1 00:00:04,240 --> 00:00:12,470 Without further ado, I'd like to welcome Michael Otsuka to deliver his second lecture. 2 00:00:12,470 --> 00:00:16,530 All right. Thank you very much, Julian, and I'm glad to be back. 3 00:00:16,530 --> 00:00:23,880 So I drew last week's lecture to a conclusion with an account. 4 00:00:23,880 --> 00:00:28,820 I'm trying to see if I can. Right. 5 00:00:28,820 --> 00:00:36,310 It drew last week's lecturer's two conclusion with an account of the virtues of a form of insurance 6 00:00:36,310 --> 00:00:42,130 created by the joining together of a number of different corporations into a mutual association, 7 00:00:42,130 --> 00:00:45,950 namely last man standing multiemployer pension scheme. 8 00:00:45,950 --> 00:00:53,650 And so here we have what we might describe as a social union of social unions, to borrow a phrase from John Rawls. 9 00:00:53,650 --> 00:01:02,030 So the employer covenant is rendered strong and enduring through the binding together of universities and colleges up and down the country. 10 00:01:02,030 --> 00:01:13,000 And this is because such collectivisation allows for the spreading of risks of insolvency across all universities and colleges in the land. 11 00:01:13,000 --> 00:01:18,700 And it also underwrites the risks of an vestment in growth assets through the spreading out 12 00:01:18,700 --> 00:01:25,840 of the costs of recovery from market downturns over decades and therefore across generations. 13 00:01:25,840 --> 00:01:31,120 Now, as was noted in the discussion following my last lecture, 14 00:01:31,120 --> 00:01:36,670 Last Man Standing form of neutrality raises some concerns of intergenerational fairness. 15 00:01:36,670 --> 00:01:45,730 So if the cost of recovery from the underfunding of past pensions promises as spread out as I proposed over the next three decades. 16 00:01:45,730 --> 00:01:51,700 Then younger workers in the case of USAC who didn't receive such generous promises will be forced, 17 00:01:51,700 --> 00:02:00,590 at least indirectly, to bear some of the costs of making good these promises to previous generations. 18 00:02:00,590 --> 00:02:06,810 And then questions of fairness also arise amongst members of the same generation. 19 00:02:06,810 --> 00:02:14,240 So as the University of Cambridge said in their submission to the 2017 USS Consultation on the valuation, quote, 20 00:02:14,240 --> 00:02:21,440 University and other financially stronger institutions continues to lend its balance sheet to the sector, 21 00:02:21,440 --> 00:02:26,240 which contains the cost of pensions provision for all employers. 22 00:02:26,240 --> 00:02:33,710 Now, I noted last week that Trinity College, Cambridge, the financially strongest of all of USSA sponsors, 23 00:02:33,710 --> 00:02:39,980 recently arranged a costly exit from the scheme to limit the exposure of their asset 24 00:02:39,980 --> 00:02:48,280 rich balance sheet to the risk sharing mutuality of this last man standing arrangement. 25 00:02:48,280 --> 00:02:55,880 And account of these concerns of unfairness to which this spreading of risks across space and time gives rise. 26 00:02:55,880 --> 00:03:03,440 It will, I think, be useful to consider the alternative of providing pensions in a manner in which all 27 00:03:03,440 --> 00:03:10,370 costs and benefits are fully internalised by the individual who receives the pension. 28 00:03:10,370 --> 00:03:20,090 So I shall therefore begin this lecture at the other end of the spectrum from the large last man standing social union of social unions. 29 00:03:20,090 --> 00:03:29,330 What I'm gonna do is start today with the consideration of a stripped down, highly atomised, individualistic form of pensions provision. 30 00:03:29,330 --> 00:03:35,480 This will serve to identify the different challenges with which we're faced in providing for our 31 00:03:35,480 --> 00:03:43,040 old age and also the range of solutions available from this individualistic starting point. 32 00:03:43,040 --> 00:03:52,720 What I'm going to do today is build back up finally to last week's highly collectivist form of pension provision. 33 00:03:52,720 --> 00:04:01,800 And in doing this, I hope I'll be able to clarify the workings and functions of the various integrated parts of a collective scheme. 34 00:04:01,800 --> 00:04:10,260 And what we shall see is that there's an interesting range of possibilities that lie between the starkly individualistic. 35 00:04:10,260 --> 00:04:14,450 And higher, they call collectivist forms of pension provision, so to speak. 36 00:04:14,450 --> 00:04:18,750 Different degrees and forms of collectivisation. Question, 37 00:04:18,750 --> 00:04:25,830 might there be an optimal point somewhere between these two ends of the spectrum which solves the problems of individualistic pension 38 00:04:25,830 --> 00:04:33,120 provision without taking on the vices attributed to highly collective pensions provision that I mentioned a few moments ago? 39 00:04:33,120 --> 00:04:41,290 And that's the question I shall ask today. Is there some optimal point between these two extremes or shall we take one the two extremes? 40 00:04:41,290 --> 00:04:51,860 Well, let me begin. With the observation that pensions provision is not essentially intergenerational or even social in nature, 41 00:04:51,860 --> 00:05:01,510 so it can arise even if we restrict ourselves to a single generation and within that generation to a single isolated individual. 42 00:05:01,510 --> 00:05:07,050 Now here, the problem of how to provide for one's old age would be especially acute. 43 00:05:07,050 --> 00:05:12,190 So we can imagine a Robinson Crusoe like character stranded alone on a desert island. 44 00:05:12,190 --> 00:05:20,320 Who knows that she'll never be rescued. And although she's now capable of roaming the island to gather food and sustain herself, 45 00:05:20,320 --> 00:05:29,680 she realises that she will one day grow too old and infirm, indeed, to retire to a more sedentary life. 46 00:05:29,680 --> 00:05:36,880 Now she knows that she'll die of starvation if she doesn't make provision while she's mobile and active for sustenance in her old age. 47 00:05:36,880 --> 00:05:41,920 Now, in trying to provide for her, so to speak, retirement on this desert island, 48 00:05:41,920 --> 00:05:47,350 she faces the two risks that render pension provision difficult for all of us. 49 00:05:47,350 --> 00:05:56,560 That's longevity risk and investment risk. Her longevity risk is that of not knowing how long she'll live in a condition of infirmity, 50 00:05:56,560 --> 00:06:03,640 in which she's no longer able to roam the land to gather food on this island. 51 00:06:03,640 --> 00:06:13,180 No. On the one hand, she wants to make sure that she's made enough provision to consume so that they last as long as she would 52 00:06:13,180 --> 00:06:19,790 live in this infirm state to the point where she managed to die of something other than starvation. 