Until recently, I had thought that only those on the point of retirement had been truly clobbered in the rout of our pension system caused by ultra-low interest rates. Then I opened my latest pension statement.
I have paid “additional voluntary contributions” into a fund under a “defined contribution” scheme. That means the amount I paid in was fixed, but what I will eventually get out is not. This fund, entirely invested in equities, did rather well over the course of 2012, its value rising by 11.7 per cent. But when I turned to look at the Statutory Money Purchase Illustration, which tells me the income I can expect in 16 years, when I turn 62, things stopped making sense. The projected figure had collapsed by just over 62 per cent in a year. How could the value of my fund increase by this much and yet the income I can expect from it crash by almost two thirds?
Quite easily, it turns out. There are two parts. First, in April 2012, the scheme’s actuaries increased their forecasts of members’ average life expectancy. So the fund I’ve built up must now last longer, which means spreading the same income over more years, leaving me with less per year.
Second, a key assumption that the government insists they use to calculate the Statutory Money Purchase Illustration has changed. The statement I received in 2012 assumed that interest rates would be 0.4 per cent a year above inflation for the next 16 years. A year later, interest rates are expected to be 0.2 per cent a year below inflation.
So changing their assumption about how long I’m going to live, and factoring in negative interest rates after inflation (which we now have, of course) for the entire remainder of my working life results in this lamentable car crash. What is one to conclude from this disconcerting experience?
First, actuaries have been wrong-footed by increasing life expectancy for many years and have been far too slow to adjust. Consequently, their past forecasts have turned out to be a long way adrift.
Second, models that try to predict outcomes decades into the future are hugely sensitive to even small changes in the numbers you feed into them. This episode is a classic example—if the present assumptions are wrong by fractions of a percentage point, the outcome will be different again.
Third, and most important,…