Expect the unexpected

It’s the start of a new year so time to make predictions.

My forecast is that most of us will be surprised by the economic and political environment we experience in 2008 – so my prediction is that predictions aren’t always possible. In fact, even people who make a living by forecasting the financial future are actually unlikely to be much more accurate in their guesses than the rest of us. Any trustee who has sat through a succession of fund manager presentations will probably sympathise with my analysis. I call this “pensions agnosticism”, and I’d like to look at what this means for company pension plans.

Let’s start by looking at that big rump of legacy defined benefit schemes. My highly scientific approach suggests all we know is that good or bad or quite benign stuff might happen over the next 12 months. As an employer, I can bet on the benign or good outcomes. If the bad stuff happens then it will be the shareholders or possibly employees and pension plan members who suffer.

This approach is most likely to be observed when employers believe that everyone else is taking the same bets or that any pain will go away if you wait long enough. There is protection in staying within the herd. In practice, we now observe a wide diversity of views and actions, prompted among other things by increasingly proactive trustee boards. This means that risk taking, and the bad outcomes that may result, have to be justified as right for the particular circumstances of that employer and its pension scheme.

Another approach is to conclude that if the pain could be great and the cure may not arrive in time, then preventative measures must be adopted. At this point we are into the now familiar world of de-risking. These actions will range from the asset strategy tweak, through the use of liability-driven investment banking products, to the purchase of annuities.

How much protection you buy is probably driven by how much you can afford. Some de-riskers are also influenced by the view that the rewards that flow from the good outcomes are small, and their risk taking efforts are better employed when making judgments about the business’s operations, not its pension scheme.

In addition to deciding on how to bet, a pensions agnostic will keep asking the “what if?” question. If you do not rely on expected outcomes or do not put all your faith in statistical models, then you need to spend much more time thinking about how you will respond to events, be they good or bad.

This type of scenario planning has two major advantages. First, it tends to be intuitive and enables businesses (and trustees) to look at how the company and pension scheme’s fortunes will fare under different conditions.

Second, it means that responses to events can be pre-planned. We think about this as “planned opportunism”. For example, it could be that everyone agrees that if a bet pays off, this will automatically trigger a decision to spend the gain by de-risking. Too often, pension schemes watch opportunities come and go, while being fixated on the long term. Pedestrians who look only to the horizon are likely to fall down a man hole or miss the £50 note lying on the pavement.

My final comment about 2008 and beyond is more an aspiration than a prediction. For most private sector employees, pensions are now a personal savings issue, not a company-provided comfort blanket. Our research shows there are huge gains for employers and employees if employees are allowed to make informed choices about how and when they save. My hope is that the pensions industry will show that it respects, and can support, the individual. And the best place for providing that support to employees is in the workplace through the employer’s benefit programmes.

Mark Duke is a principal at Towers Perrin. His e-mail address is: mark.duke@towersperrin.com