53 00:06:19,790 --> 00:06:20,670 Now, on the other hand, 54 00:06:20,670 --> 00:06:30,280 she wants to make sure that she doesn't expend unnecessary time in labour making provisions that will outlast her and go to waste after she dies. 55 00:06:30,280 --> 00:06:33,940 Now and grappling with what we can call the other risk, investment risk. 56 00:06:33,940 --> 00:06:41,150 She will need to decide which things to gather on the basis of her knowledge of how well they will keep before they spoil. 57 00:06:41,150 --> 00:06:47,410 So we can also imagine. That she has choices involving positive returns on investment. 58 00:06:47,410 --> 00:06:53,890 For example, the planting of a garden that will continue to bear nearby fruit when she's no longer able to roam 59 00:06:53,890 --> 00:07:01,290 or more fancifully the fermenting of drinks that will maybe improve with age during her retirement. 60 00:07:01,290 --> 00:07:07,790 Well, the increasingly prevalent means of pension provision in contemporary society shares, 61 00:07:07,790 --> 00:07:12,390 I think some of the flaws of this primitive, individualistic. 62 00:07:12,390 --> 00:07:16,980 Do it yourself. Method of desert island pension provision. I've just sketched. 63 00:07:16,980 --> 00:07:27,030 So what I'm referring to is the familiar and increasingly common individual defined contribution retirement savings plan known as a four oh one K, 64 00:07:27,030 --> 00:07:32,650 and you had states, D.C. pension pots and United Kingdom works roughly as follows you. 65 00:07:32,650 --> 00:07:40,500 And typically also your employer make monthly contributions into your pension pot during your working years. 66 00:07:40,500 --> 00:07:47,250 These contributions are typically set as a fixed percentage of your income and then you decide how to invest that part. 67 00:07:47,250 --> 00:07:54,690 And then when you retire, you make use of your pension pot to provide yourself with an income in retirement. 68 00:07:54,690 --> 00:08:00,840 Now, increasingly, the way that people are choosing to do this is by income draw down by drawing down their 69 00:08:00,840 --> 00:08:06,010 fun by means of withdrawals from a continuously invested part until it's depleted. 70 00:08:06,010 --> 00:08:15,660 And treating the pension pot like a big A.T.M. machine. No, such a practise of income drawdown involves significant exposure to longevity risk. 71 00:08:15,660 --> 00:08:26,780 And here's why. If you knew exactly how long you would manage to live in retirement, you could budget to cover precisely that number of years. 72 00:08:26,780 --> 00:08:31,390 But one typically doesn't know the date of one's death. 73 00:08:31,390 --> 00:08:41,060 So if you're a British man. A woman eligible for a full state pension. 74 00:08:41,060 --> 00:08:46,070 Your mean life expectancy is 19 more years to the age of 85. 75 00:08:46,070 --> 00:08:54,980 However, if a one in four chance of living seven more years beyonder to the age of 92 and a one in 10 chance of living to the age of 96. 76 00:08:54,980 --> 00:09:02,480 Now, if you're a 66 year old British woman, your mean life expectancy is 21 more years to the age of 87. 77 00:09:02,480 --> 00:09:09,170 However, you have a one in four chance of living to ninety four and a one in 10 chance of living to ninety eight. 78 00:09:09,170 --> 00:09:14,840 Let's suppose that you're a British woman chosen to retire at the age of 66 and you're in possession 79 00:09:14,840 --> 00:09:22,250 of no information that would differentiate your prospects from that of any other 66 year old woman. 80 00:09:22,250 --> 00:09:27,140 Question, how should you decide if you're trying to draw down your pension pot in retirement? 81 00:09:27,140 --> 00:09:31,280 What portion of your pot to draw down each year? 82 00:09:31,280 --> 00:09:40,790 Should you assume you're going to live the mean number twenty one more years and therefore try to decide divide your pension pot into 21 equal parts, 83 00:09:40,790 --> 00:09:47,990 one for each year? Well, if you do that, there's actually greater than 50 percent chance that you'll deplete your pension pot before you die. 84 00:09:47,990 --> 00:09:53,440 Since the median number of years, a 66 year old is somewhat higher than the mean number of years. 85 00:09:53,440 --> 00:10:00,560 Now, in order to ensure a very high chance, a 90 percent chance that you'll have a regular income until death, 86 00:10:00,560 --> 00:10:08,110 you're going to need to divide your PA into 32 equal parts, one for each year until the age of 98. 87 00:10:08,110 --> 00:10:16,600 If you do that, you're going to run a very high chance that you will not be able to take full advantage of your pension pot during your lifetime. 88 00:10:16,600 --> 00:10:18,310 You'll leave money on the table. 89 00:10:18,310 --> 00:10:26,230 So you're running a dual risk of your money running out before you die of having left much of your pot and consumed at death. 90 00:10:26,230 --> 00:10:35,800 Now, in each case, had you known how long you would live, then you would have made different choices regarding the pace of your withdrawals. 91 00:10:35,800 --> 00:10:40,160 Even now, her. It's actually up. 92 00:10:40,160 --> 00:10:44,180 No press plea. How long you're going to live in retirement? 93 00:10:44,180 --> 00:10:48,760 Let's assume that, you know, you'll live exactly 21 more years. 94 00:10:48,760 --> 00:10:56,170 You're faced with a further problem that it will be difficult to divide your path into 21 equal portions unless you invested very conservatively. 95 00:10:56,170 --> 00:11:00,460 Well, first note that the equality of the portions should be in real rather nominal terms, 96 00:11:00,460 --> 00:11:07,750 which is to say that they should be equal once one adjusts for any decline in purchasing power due to inflation. 97 00:11:07,750 --> 00:11:13,390 And one would actually need to invest in inflation index linked bombs or derivatives that hedge against 98 00:11:13,390 --> 00:11:20,530 inflation to try to bring about a division of 21 parts that are equal in real terms and second, 99 00:11:20,530 --> 00:11:23,940 investments with high expected return. 100 00:11:23,940 --> 00:11:32,010 Our purchase of the costs of a relatively high risk involving unpredictable variability of outcomes and therefore, 101 00:11:32,010 --> 00:11:36,780 unless you invest very conservatively in a manner that simply hedges against inflation, 102 00:11:36,780 --> 00:11:40,740 it will really be impossible to know how much to withdraw each year in order to 103 00:11:40,740 --> 00:11:48,420 ensure that you receive equal income in real terms throughout the rest of your life. Even if you know precisely how many years. 104 00:11:48,420 --> 00:11:50,200 You have to live. 105 00:11:50,200 --> 00:11:58,150 Now, on account of all these difficulties, the financial economist and Nobel laureate William Sharpe has described income drawdown as, 106 00:11:58,150 --> 00:12:03,340 quote, the nastiest, hardest problem in finance. 107 00:12:03,340 --> 00:12:08,770 It is, however, a problem that increasing numbers of retired individuals and United Kingdom, 108 00:12:08,770 --> 00:12:13,120 United States and I think increasingly elsewhere face on their own, 109 00:12:13,120 --> 00:12:18,460 both as defined contribution pension pots become more and more prevalent, as does income drawdown, 110 00:12:18,460 --> 00:12:25,500 as the way to try to transform these pension pots into retirement income. 