Risks to investors in planning for their retirement
Filed under: Economy, General comments, Growth, Pensions, Risk Management
The current situation in the financial market was described by Karl Marx, almost century and a half ago, where he predicted the current financial crisis may lead to nationalisation of the banks and therefore to communism; this scenario was called “Perfect Storm”. Contrary to that however, an increasing dependency ratio may lead the UK economy to become a free market where there is no welfare system – which includes pensions.
The “Demographic Bomb”, an aging population and declining birth rate, is ticking. The decreasing number of people able to work will leave the future government with less revenue in taxes and therefore less public funds available. On the other hand, the lack of private savings today, especially by the current low earner, will force the future retirees into the extreme poverty. The inability to afford the health and care services will demand further resources from the state in the form of services, allowance and income support. Studies indicate that choice in public services is something that is here to stay. In the absence of appropriate savings, the pressure to provide services, including elderly home care and health services, to meet increasing morbidity (rate of illness) will be enormous. This will place a significant strain on public expenditure and create a large deficit in the budget.
Therefore we can say that an aging population is another storm that Great Britain, like all the other developed economies, experiencing will see lead to a “Demographic Bomb” scenario “Demographic Bomb”.
From above, the consumers planning for their retirements are exposed to high risks of decline in:
1. The Basic State Pension
2. Health and Care services available
3. Income Support
Also, the recent events in the financial market will result in various risks to consumers planning for their retirement including:
1. Lack of trust in the financial system, therefore
2. Decline in savings
3. Financial illiteracy
Not to forget, the current pension system (Basic & Second State Pension) does not deal with the absolute poverty. However, to avoid poverty, the mean testing system has been put in place which guarantees minimum income. Where this provides comfort for some, it discourages savings for the medium earner (£25K – £30K annually). The research discussed on pension reveals that an individual earning £10k a year can have pension up to £8000 (almost 80 per cent) .Where as an individual earning £25K would only get £8400 in pension (almost 34 per cent). Therefore, people with a low income, relative to average earnings, will enjoy a rising replacement rate from the state with little or no private savings, should a future Govt raise the basic state pension to deal with the poverty. Hence, this imposes the risk of:
1. Increasing the burden on the public expenditure
2. Discouraging saving
Therefore, encouraging the low to medium earners to save for retirement through Personal Accounts is vital. This will lessen the future burden on public expenditure as well as on the working generation. Additionally, the FSA should focus on the risk of declining trust in the financial system. This is not achievable until systematic error placed by means-testing, which imposes the risk of discouraging saving, is addressed.
Can greenshoots grow in sand?
Hurrah, the British economy is showing signs of recovery. The green shoots are visible in the form of a small increase in manufacturing; a rise is FTSE index by 30 per cent since March, and signs of increasing house prices. Before we get carried away, let us recognise that economy built on house prices alone is a economy built on sand.
Where good news of economic recovery is a breath of fresh air among all the depressing news over that last two years, my natural scepticism and prudence tells me that it could be a blip unless the root causes of the problem are fixed. These causes to me seem to be:
- The availability of money through credit for people to spend
- Bonus culture in the city
- Lack of local savings and therefore relying on foreign investments
To ensure that the another financial crisis is not repeated, we need to
- Save and invest in the future.
- Recognise that too much risk in financial services is not rewarded (talent overrated)
- for spending with in limits and bring down public service debts
- More mixed economy relying on manufacturing as well as services and public sector
Lord Myners – The Headmaster
Filed under: General comments, Pensions, Risk Management
Yesterday evening saw my first ever opportunity to sit amongst the city’s most successful institutional investors, listening obediently to Lord Myners. He was outlining the key issues with the current governance structure, one of the most popular – and problematic – subjects of late. Unfortunately I was not taught this in great detail whilst studying for a Masters in Business Administration. Clearly this was also the case with those who I listened with yesterday.
It became apparent that the key principle of serving the shareholders (‘Principal’) also a key responsibility of an institutional investor (‘Agent’) has been totally ignored. The increase of 300 per cent in the salaries of chief executives (under the current capitalist structure) against only 60 per cent increase in the dividend value for ordinary shareholders, was not questioned by the institutional investors.
Are we (Institutional Investors), as agents, acting as highly specialized investors on behalf of their princpals (shareholders) , are forgetting our key responsibilities, which are to:
- Engage actively, and often, in corporate governance by fully participating in the shareholder meetings.
