Is Defined Aspiration Simply Risk-Shirking?

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First there was defined benefit, which workers loved; then there was defined contribution, which employers loved; now the government in the United Kingdom is heralding the arrival of the defined aspiration pension, which doesn’t look like it will be loved by anybody.

The idea, mooted by Minister for Pensions Steve Webb, is a noble one: to try and stop workers with little pension savings hurtling toward an impoverished retirement.

But what are the options and why has no one thought of them before? Well, people have, at least in some form. Hybrid pensions, which amply function elsewhere in the world, are outlawed in the UK. The idea is that staff get a guaranteed defined benefit chunk to a certain level and it is topped up by a defined contribution portion. The Association of Consulting Actuaries (ACA) was pushing government to give them the green light before the financial crisis hit. Back then, there were still a couple of major corporate benefit funds open to new members in the UK, but as aiCIO revealed at the start of January, the last FTSE100 company doing so—oil giant Shell—ended the era by closing its fund.

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We are now at the stage where employers have given up taking on risk (in terms of pension provision), and Webb is tasked with turning this around. He has suggested a couple of ideas that are in the design stage, but even from ground zero they look a touch one-sided, and not in favour of the staff they are intended to help.

One idea was to offer a guaranteed lump sum and then letting the retiring staff members fend for themselves in the annuity market. Another idea was giving young people a “ball park” pension promise that alters as they get older—a very handy loophole should there be another financial crisis. The announcement caused much debate last month, and although most welcomed any movement to tackle the problem at all, Webb did not find too many cheering.

Malcolm McLean, Consultant at Barnett Waddingham, said he feared the move had come too late. “Many employers who have had a bad experience with their final salary schemes will now be reluctant to offer any sort of guarantees on pension entitlements be they limited to a cash balance scheme or something more extensive.” The ACA, for their part, welcomed Webb’s announcement and said that their annual survey showed employers wanted to, or at least accepted that they should, take on investment risk on their employees’ behalf. However, the cost of legal, actuarial, accounting, and any other advice and management fee made it impossible. This is also a handy (and understandable) loophole:
If your business is still alive after the financial crisis, why potentially poison it with
pension risk?

Webb’s stance is admirable, but he has a tough goal to reach—and one few think he will achieve. —Elizabeth Pfeuti

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Defined benefit pension funds are on the wane, with many of them bringing their investment capability in–house. Sovereign wealth funds are notoriously hard nuts to crack. Endowments and foundations have plenty of their own ideas. So where are the next asset mandates going to come from?

This question is bouncing around the financial hubs of Europe and the United States and, increasingly, there seems to be just one answer: “Insurance companies. We are all after insurance company mandates,” said a friend who works for a large asset manager in London. “If you can talk to the guys who control these assets, you will get fund managers lining up to talk to you.” It seems he is right. Over the past year or so, there has been a secular shift towards the industry that has been mostly self-contained, at least as far as its investment management is concerned.

Just over a year ago, consulting firm Aon Hewitt, which already had strong ties to insurance, announced it was strengthening its insurance investment consulting practice and moving several of its pension professionals to work in it. Most other major consulting firms have followed suit.

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Asset managers, which had previously focused on pensions, private banking, and wealth management, have been beefing up their insurance teams. Time was that only the largest fund houses, BlackRock and Deutsche Bank for example, touted their wares to insurance clients. Now all the major firms in Europe have insurance delegations, if not outright dedicated departments. American firms are following suit.

It is not surprising, considering the numbers. Last year, global insurance assets hit $24.6 trillion, just behind mutual funds with $24.7 trillion and pension assets with $29.9 trillion, according to data monitor TheCityUK. Of course, they have not sprung up overnight—the insurance sector has had trillions in its coffers for decades—so why have asset managers only just started to catch on? Put simply: regulation.

There is a saying in the north of England: It is an ill wind that blows no one any good. In regular English, this means something must be really bad for no one to benefit—and Solvency II, the incoming strict set of rules for the insurance industry, may have dealt an ace to asset managers.

Robert Talbut, Chief Investment Officer at Royal London Asset Management and chairman of the Investment Committee of the Association of British Insurers (ABI), said, “Many people will observe that regulatory pressures on their capital position are getting greater and some insurers are going to have to look at asset management and decide whether it is core to their business or instead whether it could be done elsewhere.”

He continued, “Although it’s more talk than action at the moment, it is not going to go away. Taking a five-year view, there will be a number of insurers that exit partly or completely from the asset management business.” Royal London is an insurance company with an asset management company that manages its own, other insurers’, and other institutional client assets, totalling about £43 billion.

“We have positioned ourselves, through our systems and expertise, to be able to take on other insurers’ assets. Along with capital positions to consider, regulatory pressure is forcing insurers to consider whether their in-house set up is good enough,” Talbut said. “Rules from financial regulators on complex financial instruments and derivatives will also pile the pressure—and costs—on insurance companies,” he added. In this regard, asset managers are already set up to cope, or at least are on the way to getting there. It is their business to be up-to-speed on the latest in sophisticated rule-abiding. Managing assets for one set of liabilities is just like doing it for another, right?

Wrong.

Talbut said, “When asset managers look at insurance assets, they find these assests are much more complex than what they are used to. For example, reporting requirements are a lot more detailed; insurers need to report a lot more granular information to regulators and others, which other investors don’t have to do. The mandates are a lot more complex and demanding than they would get from a traditional client.” But that means they can charge more, right?

Wrong again.

Insurers are generally competitive in their pricing and already have the systems in place to process these assets—just as Royal London does. And these businesses are scalable. Asset management companies breaking into this market would have to compete as well and as cheaply as those already there, and it seems this money is sticky. Traditional asset managers should also be careful that the trend stops there. If insurance companies can cope with technical investment mandates, a pension or SWF mandate should be no problem. Friends Life announced last November that it was creating an in-house asset manager, Friends Life Investments, which is set to launch in July. And it is likely it will not be the only one to do so. The industry needs only a few more of these and the poachers of insurance assets may soon turn into gamekeepers—forced to expend energy at just retaining what they already have.

—Elizabeth Pfeuti