111 00:12:25,500 --> 00:12:32,370 Today, I'm going to consider the workings and merits of an interesting and innovative solution to this nastiest, 112 00:12:32,370 --> 00:12:38,500 hardest problem in finance, and this solution will soon be provided to the postal workers. 113 00:12:38,500 --> 00:12:43,120 Royal Mail and hence the pillar boxes and my title slide. 114 00:12:43,120 --> 00:12:46,520 The solution bears the name of C. D.C. 115 00:12:46,520 --> 00:12:55,880 Now, various critics regard CDC as a disease that needs to be controlled before it has a chance to spread beyond postal workers. 116 00:12:55,880 --> 00:13:03,960 The CDC stands for collective defined contribution, doesn't stand for centres for disease control, not at least today. 117 00:13:03,960 --> 00:13:09,330 Now, some oppose CDC because I regard it as an unsound alternative to existing 118 00:13:09,330 --> 00:13:16,210 individualistic forms of defined contribution IDC that I've been talking about. 119 00:13:16,210 --> 00:13:23,920 But others opposed it for a very different reason, because they regard CDC as a threat to defined benefit. 120 00:13:23,920 --> 00:13:30,010 Now, the USS pension scheme, for example, has often been mentioned as a prime candidate for CDC. 121 00:13:30,010 --> 00:13:34,530 Now some welcome. CDC as a solution to USSS problems. 122 00:13:34,530 --> 00:13:40,720 Others oppose it as an existential threat to the existing beleaguered DB scheme. 123 00:13:40,720 --> 00:13:44,830 So question, should CDC be welcomed or should it be repelled? 124 00:13:44,830 --> 00:13:48,840 I hope to shed light on that question today. 125 00:13:48,840 --> 00:13:56,200 But before directly talking about CTCA, I want to establish a point of reference, the benchmark against which we can measure it. 126 00:13:56,200 --> 00:14:05,690 Did you, son? I'm going to begin with a sketch of the traditional manner in which individuals with defined contribution pension pots have in the past. 127 00:14:05,690 --> 00:14:09,040 Address the problems of longevity and investment risk. 128 00:14:09,040 --> 00:14:18,680 It was once common for an individual to enter into the following market exchange with an insurance company at or near the point of retirement. 129 00:14:18,680 --> 00:14:25,250 So you agree to transfer the assets you've accumulated in your pension pot? 130 00:14:25,250 --> 00:14:30,740 Barron's company, and in exchange, the insurance company provides you with an annuity, 131 00:14:30,740 --> 00:14:36,020 which is the guarantee of a steady stream of income from retirement until death. 132 00:14:36,020 --> 00:14:39,380 With or without increases to partially or fully cover price inflation. 133 00:14:39,380 --> 00:14:44,060 Given that sort of annuity purchase and therefore, through this purchase of an annuity, 134 00:14:44,060 --> 00:14:50,560 you transfer all longevity and investment risk over to the insurance company. 135 00:14:50,560 --> 00:14:55,710 Well, here's how the insurance company. Is able to handle longevity risk, 136 00:14:55,710 --> 00:15:05,870 and this is also how collective pension schemes and longevity rich much more effectively than an individual can handle longevity risk. 137 00:15:05,870 --> 00:15:11,600 So as I remember, as I mentioned earlier, for someone in the U.K. who now retires at the age of 66. 138 00:15:11,600 --> 00:15:15,860 One's average life expectancy is about 20 more years, 19 for men. 139 00:15:15,860 --> 00:15:22,370 21 for a woman. Now, no individual who's attempting to draw down her pension pot on retirement on her 140 00:15:22,370 --> 00:15:27,880 own can safely assume that he or she will live this average number of years. 141 00:15:27,880 --> 00:15:33,710 For all she knows, she might live anywhere from one to 40 years beyond the date of retirement. 142 00:15:33,710 --> 00:15:39,450 And as I noted earlier, this uncertainty makes it very hard to gold. 143 00:15:39,450 --> 00:15:41,040 Let's bring in John. 144 00:15:41,040 --> 00:15:48,870 But by the law of large numbers, however, an insurance company which writes annuities for a large number of individual are the same age. 145 00:15:48,870 --> 00:15:56,620 We're retiring at the same time. Can safely assume that the different lifespans will average out to something very close to 20 years. 146 00:15:56,620 --> 00:15:59,490 This figure in this case is statistically stable. 147 00:15:59,490 --> 00:16:05,610 Just to say there's a low degree of variance when we apply it to a large population and therefore the insurance company can can budget. 148 00:16:05,610 --> 00:16:11,740 Precisely. Now, that's how an insurance company handles longevity risk. 149 00:16:11,740 --> 00:16:21,670 And here and I talked a bit about this last week, is how much union budy handles investment risk. 150 00:16:21,670 --> 00:16:27,720 Insurance companies required required by solvency regulations to have sufficient capital to 151 00:16:27,720 --> 00:16:32,730 insure that as a ninety nine point five percent chance of paying out the promised annuity. 152 00:16:32,730 --> 00:16:35,090 And to achieve this level of certainty, 153 00:16:35,090 --> 00:16:43,530 it invests in assets that come close to perfectly matching the pensions liabilities in their duration and magnitude. 154 00:16:43,530 --> 00:16:49,090 A long dated, inflation linked government bonds come closest to this match. 155 00:16:49,090 --> 00:16:56,890 As I mentioned, last week's lecture is for this reason that the cost of an annuity closely tracks the government bond yield, 156 00:16:56,890 --> 00:17:01,640 which has been falling as the graph show. 157 00:17:01,640 --> 00:17:10,610 And since these yields are now extremely low right hand side of the graph, the cost of an annuity is now very high. 158 00:17:10,610 --> 00:17:16,580 Now, well, it's possible, man, or I've just described for an individual to eliminate investment and longevity risk by 159 00:17:16,580 --> 00:17:22,490 means of purchase of an annuity in exchange for his pension pot are at or near retirement. 160 00:17:22,490 --> 00:17:29,060 Such a person is actually still faced with the following two significant financial risks leading up to retirement. 161 00:17:29,060 --> 00:17:36,700 Well, first. An individual has no control over what often on old. 162 00:17:36,700 --> 00:17:42,660 And therefore, the rate at which one can convert a pension pot into an annuity will be a point of retirement. 163 00:17:42,660 --> 00:17:48,450 And in addition to the long term decline that we can see the bond yields and graph, you can also see quite a bit of fluctuation. 164 00:17:48,450 --> 00:17:48,840 In fact, 165 00:17:48,840 --> 00:17:55,830 fluctuations from day to day in the bond yield can also make a significant difference to the rate at which one is able to convert one's pension pot. 166 00:17:55,830 --> 00:17:59,790 Depending on what month one retires, not just ones what year. 167 00:17:59,790 --> 00:18:05,850 Now, in addition to the rate at which one can convert money into one's pension pot into an annuity, 168 00:18:05,850 --> 00:18:13,560 the overall size of one's pension pot at point of retirement will also, of course, make a difference to the adequacy and generosity of the annuity. 