Many thousands of pension scheme members...have 'lost' most or all of their promised pensions when their employers' schemes have wound up.
Ros Altmann (1), The Truth about pensions in The Actuary (London) August 2004

The fact that state-sponsored pensions systems in many countries actually work rather well does not interest the libertarian theorists.

NB: In this article I use the word "he" to mean "he or she", and so on, where the context requires it. If feminist readers are offended, I ask their pardon. In writing on this topic, constant use of "he or she" is intolerably cumbersome. The use of "they" is hideously ungrammatical.

The Thatcherite obsession is not dead

Private provision is superior to State provision for all types of pensions, and therefore the pensions industry should be wholly privatized; so says (2) my fellow-actuary Terry Arthur, well-known in the financial world for his hyper-libertarian views. He has a nerve, given the trouble that has been caused in Britain by the mis-selling of private-sector pensions and the continuing problems of underfunded pension schemes in many companies.

The classic defined-benefit company pension scheme has in the past provided good pensions for many people. With this kind of scheme, a company promises to each employee a pension calculated in proportion to his years of service with the company and, if he is still with the same company when he retires, in proportion to his pre-retirement salary. The pension can even be adjusted to compensate, at least partially, for inflation during retirement.

This system can work very well for someone who is employed for most or all of his career by one solid, prosperous, durable business. But it tends to work out badly for people who change jobs. If you work for twenty years with Big Company plc and then twenty with Small Enterprise plc, you cannot expect Big's scheme to promise you a half-pension based on your final salary with Small. After all, Big has no control over Small's remuneration policy. Nor can you expect Small's pension scheme to take over intact whatever rights you may have acquired in Big's scheme. Quite possibly it lacks the financial strength to do so.

Pension scheme risks

There are more problems. If Small goes broke (or decides to wind up its pension scheme) before you retire, you will be lucky to get a partial pension from Small's scheme on the terms promised when you joined. Pensions of this type generally depend not only on the size of the accumulated fund but also on the continuing financial strength of the employer.

Top executives have been known to persuade their company's remuneration committee to grant them exorbitant salaries in their last year or two before retirement, so that they can qualify for grossly inflated pensions for the rest of their lives. This practice, of course, depletes the pension fund and makes it more difficult to pay adequate pensions to everyone else.

Too many employers have funded their pension schemes inadequately or have found devious means of reneging on their promises.

In fact, the free-marketeers who call for fully privatised pensions do not want people to have traditional lifetime careers in solid, durable businesses. They hate that kind of stability. What they want is a flexible, dynamic economy. This means an economy where companies - even big, solid ones - do not feel any obligation to employ people on a long-term basis. Hire and fire is the name of their game. And, if lots of flexible companies go bust, that does not bother the libertarians at all. It may even delight them. Bankruptcy, they say, is a sign that the free market is working.

The French example

The French have another way. Here (I write from Paris) there is a national, state-sponsored scheme that covers most employees in private-sector businesses. It is called CNAV (caisse nationale d'assurance vieillesse). Employees pay contributions based on salary, and so do their employers. Retired employees receive pensions related to their and their employers' contributions. Since one scheme covers everyone, it does not matter whether you have worked all your life for one firm or whether you have had twenty different employers. If a company for which you work, or have worked, goes under, you lose no pension. For your pension does not come from the bust company's own scheme, it comes from CNAV, which embraces just about all French companies in the private sector.

CNAV does not have any invested funds. It receives income from contributions and pays it straight out in pensions. So there is no temptation for anyone to misappropriate assets; there aren't any assets. No danger either that the viability of a pension scheme will be directly threatened by a slump in stock market values. Clever, those French, aren't they? But their system, and similar arrangements in other Continental countries, are the laughing-stock of the libertarians. The fact that such systems actually work rather well doesn't interest the theorists.

Excessive debt?

