As the European economy looks increasingly likely to derail, and with a plethora of unknown Unknowns ahead, it occurs to me that this is precisely why you take out insurance.
You don’t pay your premiums to the nice guys at Chubb because you fully expect your house to burn down. No, you cough up every year, because it might burn down. Because stuff happens. Because, in the dead of night, under some hidden floorboard, a mouse might gnaw through an electric cable and set the place ablaze. Someone might leave a burning candle too close to a curtain and forget to blow it out before you go to bed after a great dinner party and plenty of decent Chilean Rioja.
Because things just happen.
That’s also why you de-risk (or “hedge”) the pension plan if you’re a Plan Trustee. The three biggest risks (by a country mile) are, and always have been, the risk of inflation rising, the risk of long term interest rates falling and the risk of the corporate sponsor not being able to pay the bill if the assets run out.
Many pension plans have taken a long-term, large and consistent bet that none of these risks would materialise. No mice, no candles. Yes, they have had plenty of time to insure – Friends Provident Pension Scheme read up on this stuff and fully insured (hedged) on 2 December, 2003.
Lots of others have hedged since then. But some pension plans always found a reason not to.
Now, as the mice start to gnaw furiously and the curtains catch fire, there is some serious pain being taken across the pensions industry.The curent deficit numbers aren’t in the public domain yet, but when they are, it’s going to be much worse than anyone expects. The biggest, unhedged pension plans are in the most trouble. Think Titanic, think iceberg.
If the metaphors aren’t working, let me spell it out.
Inflation expectations are way higher than the pundits predicted they should, could or would be at this point in the economic cycle. Some say it makes no sense. Well, that’s why you insure.
Interest rates are insanely low and aren’t about to start rising. It’s looking like a Japanese Winter. How can be that be, when inflation is on the up? It’s counter-intuitive.
That’s why you insure.
Corporate sponsors now find themselves unable to “write the cheque”. I’ve lost count of the number of Finance Directors who confidently informed me in 2003: “We’re making so much money, we could write a cheque this afternoon and just rub out our pension plan’s deficit.” “So why don’t you?” I always asked. “Because we’ve got better things to do with our money.” they usually said.
Eight years on, and with an unexpectedly brutal time in front and behind, the chirpy, dismissive confidence has evaporated, replaced by nervous, darting glances.
That’s why you take out insurance.
If your Plan’s adviser is still giving you the same tired old reasons to wait for the “inevitable mean reversion” to higher interest rates, lower inflation and sunlit uplands, just shut your eyes, take a deep breath. and imagine an elderly, confused gentleman huddled with his wife in a small freezing room because they don’t have enough money to pay the heating bills.
That’s what happens in a world where the pension plan runs out of money because the assets never did catch up with the liabilities, and the company never did write the cheque, and the insurance / hedge never did pay out.
Because. right to the bitter end, the Pension Plan Trustees always believed there was going to be a better time to de-risk.