169 00:18:13,560 --> 00:18:23,390 One, we'll be able to purchase that retirement. Now, how do we deal with this fact that it's really important how much money you have at retirement? 170 00:18:23,390 --> 00:18:29,030 Well, in order to try to maximise the value of one's assets, a point of retirement. 171 00:18:29,030 --> 00:18:36,860 Pensions pots are typically made, mainly invested in growth, assets, equities and property, which have higher expected returns than bonds. 172 00:18:36,860 --> 00:18:42,720 Throughout most of the working life of a D.C. potholder. 173 00:18:42,720 --> 00:18:54,000 Since, however, returns on equities and property tend to be more volatile than those of bonds, the investment. 174 00:18:54,000 --> 00:19:01,470 The investments of a D.C. pension pot holder are typically sent by default on a lifecycle path of de risking. 175 00:19:01,470 --> 00:19:07,390 Now that's the USS default amongst those out of growth assets and into bonds during the years leading up to retirement. 176 00:19:07,390 --> 00:19:11,410 And here's the rationale for having good growth assets for, say, 177 00:19:11,410 --> 00:19:15,350 the first 30 years of your working life and then for the last 10 years de risking into bonds. 178 00:19:15,350 --> 00:19:23,710 The rationale is that one needs to protect against a great fall in the value of one's assets from which you won't have much time to recover. 179 00:19:23,710 --> 00:19:29,030 Close to the point at which one needs to transform these assets into an annuity. 180 00:19:29,030 --> 00:19:36,680 And one need to do this, even though this involves a shift in investments with lower expected monetary returns. 181 00:19:36,680 --> 00:19:43,100 Historically, however, such de risking would have been typically costly and ineffective as a means of 182 00:19:43,100 --> 00:19:48,470 protection against downturns in the stock markets for U.S. and U.K. workers. 183 00:19:48,470 --> 00:20:01,570 And here's an illustration. In these. How big one's pension pot would have been at various dates of retirement? 184 00:20:01,570 --> 00:20:08,590 After a full working career, if wanted, kept it 100 percent invested in stocks or equities, the pink line, by contrast, 185 00:20:08,590 --> 00:20:14,290 indicates how big one's pension pot would've been a retirement if one had the risk out of stocks and bonds. 186 00:20:14,290 --> 00:20:24,290 As one neared retirements now, as these graphs illustrate the vast majority of years from 1948 to 2007. 187 00:20:24,290 --> 00:20:28,250 Even those proceeded by fairly sharp downturns in the stock market. 188 00:20:28,250 --> 00:20:33,050 This sort of de risking would have made workers in the UK and the US actually poor in retirement. 189 00:20:33,050 --> 00:20:41,720 Then a high wire strategy of remaining invested purely in stocks or equities throughout one's career. 190 00:20:41,720 --> 00:20:51,770 Now, in comparison with the collective multiemployer defined benefit pension scheme, which was the topic of last week's lecture. 191 00:20:51,770 --> 00:20:54,380 I think we should conceive and it's useful. 192 00:20:54,380 --> 00:21:05,320 Steve, of the individual with his own defined contribution, pension pot as a pension scheme consisting of a single member. 193 00:21:05,320 --> 00:21:07,760 So within it, most a few decades. 194 00:21:07,760 --> 00:21:12,680 He's working life and his life itself will come to an end, and this is for the simple reason that the days of our lives, 195 00:21:12,680 --> 00:21:18,770 the days of our years are three score years and ten, and if by reason of strength, they before score years. 196 00:21:18,770 --> 00:21:25,680 Yet it is their strength. Labour and sorrow for Jews soon cut off and we fly away. 197 00:21:25,680 --> 00:21:27,960 But when he retires in individuals, 198 00:21:27,960 --> 00:21:38,790 one person pension fund will stop receiving any further contributions into it along lines of a DB fund of a sponsoring employer who ceases trading. 199 00:21:38,790 --> 00:21:41,940 If you would like to guarantee a pension income for life, 200 00:21:41,940 --> 00:21:48,000 what this individual with is one person pension scheme now needs to do is arrange for the assets of his 201 00:21:48,000 --> 00:21:55,140 pension scheme to be bought out by insurance company that provides a bond back to annuity in exchange, 202 00:21:55,140 --> 00:21:59,100 as described earlier, at least as one alternative. Now, as I noted, 203 00:21:59,100 --> 00:22:04,740 the individual also feel the pressure to de risk from stocks to bonds during the years leading up to retirement 204 00:22:04,740 --> 00:22:11,260 in order to provide protection against a great fall in the asset value before purchasing the annuity. 205 00:22:11,260 --> 00:22:17,410 And so instead of the individual closing his pension scheme and having an insurance company buying it out, so to speak. 206 00:22:17,410 --> 00:22:23,590 Question we. I want to ask now is might there be a more cost effective way for an individual to manage 207 00:22:23,590 --> 00:22:30,060 longevity and investment risk than by means of life-cycle deed risking and purchasing an annuity? 208 00:22:30,060 --> 00:22:38,860 The insurance company buyout. The answer is yes. As was the case last week and general theme, 209 00:22:38,860 --> 00:22:48,280 the solution to the problem of expensive pension provision involves collectivisation into a mutual association for mutual advantage. 210 00:22:48,280 --> 00:22:50,080 But unlike last weeks, 211 00:22:50,080 --> 00:23:00,560 this mutual association involves individuals who retire at the same time rather than the various employers of the last man standing pension scheme. 212 00:23:00,560 --> 00:23:09,180 Here's one promising. He operates. 213 00:23:09,180 --> 00:23:18,060 Largely within and involves only minor modifications of the familiar structures of individual defined contribution pension pots. 214 00:23:18,060 --> 00:23:21,900 So rather inexpensively give risking their portfolios to in the years leading up to retirement, 215 00:23:21,900 --> 00:23:26,550 at which point they purchase an annuity whose income is pegged to the yield on bonds. 216 00:23:26,550 --> 00:23:28,590 Under this solution, 217 00:23:28,590 --> 00:23:37,770 individuals keep their pension pot continuously invested throughout their working lives in a portfolio heavily weighted for its growth assets. 218 00:23:37,770 --> 00:23:41,070 But when an individual reaches retirement age, 219 00:23:41,070 --> 00:23:51,160 he and others who retire at the same age and the same date enter into the following income drawdown, mutual arrangement with one another. 220 00:23:51,160 --> 00:23:59,780 So the average life expectancy of this cohort. Map moves are the same age as Imputed. 221 00:23:59,780 --> 00:24:06,550 Let's assume that's 20 years. And then these individuals hire the services of an actuary who will provide them with a 222 00:24:06,550 --> 00:24:11,530 best estimate of the long term returns of their pension pots over the next 20 years. 