by Catherine Donnelly.

21 February 2021

Elon Musk’s approach

Elon Musk is one of the world’s most famous entrepreneurs. He is a consummate industry disruptor, from electric cars to infrastructure to healthcare. How does he do this? He doesn’t start from how things are being done right now. He doesn’t get stuck in the ‘sunk costs’ fallacy that results in suboptimal architecture or unsuitable processes being used in his businesses. He doesn’t worry about what other people think.

Instead, he asks: how would we do this, if we were starting from scratch, to create a customer-focused product? The customer comes first, always. And then Musk starts from scratch and creates, and keeps improving upon, a customer-focused product.

The system is flawed

The first UK industry pensions conference which I attended had a panel session on alternative careers for pensions actuaries as the main event. The reason was the widespread closure of defined benefit (DB) pension schemes, the main source of work for pensions actuaries. I came away feeling rather down and quite cross – why are the pensions actuaries letting down society? Why are they giving up? Why are they letting defined contribution (DC) pension plans take the place of DB schemes, without a whimper?

The one thing which DB schemes do, which DC plans do not, is provide a lifelong income to their pensioners. For the average person, who will have neither a large amount of pension savings nor be buying financial advice, the value of this is incalculable. While working, they pay monthly contributions to their DB pension scheme. They are told how much monthly income they will receive during their retirement. Then, they get that income in retirement, paid monthly into their personal bank account, just like a salary. There are no decisions required from the member. This is a good thing.

People demonstrate time and time again that they don’t want to make pension-related decisions. Offered a range of funds to invest their DC pension contributions, over 90% of members choose the one designated as the default. Asked to decide on a contribution rate, most people choose whatever is labelled as the minimum rate. What else should they choose?

Education is not the answer. People should not be expected to be pension, longevity and investment experts. But this is exactly what the current DC system requires them to be. Any system which requires everyone to be an expert to understand it and then asks everyone to make decisions which even experts struggle to answer, is intrinsically flawed.
Asking a population to pay individually for financial advice is not the answer either. Most people will not pay for advice because they don’t know if it is worth paying for. They perceive that the interests of their advisor may not align with their own.

Neither may the funds and products they are investing in be run in their interests either. The objectives of the funds they can invest in are to achieve some target level of return, with a risk rating or warning attached. How can the average pension saver interpret this when their goal is to have enough money to live on in retirement?
Frankly, the pension system is exhausting for the person using it. It makes their brain hurt. They don’t understand what is meant by a pension. This isn’t surprising since the word “pension” can mean so many things. They don’t know what they should do. Why should they? The pensions system hasn’t been designed with their needs in mind. The questions they are asked just shouldn’t be asked of them.

Pivot to a new opportunity

The Pensions Scheme Act 2021 breathes life into Collective Defined Contribution (CDC) pension plans in the UK. These are a huge opportunity to offer most people what they want in retirement: a stable, lifelong income. Pensions actuaries should be jumping up and down in excitement at this opportunity.

CDC pension plans should be the future of UK pensions. They can look like the very popular DB schemes. Members pay contributions and receive an income in retirement. No decisions are required by the members. This is a good thing.
CDC pension plans will have the objective of delivering a target level of retirement income. This is another good thing, since it aligns the aim of the pension plan with the members’ needs. Of course, the income paid to retirees is likely to change, so continual communication of this fact in a meaningful way to a CDC plan’s members is critical. However, the fluctuations in income are unlikely to be as large as under income drawdown. This is due to the pooling longevity risk within a CDC; pooling delivers an enormous financial benefit and risk reduction for individual members.

Since Elon Musk hasn’t yet turned his attention to the pensions industry, there is room for actuaries to step boldly into a new opportunity. Instead of seeing obstacles – whether a fear of finger-pointing or a fear of failure or a fear of something different – think about what the average person expects from a pension. Then “be more Musk“ and deliver it.

Dr Catherine Donnelly and her team will be studying CDC pension plans within the research programme ‘Minimising longevity and investment risk while optimising future pension plans’, which is funded by IFoA’s Actuarial Research Centre.