They argue that the obligation of the state, or a state-sponsored institution such as CNAV, to pay pensions in future years is a "debt" which should be seen as part of the national debt. Then they insist that, on their basis, the total national debt is far too large.

This is nonsense. Future pension payments will mainly be covered by contributions; it is only the excess if any, of future pensions over future contributions that could be considered a debt. But a real existing debt, such as a government bond, is an amount that is fixed and known already. If there will be a future gap between pensions and contributions, that gap is not a fixed sum printed in the documentation of a government bond. It depends on future government policy.

If the gap becomes troublesome, there is always the possibility of raising contribution rates, or trimming pension rates for future pensioners, or extending the period of contribution needed to earn a full pension, or raising the retirement age. If people are living significantly longer, it is not unreasonable to ask that they work a few years longer if they want a full pension.

Personal pensions for all?

What the free-marketeers want is that everyone should have his own personal pension plan, built up by investing contributions over the course of his working life. Every individual should be fully responsible for his own pension. This method has the advantage of avoiding loss of pension when one changes jobs, or if one's employer goes bankrupt. But there are serious disadvantages.

One is that administrative costs for millions of small personal plans are likely to be much higher than those of a national scheme like CNAV. Another is that one's pension is unpredictable; it depends upon the stock market value of the personal pension plan at retirement date.

Another is that people may be unable to pay contributions during periods of illness or unemployment. In CNAV, as in the British state pension scheme, one can be credited with contributions to cover such periods - if you can't pay, then, in effect, the state pays.

Risk-sharing

The effect of a compulsory national scheme is to reduce costs and to spread risks, avoiding the concentration of too much burden of risk - be it health risk, unemployment risk, or market risk - on individual workers and pensioners. Here we discover the basic reason for the libertarians' hatred of such arrangements. They are against the whole idea of spreading risk, or "socializing" risk, as they put it, thus associating risk-sharing with the socialism they so deeply abhor. They believe that every individual must bear his own risks.

In that case, why tolerate any form of insurance? They accept the existence of normal commercial insurance, where the individual buys a policy under which he personally pays (if he can afford it) the market price for protection against whatever risk he wants to avoid. That is a free-market transaction, so it's OK. But compulsory state-sponsored insurance, including pension provision, covering an entire society - that is another matter.

There, the individual does not pay the market price to cover whatever risk faces him as an individual. He pays the cost averaged across the whole population. In health insurance, for instance, he pays an average premium, not a premium based on his own medical condition. In pensions, he contributes (or gains credits for periods of illness or unemployment) in proportion to his income, but otherwise on the basis of average pension cost.

Insurance as redistribution

Here is a clear advantage for anyone whose "risk profile" is worse than average - who is, for instance, less healthy than average, or more likely to be unemployed. The advantage is paid for by those whose circumstances are better than average. This is an equalising mechanism. Libertarians hate that kind of thing. That is why societies which have pursued libertarian policies - the United States in particular, but today many others which have followed the American example - suffer from exorbitant and widening inequalities.

St Paul commended (3) equalising arrangements, that now at this time your abundance may be a supply for their want, that their abundance also may be a supply for your want. Should you wish to argue that Paul favoured only some kind of voluntary risk-sharing, let me remind you that in the Jewish community in which he was brought up, risk-sharing was not voluntary. It was (and still is) a formal obligation (tsedakah) under Jewish law.

But libertarians, fond though many of them are of thumping the Bible, do not agree with St Paul. Their motto is rather everyone for himself. A fine basis indeed for a civilised society!

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References

1 Dr Ros Altmann is a pensions and investment expert, investment banker and economist, advising the pensions industry on policy and strategy. She is a Governor of the London School of Economics and of the Pensions Policy Institute.

2 T G Arthur, Ageing: a universal state pension is the problem, not the solution, paper given at the Actuarial Conference on the theme Ageing Population: burden or benefit?, Edinburgh, January 2002

3 Second Epistle to the Corinthians, chap. 8, verse 14 (King James version)