223 00:24:11,530 --> 00:24:17,470 And so the actuary also calculates how much could be withdrawn each month on the pension pots of each retired member, 224 00:24:17,470 --> 00:24:25,210 such that if the expected long term returns on investments is precisely realised each year in an equal amount, 225 00:24:25,210 --> 00:24:33,040 it's withdrawn from the fund each month. Then the entire park will be completely depleted after exactly 20 years. 226 00:24:33,040 --> 00:24:40,020 The average life expectancy. Now, each individual would receive these equal amounts in the form of income drawn down from 227 00:24:40,020 --> 00:24:45,390 the fund directly proportional to the size of his pension pot at time of retirement. 228 00:24:45,390 --> 00:24:53,110 Now. We haven't yet solved the problem mentioned earlier with income drawdown, 229 00:24:53,110 --> 00:24:58,150 that some individuals will live longer than the rate at which their pension pot 230 00:24:58,150 --> 00:25:03,760 is drawn down and others will die before their part is completely depleted. 231 00:25:03,760 --> 00:25:09,700 And it's at this point that we introduced the following vital and in fact, dramatic twist. 232 00:25:09,700 --> 00:25:13,600 For anyone who dies before 20 years have elapsed, 233 00:25:13,600 --> 00:25:19,390 the assets he would have received between his death and his 20th year of retirement are redistributed to 234 00:25:19,390 --> 00:25:27,070 everyone else's pension pot to be drawn down by the rest of them in the event they live more than 20 years. 235 00:25:27,070 --> 00:25:34,470 In the past, Debrett, that anyone who dies after 20 years have elapsed. 236 00:25:34,470 --> 00:25:39,870 Has his unconsumed assets also redistributed to the pensions pots of those who live even longer? 237 00:25:39,870 --> 00:25:44,870 Eventually, all the assets are redistributed, so they end up being drawn down. 238 00:25:44,870 --> 00:25:50,350 You're going to and drawing down by the last person alive. 239 00:25:50,350 --> 00:25:56,820 So unlike a multiemployer pension scheme such as you assess, this is literally a last man standing arrangement. 240 00:25:56,820 --> 00:26:06,690 He's the last person standing arrangement. Now, the scheme I've just described is essentially a version of an arrangement known as a tontine, 241 00:26:06,690 --> 00:26:11,340 which traces its origins to Europe in the 17th century, 242 00:26:11,340 --> 00:26:14,880 was widespread in the 18th and 19th centuries, 243 00:26:14,880 --> 00:26:22,660 and played an especially large role in providing for the retirement to people in the United States at the turn of the 20th century. 244 00:26:22,660 --> 00:26:32,830 The Tontine also figures in various works of fiction involving murder plots, as we can well imagine, including this episode of The Simpsons. 245 00:26:32,830 --> 00:26:39,690 Now, unlike many of the historical instances which involve the transaction with an insurance company or the government, 246 00:26:39,690 --> 00:26:47,070 the version of the tontine I've just sketched takes the form of a mutual association. 247 00:26:47,070 --> 00:26:51,970 In the case of ordinary individual income drawdown assets and one's pensions, 248 00:26:51,970 --> 00:26:58,880 part that one wasn't hasn't consumed a death go to one's heirs or whom everyone designates in one's will. 249 00:26:58,880 --> 00:27:09,230 Under this Tontine arrangement, by contrast. The assets go to everyone else in one's cohort who belongs to the mutual association in 250 00:27:09,230 --> 00:27:16,190 a manner that provides insurance against the risks about living one's own pension pot. 251 00:27:16,190 --> 00:27:23,690 Although I've just explained how such a tontine handles longevity risk, I've not yet explained how it handles investment risk. 252 00:27:23,690 --> 00:27:34,490 And that's what I want to explain now. Given the volatility and uncertainty of returns on growth assets expected long term returns on its shores, 253 00:27:34,490 --> 00:27:40,100 assets will very, very, very are very unlikely to be precisely realised. 254 00:27:40,100 --> 00:27:42,680 And therefore, if one is invested in growth assets, 255 00:27:42,680 --> 00:27:48,140 one runs the risk of either draw down the growth assets too quickly so that the longer the members, 256 00:27:48,140 --> 00:27:50,420 the cohort that form the mutual association, 257 00:27:50,420 --> 00:27:58,250 outlive them or else drawing down the assets too slowly so that some of them go to waste by remaining on the table unconsumed. 258 00:27:58,250 --> 00:28:02,080 After all, members of the association die. 259 00:28:02,080 --> 00:28:10,810 Now, there is a way to manage such investment risk, and it's by means of of the same sort of lifecycle de risking that I talked about earlier. 260 00:28:10,810 --> 00:28:17,770 But unlike the case of such risking from a growth portfolio into a bond portfolio during the last decade of one's working life, 261 00:28:17,770 --> 00:28:26,950 which is represented by the downward slope of the yellow dotted line, the downward slope is from the age of 57 to sixty seven. 262 00:28:26,950 --> 00:28:34,900 Here, the de risking out of growth assets and into bonds are again only a point of retirement represented by the downward slope in the purple line. 263 00:28:34,900 --> 00:28:43,300 It's assumed to be 67. And the portfolios of the cohort that forms a tontine gradually de risk. 264 00:28:43,300 --> 00:28:49,850 I mean, it's a it's a more gradual Driskell less steep decline. 265 00:28:49,850 --> 00:28:56,990 Members of the members took one arrives, a pure bond portfolio shared only by those who are unusually long live. 266 00:28:56,990 --> 00:29:06,330 I mean, it's only when people reach the age of 90 that the portfolio is already just a few risks all the way to bonds. 267 00:29:06,330 --> 00:29:12,840 Now, under an innovative arrangement along these lines that Royal Mail has proposed. 268 00:29:12,840 --> 00:29:20,160 Complete de risking into a low bond portfolio takes exactly as long as plotted on the graph. 269 00:29:20,160 --> 00:29:25,320 Only one his 90th birthday. An actuary for Royal Mail, Willis Towers Watson, 270 00:29:25,320 --> 00:29:34,340 has estimated that such an arrangement can be expected to give rise to an average level of pensions income for people who retire now, 271 00:29:34,340 --> 00:29:41,670 which would be 70 percent greater than the income they would have received if they did risk in the more traditional fashion. 272 00:29:41,670 --> 00:29:46,860 From a growth portfolio into a bond portfolio during the last decade of the working 273 00:29:46,860 --> 00:29:52,260 life as depicted by the yellow dotted line and purchased an annuity upon retirement. 274 00:29:52,260 --> 00:29:57,660 Now the reason pension pensions, income is so much greater during retirement has entirely to do with the fact that 275 00:29:57,660 --> 00:30:03,840 the portfolios of members remain entirely invested in growth assets for longer. 276 00:30:03,840 --> 00:30:10,510 So it all comes down. To the difference between the yellow dotted line and the purple line, 277 00:30:10,510 --> 00:30:14,870 the yellow dotted line represents returns on a pension pot for someone who does risks in 278 00:30:14,870 --> 00:30:21,290 traditional life-cycle faction life-cycle fashion to purchase an annuity at retirement. 