- Influence the management of corporations by exercising our voting rights in a company. At the same time influencing the conduct of corporations, providing them with capital – all part of the job of investment management.
Instead the fear to lose highly paid clients has been both myopic and damaging. This is the great lesson I learnt yesterday and it reflects a clear division between views of socialist and capitalist leaders.
Pension funds need focus investment strategy
Like BT pension fund, lots of other define benefits schemes are strugling to keep up with the contribution requirement.
The funding ratio (value of assets / value of liabilites) is deepening for the providers and therefore need a new investment strategy. Risk must be measured and managed relative to liabilites rather than from a pure asset risk perspective. Therefore the following risks should be taken into account for scheme that is facing high demand for contribution.
- Logevity risk: An important input to calculating the liability cash-flows for a pension schem is the time period that a pension is expected to be paid
- Equity market risk:
- Mismatch between the duration of assets and liabilities risk: When the duration of a portfolio of assets differs from the duration of the liabilities, interest rate and inflation changes will impact the value of assets and liabilities differently-causing a change in the funding ratio.
Scheme sponsors and trustees should be aware of the above risks and manage it improve the funding ratio.
How To Rescue Britain’s Failing Pension Funds
Filed under: Economy, General comments, Growth, Pensions, Risk Management
The former Director General of the CBI, Sir John Banham, has called for pension funds to take greater responsibility for how and where their money is invested, with trustees acting as ‘owners of companies’ rather than as ‘speculators in shares’.
In a report submitted to the RSA’s Tomorrow’s Investor project , Sir Banham argues that investors must ‘bridge the ownership gap’ and insist that fund managers only invest in companies where they are fully satisfied about the long-term potential for business.
In his report, Decent Pension Returns in Turbulent Times, he sets out eight tests that companies must pass in order to merit pension fund investment.
Idea in Brief:
· The dismal performance of the UK fund management industry is one of the main reasons why the outlook for pensions and pensioners is distinctly cloudy.
· The underlying cause of the problem includes seeking to avoid risk, compounded by the way investment funds are allocated to different classes of assets and ineffective regulation of Britain’s major financial institutions
· This has created a gap between the ultimate owners of UK public companies and their managements, and perverse incentives for those managing other people’s money.
· The recent financial turmoil has made it more critical that all the institutions concerned abandon their conspiracy of silence and denial, and put themselves in the shoes of their ultimate client: People saving for their retirement.
· Solution: World class asset management, Global asset allocation, Smart Indexation, Bridge the ownership gap, and Positive incentives for fund managers.
The FSA publishes a revolutionary review
Lord Turner of Ecchinswell, who became FSA chair in September 2008 has spoken again. Back in 2005, he published the pension reform which is likely to result in the revolution in the pension industry through Auto-Enrolement in 2012.
I hope the new proposal by Lord Turner proves revolutionary too and manage to avert a repeat of the global banking crisis, the blame of which is highly put on the shoulders of the mangers and their poor risk management practice. However, it is important that we listen to the both sides of the story.
The risk managers who did a good job in identifying the risk and raised the concerns were either asked to shut up or shown the door. Paul More of HBOS is the great example of that.
Although I have not read the revolutionary paper yet but I hope there is a clause where risk manager, just like compliance officer, is oblige to report any misconduct that is being identified and imposes a risk to their shareholders, economy and pensioners. This will provide risk managers a power which they do not have, and badly need, with out worrying about losing their job.
Also, the risk management is seen as a function that is driven by regulators instead of a value adding strategic tools 
for enterprenuers . From my experience in risk management, I believe this is a wrong attitude to have and sold incorrectly by no other than but passive risk managers and week regulations.
The risk management framework which includes identifying, controlling, monitoring and finally managing the risk can be use as a strategic tool. It highlights opportunities whilst achieving great efficiency for the business. Especially the operational risk framework which not only creates a great value for the business by highlighting the inefficiency in the business processes but also driving resources to the right direction.
Is not that what we need, to get out of the recession? An efficiency, cost effectiveness and innovation in businesses.
RSA Vision
News- FT.com
- Pension industry speeds up transfers March 17, 2010
- Pension relief: Use it or lose it March 15, 2010
- Investors give up salary to cut tax March 12, 2010
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