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The full Monte Carlo

As DB goes to DC it reminds me of that line from Joni Mitchell&#39s Big Yellow Taxi “You don&#39t know what you&#39ve got till its gone.”

I can remember many instances of talking to groups of workers about changes to their pension schemes. I have been doing this since 1978 or the best part of 25 years.

My first presentation at the tender age of 22 found me nervous but my fears were removed by my boss who reminded me that the audience knew nothing about the existing scheme anyway so any errors on my part would go unchallenged.

Some years later, I found myself giving a talk to tanker drivers where the previous speaker, an actuary, had delighted them with a talk on time-weighted returns and standard deviation of investment options. Given that the audience was almost asleep when I kicked off my presentation, I focused on what I felt would matter to them. Not the endless ream of figures but to appreciate why having a choice at retirement is so important.

Choice comes from making adequate provision and focusing on contributions is counter-productive as it leads to lower amounts being committed to pension provision.

This is the big problem with compulsion – it is not forcing people to contribute that will concern the politicians, it is setting the levels at which they will contribute.

Too low and the stress on state benefits will not ease, too high and the public may feel that they are working for their pension plan and little else.

The focus has to be on benefits or on choices, this means that contributions will vary according to risk profile and/or age and the compulsion approach will need to factor in individual requirements.

In other words, any politician silly enough to fix compulsion at too low a rate needs to be in advanced years if the impact of that decision is not to comeback and haunt them.

The recent CP 136 (yes, 15 since CP121) deals with pension projections being provided on the current basis plus additional figures on a “today&#39s money”, it then goes on to look at stochastic projections or, as they are more commonly referred to, “Monte Carlo” illustrations does this mean that the client could soon be faced with projections at three rates plus a real value projection plus a probability of any of the previous being likely.

To perform a Monte Carlo, the user needs to input past performance data and/or to input their projections for the time horizon in question.

The problem with all projections is that they assume nothing changes or, in the case of Monte Carlo, any changes are within set parameters.

Quite apart from the irony of the FSA considering projections which need the dreaded past performance figures to produce an illustration, we need clarity and too many bases can only lead to confusion and most likely inertia as opposed to action.

But before I close, back to the tanker drivers, I simply asked them to for a show of hands as to how many of them liked to go out and enjoy themselves over the weekend. The response was overwhelming and I then drew the link between their earnings and the cost of an average weekend.

I then reminded them of the likely level of state benefits and they agreed that this would seriously curtail their social life after 65. In other words, making adequate provision was sensible as their social life could be protected past 65.

Perhaps that is what effective compulsion really looks like.

Robert Reid is principal of Syndaxi Financial Planning.

He can be contacted via email c/o the editor at robert.reid@centaur.co.uk

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