279 00:30:21,290 --> 00:30:28,280 The high horizontal line at left represents expected long term returns on a growth portfolio, 280 00:30:28,280 --> 00:30:33,120 which is estimated to be a bit less than four percent above the yield on long dated government bonds, 281 00:30:33,120 --> 00:30:38,350 the so-called risk free rate, which is zero on the vertical axis. 282 00:30:38,350 --> 00:30:43,640 Now, the initial drop in the yellow line represents the decade long de risking in the years leading up to retirement, 283 00:30:43,640 --> 00:30:51,610 the further drop down to the low yellow horizontal dotted line. 284 00:30:51,610 --> 00:30:54,700 Come from a guaranteed inflation linked annuity. 285 00:30:54,700 --> 00:31:00,490 When benchmarked against the very yield, low yield on long dated government bonds and since its inflation protected, 286 00:31:00,490 --> 00:31:06,610 its even lower than the average bond yield. And I think that it's also low because they're also selling survivor benefits. 287 00:31:06,610 --> 00:31:14,980 Now, by contrast, the Purple Line represents the high returns on a growth portfolio in which scheme members are invested 288 00:31:14,980 --> 00:31:20,560 until the point of retirement and then this gradual de risking descent to a pure bond pool portfolio. 289 00:31:20,560 --> 00:31:27,760 By the time any scheme member reaches the age of 90. Now, the that the. 290 00:31:27,760 --> 00:31:37,930 The absence of deerskin before retirement improves expected pensions income by about 15 percent in comparison with an annuity. 291 00:31:37,930 --> 00:31:43,140 And this this bit, this this this gap is about a 15 percent difference. 292 00:31:43,140 --> 00:31:53,810 And the returns on investment and growth assets during retirement. As compared with being in an annuity. 293 00:31:53,810 --> 00:31:57,120 Improves expected income and trauma by a further 50 percent. 294 00:31:57,120 --> 00:32:04,040 Now, these two improvements compound to a 70 percent or wrong approvement relative to the yellow dotted line. 295 00:32:04,040 --> 00:32:11,480 Now, it's important to stress that the 70 percent improvement upon retirement income that one gets from 296 00:32:11,480 --> 00:32:18,690 an annuity represents the amount of improvement one can expect on average over this guaranteed. 297 00:32:18,690 --> 00:32:28,060 Annuity income. Now, depending on how returns on growth assets actually turn out relative to bonds, the amount that people end up receiving trauma, 298 00:32:28,060 --> 00:32:35,430 it might be more or might be less than a 70 percent improvement on this guaranteed income from an annuity. 299 00:32:35,430 --> 00:32:42,180 Now, in the case of any cohort that retards in a given year and enters into this Tontine arrangement, 300 00:32:42,180 --> 00:32:50,740 the Purple Line represents the expected return on their pension pot before and deter and during retirement. 301 00:32:50,740 --> 00:32:55,150 Now, especially during the period in which people invested entirely in growth assets, 302 00:32:55,150 --> 00:33:02,830 the actual returns of cohorts of different ages who were time, different years, might actually vary quite a bit. 303 00:33:02,830 --> 00:33:12,080 Not to reduce this variability and unpredictably unpredictability of income, which depends on data retirement. 304 00:33:12,080 --> 00:33:20,190 Well, here's a solution, if one doesn't want to have such a trip to run the lottery of, 305 00:33:20,190 --> 00:33:27,650 you know, well, all of my assets grow during the period before retirement, at retirement. 306 00:33:27,650 --> 00:33:35,990 Different cohorts might agree in advance to smooth over the higher or lower returns on investments that cohorts enjoyed different years. 307 00:33:35,990 --> 00:33:42,690 So if the returns of the pensions part of a given cohort exceeds the expected mean represented by the purple line, 308 00:33:42,690 --> 00:33:47,510 those higher than expected returns will be transferred by this prior ex ante agreement to the 309 00:33:47,510 --> 00:33:55,320 pensions parts of those cohorts whose returns fall short of the purple line as a result. 310 00:33:55,320 --> 00:34:00,420 Of this race varying between different cohorts. 311 00:34:00,420 --> 00:34:06,690 The different codes would receive an income closer to that which is implied by the purple line than they would have received of each cohort, 312 00:34:06,690 --> 00:34:14,040 completely internalise all their gains and losses. With no transfer from cohorts, with good investment by luck to those with bad investment. 313 00:34:14,040 --> 00:34:19,470 Luck now with the introduction of this smoothing of investment returns between 314 00:34:19,470 --> 00:34:23,520 the different cohorts that are entering into these Tontine arrangements, 315 00:34:23,520 --> 00:34:36,800 we've now finally arrived at a description of the workings of Royal Mail's proposed new pension scheme, CDC, or collective defined contribution. 316 00:34:36,800 --> 00:34:41,450 Now, in the absence of such smoothing of returns between different cohorts, 317 00:34:41,450 --> 00:34:52,220 this Tontine arrangement I described earlier is a variant of C. D. known to I. 318 00:34:52,220 --> 00:34:59,430 D. c. It's called see IDC. 319 00:34:59,430 --> 00:35:03,570 Which stands for collective, individual defined contribution. 320 00:35:03,570 --> 00:35:10,640 Now, one of the virtues of the Royal Mail scheme that's designed so that will be possible to write generous pensions, 321 00:35:10,640 --> 00:35:19,250 even on the assumption that the scheme closes to new members and slowly goes into run off as existing members retire and then die. 322 00:35:19,250 --> 00:35:28,360 And the way it does so if if if Royal Mail slowly goes out of business or the scheme closes. 323 00:35:28,360 --> 00:35:34,960 Is that then it would naturally, gradually transform from CDC to see IDC. 324 00:35:34,960 --> 00:35:43,810 So absent the influx of new members into the scheme will eventually arrive at the last cohort of workers who retire at the same time. 325 00:35:43,810 --> 00:35:51,040 In the scheme and the last cohort and those immediately preceding them will be treated pretty much a self standing tontine 326 00:35:51,040 --> 00:36:01,210 arrangements along the lines that I initially described with no cross subsidy or smoothing between the different cohorts. 327 00:36:01,210 --> 00:36:12,870 And therefore the scheme will eventually resolve itself into a pure version of C IDC or the Tontine arrangement I described earlier. 328 00:36:12,870 --> 00:36:17,220 Now, it will be possible for these final cohorts to stand on their own bottoms, so to speak. 329 00:36:17,220 --> 00:36:24,970 Given the gradual de risking of their portfolios as represented by the purple slope, which I described earlier. 330 00:36:24,970 --> 00:36:32,800 Now, in the absence of smoothing between different cohorts, there will be more variability in pensions, income, depending on your retirement. 