The pensions model that has served the actuarial profession for so many prosperous years is broken.
The pensions model that has served the actuarial profession for so many prosperous years is broken. The main reason is pure cost, driven in the main by interest rates that are the lowest in over 400 years of financial history. Longevity is an issue too, but interest rates have broken the camel's back. For years, actuaries have derived discount rates from the assets held in pension schemes. With interest rates in excess of, say, 5% this made a lot of sense. But nothing is ever stable in deregulated capitalism.
Macro economists argue that low interest rates are here to stay, given the imbalance between the quantum of assets and available investment opportunities in bonds. There is little the Bank of England can do about it. There is just too much capital in the financial system looking for yield.
If actuaries knew that interest rates would stay at zero interest rate policy (ZIRP) levels for the next 10 years, would they advocate continued investment in bonds? The UK has a massive current account deficit and is also living beyond its means. Do gilt yields below 2% make sense?
Beyond the elevated and unpriced risk element of sovereign bond investment, at a time of global deflation, it does not make sense to invest in anything that delivers such a pathetic yield when the real world is crying out for investment.
Decent cash-generating businesses are starved of capital. Much of the infrastructure of the West is tatty, if not falling apart. Banks are not lending coherently. There are many ignored investment opportunities outside the financial system that have the capacity to generate returns in excess of 7%. They may require higher management charges but the benefits in terms of discount rates, and ultimately pension sustainability, are enormous.
It is time for pension actuaries to drop the comforting memes of the past and get real. Otherwise the golden goose gets it.
Cathal Rabbitte
22 April 2016
