Pension Crisis

How much are our lax attitudes costing us?

There are several different types of pension – not all of which apply to everyone – but anyone living in the UK with at least 10 qualifying years on their National Insurance record is entitled to a state pension. The current weekly state pension payment an individual can expect to receive upon retirement is ￡179.60.

However, when it comes to the UK’s awareness of the state pension, more than nine in 10 people (92%) are unaware of what weekly amount they are entitled to upon retirement. Within that, a further 13% believed they wouldn't be entitled to any state pension at all.?

Opting out of pensions

Beyond the state pension, other types of pensions are available, but require additional payments to be made by an individual or their employer. These private pension schemes include a workplace or personal pension. These both help top up the amount of money offered by the government, meaning an individual will have more to live off in the future.

However, the latest figures show workplace and personal pensions may be low on the agenda for many. The current workplace pension scheme automatically opts workers into the scheme, but a quarter (25%) of the UK chose to opt-out of either a workplace or private pension altogether.

Global lessons

That's potentially a worldwide problem, particularly as so-called non-banks — including investment funds, pension funds, and insurers — have ballooned in size since the financial crisis and in some cases have taken on risks that once sat on bank balance sheets. Comprising non-banks like insurers, investment firms, and pension funds, the shadow banking system isn't subject to the same rules as traditional banks, particularly when it comes to requirements to hold cash against market shocks.

"If you don't have that view of non-bank finance and the system as a whole, then these things sort of bubble. And they happen very slowly, but when they then go wrong and go the other way, it can happen very fast and that’s what we’ve seen just now," said Iain Clacher, professor of pensions and finance at Leeds University.

UK blowup

U.K. pension funds, which hold around ￡1 trillion in assets, became stuck in a “doom loop,” where they had to sell more government bonds, known as gilts, to meet cash calls on leveraged bets. While it might not be reasonable to expect market participants to insure against all extreme market outcomes, it is important that lessons are learned and appropriate levels of resilience ensured. A similar issue is at play in the EU debate over the huge cash calls putting pressure on gas and power companies hedging electricity prices in volatile financial markets.

'Safe' assets

Yet perhaps the biggest problem for the financial system was not so much the direct trouble at pension funds but the turbulence caused in government borrowing markets. It was dysfunction in that market and the potential spillover to the real economy that ultimately prompted the BoE to act to protect the U.K. financial system. Post-crisis regulations have pushed banks, insurers, and pension funds to invest more in “safe assets” like government bonds — but those assets aren't immune to a sell-off.

Pensions across industries

Pension offerings can be a big pull for many when selecting a career. Some industries carry reputations for offering attractive pension schemes – for example, careers in teaching and the police.? Data shows how considerable the pull of a pension can be, revealing that over one in five (21%) Brits admitted the pension offering was predominantly or partially the reason they chose their most recent role.? And, it appears that certain industries’ pension potential has a larger impact than others. Those working in a creative role were most likely to acknowledge this reason, with 41% of people working within the field having selected their job predominantly or partially due to the pension offering.??

The most popular method by far to generate an increased income for the future is putting money into a savings account – something almost two-fifths (38%) of people are currently making use of. However other common methods also include:?

• Planning for the future
• Investing in stocks and shares?
• Investing in property?
• Awaiting an inheritance?
• Getting a second job?
• Putting money into premium bonds?
• Foreign exchange trading

With pensions all about planning for the future, many Brits also find other ways to make additional money outside of their main career to have a more comfortable retirement. By increasing leverage, many UK pension schemes have been operating as badly run hedge funds, increasing the risk for themselves and the whole financial system. This greed, stupidity, and laziness were encouraged by investment consultants, who get paid for complexity.

Some pension schemes have bought “leveraged gilt funds” — the clue is in the name. These instruments create leverage through derivatives and gilt repo, which allow holders to exchange government bonds for cash. The economic risk is taken on by the pension schemes. If a fund has a typical three times leverage for every 10 per cent fall or rise in the value of the underlying gilt, the value of the fund falls or rises 30 per cent.

What was the trigger for the meltdown??

As gilt interest rates rose following the “mini” Budget, UK government bond prices fell and the value of the leveraged units fell even more. This triggered calls for pension schemes to stump up more collateral on their trades. We are left in a position in which the taxpayer has effectively had to bail out pension schemes via the Bank of England intervention. This is moral hazard writ large: “Heads we win, tails we come asking for a taxpayer bailout . . . ”

Over the next few months, we will also see pension schemes selling less liquid assets, especially those in private equity. Some companies with well-funded schemes will be able to offload their pension risks entirely with buyouts from third-party insurers.