331 00:36:32,800 --> 00:36:38,080 But this gradual purple de risking of each core cohort's portfolio, 332 00:36:38,080 --> 00:36:42,520 combined with a redistribution mechanism from the dead to the living of the tontine, 333 00:36:42,520 --> 00:36:54,010 will still render it very likely that all members of a given cohort will receive a relatively steady income until death, 334 00:36:54,010 --> 00:37:03,230 which is much more generous than the guaranteed income in retirement. One could purchase in the form of an annuity from an insurance company. 335 00:37:03,230 --> 00:37:12,290 No one could attempt to overcome this problem of increased variability in the income of members of different 336 00:37:12,290 --> 00:37:20,960 cohorts as the scheme winds down by taking steps to ensure that the scheme remains open for the long term. 337 00:37:20,960 --> 00:37:25,400 With a steady influx. Of new members, in fact, 338 00:37:25,400 --> 00:37:33,890 if one could be confident that the scheme would remain open with a steady influx of new members for at least the next two or three decades, 339 00:37:33,890 --> 00:37:41,560 then one wouldn't even be able to introduce this gradual de risking of the portfolios of members in retirement. 340 00:37:41,560 --> 00:37:48,940 Rather, if you knew that the scheme would remain open for 20 or 30 years, one could remain indefinitely invested in a high level of growth assets, 341 00:37:48,940 --> 00:37:51,970 as one would always have the option of smoothing differences and returns between 342 00:37:51,970 --> 00:37:56,470 different cohorts in order to provide everyone the level of pension income, 343 00:37:56,470 --> 00:38:05,550 which is implied by the expected return of at least. 344 00:38:05,550 --> 00:38:07,770 Be likely to provide that. 345 00:38:07,770 --> 00:38:15,810 Now, what I've just done is introduce, introduce smoothing, not just between all existing members of the scheme, as in the case of Romell, 346 00:38:15,810 --> 00:38:24,160 but also between existing members and the anticipated future members of the scheme, which you anticipate will join over the next 20 or 30 years. 347 00:38:24,160 --> 00:38:29,260 Now, as I shall now explain. We've actually now arrived. 348 00:38:29,260 --> 00:38:36,970 By means of building up from individual defined contribution pensions, parts through the addition of different forms of risk pooling. 349 00:38:36,970 --> 00:38:44,830 We've now arrived at a pension scheme, which is very much like the USS scheme that existed in nineteen ninety six. 350 00:38:44,830 --> 00:38:49,540 The valuation of which was the launching point of last week's lecture. 351 00:38:49,540 --> 00:38:57,340 Now, as I mentioned last week, this was a scheme funded on the basis of a best estimate of returns on a portfolio indefinitely 352 00:38:57,340 --> 00:39:03,100 invested heavily in growth assets with a roughly 80 percent weighting towards equity. 353 00:39:03,100 --> 00:39:08,040 Now, in comparison with the purple line of our CDC scheme. 354 00:39:08,040 --> 00:39:14,740 The investment approach, if you are thrust in the 1990. 355 00:39:14,740 --> 00:39:19,890 Committed by this green horizontal line. Just. Drawn in. 356 00:39:19,890 --> 00:39:25,530 In 80 percent, equities portfolio is not as heavily invested in growth assets as the purple preretirement portfolio. 357 00:39:25,530 --> 00:39:32,430 Royal Mail and for that reason, the green horizontal line is lower than the horizontal preretirement portion of the purple line. 358 00:39:32,430 --> 00:39:39,780 But unlike the purple line, there's no de risking of the assets that corresponds to the retirement years of individual members. 359 00:39:39,780 --> 00:39:43,950 And therefore, the green line never slopes downward. 360 00:39:43,950 --> 00:39:54,180 The justification for this lack of de risking is that even though individuals will age and die, the scheme as a whole will remain relatively youthful. 361 00:39:54,180 --> 00:40:02,920 As the average age of scheme members will remain relatively unchanged through the anticipated influx of new members to replace those retire. 362 00:40:02,920 --> 00:40:09,940 And then it will always, therefore, remain possible to smooth differences in investment returns across different cohorts and plan that we 363 00:40:09,940 --> 00:40:17,280 will get the expected long term be able to deliver the expected long term return through such smoothing. 364 00:40:17,280 --> 00:40:28,500 There's another crucial respect in which this intergenerational CDC scheme converges on USS as it existed in 1996. 365 00:40:28,500 --> 00:40:36,810 And this has to do with the level of guarantee of the defined benefit or the final salary that. 366 00:40:36,810 --> 00:40:44,190 And this is a point I want to stress as I draw today's lecture to close. 367 00:40:44,190 --> 00:40:50,670 Now, as the name implies, CDC is a type of defined contribution. 368 00:40:50,670 --> 00:40:56,130 Now, like the more familiar, individualistic version of defined contribution, 369 00:40:56,130 --> 00:41:04,870 IDC individual defined contribution risks are placed on workers rather than employers. 370 00:41:04,870 --> 00:41:13,500 But with CDC, risks are borne by workers collectively rather than individually, in the manner I've been describing. 371 00:41:13,500 --> 00:41:16,450 Now, as in the case of ITC, however, 372 00:41:16,450 --> 00:41:26,920 the employer's obligation extends no farther than the putting of a contribution into the pension fund of a given fixed amount in a given year. 373 00:41:26,920 --> 00:41:35,080 No further obligation. The CDC pension a worker ends up receiving in exchange for his country, which might be relatively generous. 374 00:41:35,080 --> 00:41:43,040 Is based on a target rather than a hard promise of a given amount of pensions, income in retirement. 375 00:41:43,040 --> 00:41:52,810 The CDC target consists of that pension, which you will be possible deliver if, but only if investment returns are as good as expected. 376 00:41:52,810 --> 00:42:00,170 With these smoothing mechanisms. If investment returns are less good than expected and hence the targeted pension is underfunded. 377 00:42:00,170 --> 00:42:05,040 There is no obligation on the part of the employer to repair the underfunding. 378 00:42:05,040 --> 00:42:08,490 Director of Deficit Recovery Contributions. Rather, 379 00:42:08,490 --> 00:42:16,710 the future or her pensions and income of workers adjusted downward to the point 380 00:42:16,710 --> 00:42:21,500 where they can be funded out of the lower than anticipated actual returns. 381 00:42:21,500 --> 00:42:29,110 Now, these cuts in pensions, Meydan hopefully will be later restored if returns on investments and exceeding expectations in later years. 382 00:42:29,110 --> 00:42:39,820 Now. In 1996. The year the valuation of USS with which I began last week's lecture, 383 00:42:39,820 --> 00:42:48,950 things were in fact a little different in so far as the enforceable obligations of employers to deliver pensions were concerned with c.D. 384 00:42:48,950 --> 00:42:54,530 A little different from CDC insofar as the enforceability of the pensions obligations concerned. 