Superfunds or Superfiduciaries?
This blog post from Insurance and Pensions Europe reports on the ongoing work to put the UK defined benefit pension retirement system back on solid footing. Apparently there is a move afoot to consolidate local plans on the theory that pensions are failing because their funds are too small. Superfunds are the solution!
What if what is really needed is a radical – in the Latin sense of “going to the root” – rethink of what pensions are designed to do, and how they are empowered to achieve their design purposes.
What if we take out a clean sheet of paper, and begin by drawing this “faucets and drains” image of a pension as an actuarial risk pool that aggregates surpluses saved by or for the benefit of a statistically significant population of statistically similar plan participants, using the law of large numbers to socialize the risks of not dying soon enough, and so outliving one’s retirement savings. Pensions are like the inverse of life insurance. Where life insurance provides protection against the financial burdens we impose on our loved ones if we die too soon, pensions provide protection against the financial burdens we impose on our loved ones if we live too long.
Thanks to Jon Lukomnik for giving us this metaphor (although the drawing is mine).
A quick look at this image shows us that one important design function of a proper pension is to generate investment earnings that, together with worker earnings, replenish the risk pool as money drains out to cover plan expenses and pay benefits.
A moment’s reflection on this image also shows that the overriding design function of a pension is to keep its actuarial risk pool properly full and flowing, balancing new cash inflows from workers and investments against constant cash drains to cover plan expenses and benefits. That is the only way the plan can continue paying benefits indefinitely, and if the plan cannot pay benefits, why does it exist?
What cannot be seen in this particular image are the powers we invest in our pensions, with which to generate the investment earnings their actuarial risk pool needs, to keep it properly balanced, full and flowing.
However, reflecting on this purpose does show us the values that a pension is designed to value: balance, and flow.
The powers we invest in our pensions, though which to pursue these core values of balance and flow, include size, purpose and time.
What can they do with these powers?
They can negotiate. They can sit down across the table from an enterprise that needs investment, and work out agreements 1). on strategies for generating cash flows through commercial transactions, 2). on expectations for cash flow generation, and 3) on priorities for sharing out cash flows as generated.
Bill Janeway, formerly of Warburg Pinkus, teaches us “cash flow is happiness for [enterprise]”.
Jon Lukomnik, formerly of the New York City Employees Retirement System, teaches us that cash flow is happiness for pensions: “how can I generate adequate cash flows, forever”.
What if we match the happiness of cash flow to enterprise with the happiness of cash flow to pensions, directly?
Would that be a good way to help keep our pension systems in proper balance, and their actuarial risk pools properly full and flowing?
How could we do that?
Maybe by recognizing the super powers and super duties of pensions as superfiduciaries.
Maybe then we would not need to create superfunds, because we would already have funds that are doing a super job at valuing their core values, of balance and flow.