A few thoughts about levelling down

I've blogged a few times before about levelling down in respect of pension provision, because I find the arguments put forward by people like Ros Altmann wholly unconvincing. So I though I would try and explore the logic of the argument in reference to Personal Accounts.

The common claim is that when Personal Accounts come into force (or perhaps ahead of it) with the requirement of a 3% contribution from companies if employees don't opt out, many employers will "level down' the provision they offer. (Incidentally, note that depending on strength with which this point is expressed it falls into one of the two classic reactionary forms of argument as set out by Albert Hirschman. If, taking the stronger line, it is argued that Personal Accounts will result in less saving, it's perversity. If on the other it is argued that the reform will have no impact (because levelling down offsets the gains) it's futility.)

In practice levelling down by companies would presumably mean either reducing their contribution to a non-Personal Accounts DC pension scheme to the 3% level (from a higher level), or simply enrolling their staff into Personal Accounts and closing their existing scheme (which again must have been more generous than 3% in order to count as levelling down). Just to be clear - the only other possibilities are first, that the employer already has a scheme that is better than Personal Accounts and sticks with it, or that the employer did not have a scheme, or pay into a scheme, and now is forced to pay into Personal Accounts. In the first case there is no levelling down, in the second case there is levelling up.

So, why would an employer level down? Well one reason is because they can save money. Fine, but this does first lead to a question over why they don't level down now, rather than when Personal Accounts go live in 2012. In fact they could level down now to zero. So why don't they do so? There are at least three possible (not necessarily credible) reasons. First, they see some value to providing a pension, perhaps because it helps recruit and retain staff. Second, they fear employees' reaction if they do level down. Third, they are unaware that they could contribute less (nothing, in fact).

Obviously in the first case the introduction of Personal Accounts could actually reduce the value of providing a pension (because the comparative advantage to the potential employee is reduced) which could be argued to provide a reason to increase the level of company contribution. The second case is possibly more plausible. Companies may wish to reduce their pension commitments and Personal Accounts could provide the cover to do so. Companies could argue that their pension costs will go up (if everyone ends up auto-enrolled) and thus they need manage this. I think the final case is less plausible, but there may be small businesses out there which have a GPP or stakeholder set up with a contribution of over 3% and perhaps their adviser may make them aware of the incoming regime and urge them to respond.

But we can see that in practice most employers are not levelling down now. So they are not sufficiently concerned about costs to take pre-emptive action. And if companies do reduce contributions now, how much weight do we place on the introduction of Personal Accounts, which don't go live for another 3 years. To what extent is the company simply saving money, rather than being pushed into an action by impending reform? It simply is not clear that the reform 'causes' the company decision. Critics of Personal Accounts need to present evidence if there is any.

A more realistic version of the levelling down argument is that companies wish to maintain their current pension costs rather than reduce or increase them. What do I mean by this? Well, I think the main cause of any any adjustment to companies' pension provision will not actually be Personal Accounts at all, it will be the requirement to auto-enrol. Think about it - this is where the cost pressure really is. If I am running a scheme with a 6% company contribution maybe only 40% of my employees actually join it. But if they are auto-enrolled and only 1 in 5 decide to opt out (ie I now have a membership rate of 80%) then my pension costs have risen by 100%. If I then decide to 'level down' to the 3% minimum I keep my total pension costs the same, but the amount contributed to each employee's pension has halved.

This seems to me to be a not unrealistic (if very simplified) picture of how some companies may think and act. But it is clear then that the real issue for companies will be auto-enrolment (whether into Personal Accounts or existing schemes) not the new scheme in itself. It also means that - if companies adhere to my stylized version of responding to auto-enrolment - the 'levelling down' refers to the amount contributed to each pension, not the amount contributed in aggregate.

This is important, because it means that what is actually implied by critics of auto-enrolment (not Personal Accounts!) is that it is better for employers to contribute more to fewer employees than it is to contribute less to more. This is not an unreasonable position (for example because they may think that the minimum contributions are too low) even though I don't share it. But it is a position that is not made explicit - either because those advancing the argument don't want to be explicit, or because they haven't thought through the logic of their position.

