 10 April 2012

Challenging times ahead
With regard to ‘A challenge from the editor’ in the April letters page, I hope it does stimulate some debate. In asking whether we can ever expect a zero-failure tolerance in financial stability and, if this is the aim, what the cost of achieving this would be, I think you have summed up well where the current reams of legislation in most sectors are trying to take us. I would argue that nowhere is this more so than in the case of pensions.

It comes at some cost though and David Collinson rightly points out the huge difference in cost of defined contribution vs defined benefit this week.

I really hope someone starts to think about reversing the trends. Pensions minister Steve Webb has some appetite for it, but, unfortunately I can’t see that he’ll change anything dramatically enough to stop what is currently happening. I hope I am wrong.

Perhaps the first step that needs to be taken though is to get the majority of actuaries to wake up to the problem. Ever since Exley, Smith and Mehta’s paper on financial economics, the movement to market values and risk-free discount rates has got stronger and stronger each year. Their paper was excellent and, to answer certain questions, it provides the only method to get the answer. However, those questions don’t include ‘How much money do I need today to provide for tomorrow?’, which is central to pension scheme funding. The proof of the flaws in the approach can be seen from the outcomes – the end of defined benefit pensions to be replaced by defined contribution vehicles that aren’t fit for purpose.
Mark Rowlinson, 9 April 2012

Moving with the times
When I started work as a graduate actuarial trainee at the Prudential in 1951, my annual salary was £280 per annum. My grandson will soon be starting down the same road with a salary of £28,000 per annum, which is an inflation rate of just under 8% per annum for 61 years! Unfortunately I don’t think he will be much better off than I was.
Julian Tonks, 6 April 2012

The editorial team welcomes readers’ letters but reserves the right to edit them for publication. Please email
[email protected] The deadline for receiving letters for the June issue is 15 May.

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