Current debate over Defined Benefit (DB) pensions has captured the attention of the public and press. People are living longer, investment returns are lower than expected, and economic uncertainty has led to the closure of DB pension funds to future accrual in order to cap the ever rising cost of servicing these liabilities. Following these lethal blows, 2012 saw the introduction of auto-enrolment, and in 2013 the Department for Work and Pensions (DWP) is consulting on the topic of whether the industry should change the discount rate used to value liabilities to a smoothed one, in order to reduce the impact of current low gilt yields.
However, we are still faced with two serious challenges that have yet to be fully faced:
- Repairing DB pension deficits and improving member security without harming the commercial future of our corporates.
- Growing and securing an adequate and sustainable income in retirement for those not in a DB pension.
As an industry, I believe that we are on the whole trapped in what Jim Collins describes in his book “Built to Last – Successful habits of visionary companies” as The tyranny of the OR. Collins defines the tyranny of the OR as the rational view that cannot easily accept paradox, that cannot live with two seemingly contradictory forces or ideas at the same time. The tyranny of the OR makes people believe that things must be either A or B, but not both.
- High cost pensions or less secure pensions
- Investment returns or low risk*
- Risk or low return. See the Pension Regulator’s Trustee Tool kit, which assumes risk and return are linear.
In order to repair fix the pensions problem, we must instead adopt what Jim Collins and Jerry Porras call the Genius of the AND. This is the ability to embrace and allow both extremes. We can reduce the risk of investment underperformance against the liabilities AND maintain the expected return in order to reach full funding and improve member security. We must flout the calls of naysayers and shoot for this ideal.
A truly visionary pension fund embraces both ends of a continuum: conservatism and progressiveness, stability and revolution. They manage risk AND generate investment performance to outperform their liabilities.
Redington’s 7 Step Framework to Full Funding allows pension funds to embrace the Genius of the AND, helping stakeholders to accomplish with trustees and sponsors that which should not, according to traditional standards, be possible. The 7 step framework encourages vision and creativity and yet is grounded in robust, accountable and disciplined business principles. It’s not about sitting around dreaming, it’s about planning and strategising for the best case scenario, in a world in which the best case scenario is allowed to exist, even within the harsh economic environment that surrounds us.
No doubt there is a great challenge in altering our collective mindset; embracing new ideas is not an easy task for any collective of professionals. I first wrote about the benefits to pension funds of investing in Social Housing, for example, in 2010; despite glaring evidence to prove its aptness, only now is it beginning to be adopted in earnest. But because we can’t afford not to, we must switch, and switch quickly
- My pension fund will reduce risk OR have long-term investment performance
- My pension fund will reduce risk AND have long-term investment performance
“The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.
One should, for example, be able to see that things are hopeless and yet be determined to make them otherwise.”
― F. Scott Fitzgerald, The Crack-Up
In the pursuit of pensions as well as business goals, a dualistic third approach of generating investment outperformance and managing risk is ever present. The habit of making either/or decisions leads to thinking in the realm of Black OR White and Risk OR Return. If important decisions are made through the tyrannical lens of OR, vision is inhibited, and progress is therefore hampered. Without dreaming up a goal that could be, it will never be.