A final point - obviously a company facing auto-enrolment could choose to level down to an extent that their aggregate commitment is lower as well as their average contribution rate. This would be levelling down in both senses. But once again it is the company's decision to pitch their commitment at this level, and again it is not clear how the reform 'causes' them to take this step. Once again, it's over to the critics to provide the proof.

Spot on

"To date, institutional investors have said little about the lessons they have learnt over the last two years. Put simply, they have not produced satisfactory answers to the question ‘what were the owners of these banks doing?’ Remember that shareholders approved value-destroying transactions, and remuneration practices that now appear to have been poorly aligned with corporate health and shareholder wealth. I expect institutional investors, on behalf of their clients, to be much more challenging in the future than they have in the past, but I wonder whether their clients have similar increased expectation and have reflected this in their manager dispositions and incentives."

"The unitary board and Combined Code assume that shareholders will act as informed and value-pursuing investors. A failure by fund managers to act in this way, or to be required to do so by their clients, raises questions about the underlying foundations of the unitary board and Combined Code. Sir David Walker will need to give this careful consideration."

Source.

Hooray

!!!

Nice line, nice image

But they may point in different directions.

1. A description of the existence of firms in the midst of markets: "islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk"

The quote is from D.H. Robertson and I found it in here.

2. I like this.

Why how shareholders vote matters

I'm at home looking after The Boy today, and he's currently in mid-snooze so thought I would bung up a link to a paper (PDF) on 'corporate voting' that looks interesting, though I don't share its approach. I found this remark particularly interesting:

"[I]n principal-agent settings, voting provides legitimacy to a system by which agents act for the larger group. It serves both to legitimize the choice of the agent as well as a means to monitor the work of the agent."

There is a really bad argument advanced in some quarters that voting doesn't matter that much. I understand the point - though I would counter that it is often made by organisations whose own voting is sometimes questionable - and it has some validity. But I think it hugely underestimates the legitimising function voting performs. All those votes fund managers cast in favour of executive remuneration policies matter, those votes against trade union-backed resolutions matter, and their votes against governance-related resolutions matter. Unless it genuinely is the case that the issue being voting on has been dealt with, a vote in favour is an endorsement, will be read as such by the company, and will be portrayed as such to the market. When Stuart Rose survived the LAPFF resolution at the M&G AGM this year he didn't say "I take on board the scale of the vote in favour" he said "we won". Companies know this, so should trustees. And they should hold their fund managers accountable for questionable voting decisions.

Exactly!

Paul Myners once again came out with some interesting comments today, when he spoke in response to the Asset Management Working Group report. This bit in particular caught my eye:

If fund managers show no wish to act in the way economic theory tells us we should expect owners to do then we will have to ask whether core assumptions that underpin the unitary board and the Combined Code accord with reality. The concept, for instance, of ‘comply or explain’ clearly assumes investors acting as informed owners, engaging with the unitary board; not an assumption that sits entirely comfortably with the behaviours of many fund managers that has enabled the emergence of the ‘ownerless corporation’. This is a significant issue for Sir David Walker to address – have we assumed more from fund managers than they are in practice willing and able to deliver? If so, how do we address this governance deficit? To whom should the unitary board account if shareholders are not willing to fulfil the role?

Needless to say I think that nails it. I think the fund management industry risks a lot by not taking the governance question seriously. And to be honest I'm not sure the AMWG report takes us any further forward given that the comments on engagement seem to correspond very closely to the views expressed by the IMA. Be careful what you wish for.

Bits & pieces

1. The Other TPA report an acknowledgment by the BBC that they may have been hoodwinked by the actual TPA.

2. Great post on S&M about Tobin taxes. The Andrea Terzi paper Chris links to is well worth a read.

3. Via Tim Worstall, an interesting little piece by Eugene "EMH" Fama in defence of... err... the EMH.