385 00:42:54,530 --> 00:43:01,360 So back in 1996. There was no legal requirement to make good. 386 00:43:01,360 --> 00:43:05,680 And you underfunding of an ongoing scheme with extra deficit recovery contributions, 387 00:43:05,680 --> 00:43:14,380 all these calls for deficit recovery, Confucians were not binding. In 1996, moreover, before 1997, 388 00:43:14,380 --> 00:43:20,350 it was possible for an employer with a final salary scheme to freeze his liabilities 389 00:43:20,350 --> 00:43:25,690 by deciding to wind up his pension scheme so long as the scheme rules permitted this. 390 00:43:25,690 --> 00:43:30,700 And if the assets in the scheme were insufficient to meet the accrued liabilities, 391 00:43:30,700 --> 00:43:35,950 the benefits could be reduced under the order of priority spelled out in the scheme rules. 392 00:43:35,950 --> 00:43:47,220 Now. You were exposed to the original scheme rules allowed for a majority of sponsoring institutions to terminate the scheme at any time. 393 00:43:47,220 --> 00:43:52,800 So long as they were basically for the scheme to be terminated any time, 394 00:43:52,800 --> 00:43:56,760 so long as they secured the consent of the joint negotiating committee with 395 00:43:56,760 --> 00:44:01,620 equal employer and union membership and an independent chair with casting vote. 396 00:44:01,620 --> 00:44:09,340 Now, what would happen if? Employers plus the Jahns, he decided to terminate the scheme. 397 00:44:09,340 --> 00:44:13,990 Well, what would happen is that the assets would, in the scheme and in the fund, 398 00:44:13,990 --> 00:44:20,170 would then be distributed first to secure the pensions of pensioners who are receiving pensions and payment, 399 00:44:20,170 --> 00:44:28,830 then to secure the pensions of deferred members, and finally to secure the benefits of active members with what remained. 400 00:44:28,830 --> 00:44:34,470 And if the assets in the fund at the time proved insufficient to provide us as U.S. assets, quote, 401 00:44:34,470 --> 00:44:43,350 promised 180 of final salary pension to a given category of scheme members, they would've been out of luck. 402 00:44:43,350 --> 00:44:49,590 I don't think many people realise how soft the deeply promise was in the 90s. 403 00:44:49,590 --> 00:44:56,480 Now, today, the situation both for you, assassin for pension schemes more generally is very different. 404 00:44:56,480 --> 00:45:03,290 In the mid 2000s. Legislation came into force, which requires solvents, 405 00:45:03,290 --> 00:45:13,410 answering employers in the UK lined up IBI scheme to secure the pensions liabilities law members, active, deferred and pensioners. 406 00:45:13,410 --> 00:45:19,550 By paying a sum of money sufficient to cover the cost of purchase of annuities, which will provide the exact same pension. 407 00:45:19,550 --> 00:45:24,690 So instead of being the walk away, close down the scheme, spread the assets around for as far as they go. 408 00:45:24,690 --> 00:45:26,310 Now, if someone wants to leave a scheme, 409 00:45:26,310 --> 00:45:34,740 they have to buy out the pensions liability so everyone receive exactly the same pension if you are wanted for a scheme while you're still solvent. 410 00:45:34,740 --> 00:45:42,500 Now, as I previously noted, the cost of annuities closely tracks the yield on long dated government bonds. 411 00:45:42,500 --> 00:45:49,100 And Trinity College actually had to pay that high cost in order to do the scheme while still solvent. 412 00:45:49,100 --> 00:45:58,490 Now, another important difference between 1996, a pensions protection fund was created in the meantime in the mid 2000s. 413 00:45:58,490 --> 00:46:06,780 The Pensions Protection Fund protects scheme members from employers who wind up their pension schemes on a get on account of insolvency 414 00:46:06,780 --> 00:46:15,690 while lacking sufficient means to buy out their pensions liabilities with an insurance company or otherwise pay all pensions as they fall, 415 00:46:15,690 --> 00:46:24,290 too, from the assets in the scheme. The members received compensation from the pension production fund for loss of their pension, 416 00:46:24,290 --> 00:46:31,450 and the fund is financed by insurance premiums levied on all schemes which are invested in a portfolio weighted towards bonds. 417 00:46:31,450 --> 00:46:36,650 And the Pension Protection Fund explains that its own portfolio with bond weighted quote, 418 00:46:36,650 --> 00:46:42,710 because we need to be solvent at times when general pension schemes are significantly underfunded. 419 00:46:42,710 --> 00:46:53,090 We keep the need a low risk strategy that aims to be relatively uncorrelated to the funding levels of the schemes to protect. 420 00:46:53,090 --> 00:46:59,330 Now, note that these forms of protection against loss of one's promised DB pension, 421 00:46:59,330 --> 00:47:07,880 which weren't around in nineteen ninety six, all involve backstops that secure pensions out of bond portfolios. 422 00:47:07,880 --> 00:47:15,650 And it's for this reason that the regulator is keen to ensure that the funding of DB schemes does not fall too far 423 00:47:15,650 --> 00:47:23,540 short of the cost of purchasing such a bond portfolio in the event that an employer becomes weak or insolvent. 424 00:47:23,540 --> 00:47:35,450 At the same time that the returns on the assets in their DB scheme are less than expected. 425 00:47:35,450 --> 00:47:42,800 The contrasting approach of the 1990s to finding DBI schemes of low contributions with 426 00:47:42,800 --> 00:47:48,710 greater reliance on the higher expected returns of growth assets makes good sense, 427 00:47:48,710 --> 00:47:57,540 I think. Only in the absence of the legal protections of our pensions that have arisen since the mid 90s. 428 00:47:57,540 --> 00:48:04,060 So we can't return to those days of low contributions and his all the way down 20 percent. 429 00:48:04,060 --> 00:48:14,170 And reliance on high returns from growth assets. We are also forgoing the bond based protections of our pensions promises that have arisen since then. 430 00:48:14,170 --> 00:48:18,370 In other words, we cannot have our cake and eat it, too. 431 00:48:18,370 --> 00:48:26,470 Where the cake is low contributions, combined with reliance on high expected returns on growth assets and eating it too, 432 00:48:26,470 --> 00:48:34,520 is the bond underpinned legal protections of our pensions promises. 433 00:48:34,520 --> 00:48:39,390 Sir Ralph Bupp. If like many. 434 00:48:39,390 --> 00:48:49,170 You regard the 1960s to the 1990s as a golden age of defined benefit pension provision, and you would like to return to those days. 435 00:48:49,170 --> 00:48:54,990 Then you should seek to transform today's defined benefit into a collective defined 436 00:48:54,990 --> 00:49:01,050 contribution where that's likely to provide from high returns on low contributions, 437 00:49:01,050 --> 00:49:07,800 but does not and cannot guarantee the generous pensions that people actually received. 438 00:49:07,800 --> 00:49:20,060 But we're not guaranteed. Back in the 90s and before, the so-called golden age of defined benefit pensions was in essence, even if not a name. 439 00:49:20,060 --> 00:49:24,265 An age of collective defined contribution. Right. Thanks.