An alternative take on the pension funding debate

A conversation with the ghost of a generation yet to come, taking place in the fictional country of Norania.

Ghost of a generation yet-to-come: Oh. Hello. I hear you’d like to provide a pension benefit for me. That’s kind of you.

Ebenezer Treasurer: Well, you are my offspring, and it seems expected of me. It can’t be as generous as the one I’ve been given, of course, but I intend to do everything I can to look after you. By my calculation, we’re going to need about 200 million Noranian dinars in twenty years to make that happen.

GOGYTC: OK. So, since Norania’s interest rates are around 4%, in today’s money that’s …(pause while the futuristic equivalent of a smartphone is consulted)… 91 million dinars. Excellent. And you’ve set that aside, right?

ET: Oh no; I didn’t invest it in bonds, I invested it in equities. That’s much better for you – my economists and actuaries all agree that has a 95% chance of generating a higher return.

GOGYTC: Fair enough, I think. I suppose I can afford some investment risk. So if equities perform as we hope and return, say, 6% a year on average, I can expect my pension pot to grow to …(pause)… 293 million dinars. That sounds OK.

ET: No no. 200 million. I already told you that.

GOGYTC: 91 million increased at 6% a year for 20 years is 293 million.

ET: Right. But you only need 200 million. So I’ve set aside 62 million dinars rather than 91. Very handy. That was a big help in balancing the budget.

GOGYTC: So 68 cents of equity is worth 100 cents of bonds in your world? Wasn’t it one of your generation who said “If you take money out of your left pocket and put it in your right pocket, you’re no richer”?

ET: That was one of the last lot. Smart man – they gave him a Nobel for that.

GOGYTC: For something that obvious?

ET: As he always said “Remember, we proved it rigorously”.

GOGYTC: Very funny. But you owe me 29 million dinars. Or I sue.

ET: You don’t exist yet. You don’t get a seat at the negotiating table.

GOGYTC: I’ll sue in twenty years.

ET: And I won’t exist then. Anyway, it’s perfectly well documented that equity investment is prudent.

GOGYTC: I’m not complaining about the investment strategy, I’m complaining about the claim that you’ve funded my pension.

ET: Well, me and investment markets. We’re making the money work. Taking sensible risks that will enhance expected returns.

GOGYTC: Hold on a moment. There’s no risk for you from investing in equities. I’m the one that loses out if your economists are wrong about equity returns. And when have they ever been right?

ET: Calm down. This is how we make the benefit affordable.

GOGYTC: I’m the one bearing the risk. And you’re giving yourself credit for the risk premium before it’s even been earned.

ET: I can’t spend all day talking about this. If I set aside 91 million and invest it in equities, you’re going to end up over-provided for. That wouldn’t be fair. We can’t afford to set money aside that we don’t need to.

GOGYTC: So my pension is only 68% funded.

ET: 100% funded.

GOGYTC: 68%.

ET: 100%.

… carries on for a while…