Nothing on the AMIPP website is financial advice.  You should check everything for yourself before making any use of the pages.

This page is about considerations that come into play when pension schemes change and you have to plan accordingly.  Items  "How long to live?" and "Inflation & increase cut-offs" were provided in February. "The Comparator" was provided in May.

How long to live?

Pensions, whether occupational, state, or bought annuities, are for life.  If you didn't live long in retirement, you might be able to live on savings rather than a pension.  But for most people, living a long time would mean living beyond their resources, if there were no pension.  So a pension is an insurance against living "too long".  When polled, people tend to underestimate how long they will live (in comparison with how long the experts on mortality expect them to live) and the younger people underestimate by more.

Newspapers tend to report life expectancy.  Life expectancy is an average; it gives the average number of years lived (or expected to be lived, when adjusted for its historical tendency to increase) by a certain category of people; for example females aged 65 have an expectancy of about 22 years.  For various reasons it isn't that useful in itself as a single number.   There will be influences that make the number doubtful for you.   Have you smoked since a teenager?  Did your parents die at 103? Can you afford the best medical care?

However, mortality tables can tell us something more useful than a single number - the variability in years to live.  The ages at which people die do not turn out to be clustered around the expectancy, they vary more than that.

Experience suggests a distribution like this.

(It is not worth delving into the detail numbers much.  The chart is only for one category of people.  It is of dubious applicability to you even if you are in the category because of your individual characteristics.  It is based on one particular mortality table, and there are others.  The scale is pro-rated to a million although there probably weren't a million in the sampling for the table. There is approximation in the way the chart was derived from the tables. )   

The message from the chart is in the wide range of possibilities that your planning has to allow for.

Hopefully without diluting that message, AMIPP could add here the distributions for other categories of people, the years lived by people after their partner dies, and so on.  (On request)

Inflation & increase cut-offs

Increases on pensions derived from service after April 1996 are regulated.  Comparison of your years of service before that date with the years of service after will give an approximation to the fraction of your pension that is subject to the new algorithm for calculating pension increases.  It will somewhat overestimate because some of the pension is regulated as Guaranteed Minimum Pension.  Newsletter 16 has a paragraph and link about GMP.

The unregulated part of pensions has been gaining in amount but losing in value over years, the loss in value being about 1% a year recently.

The new algorithm for increases introduces a maximum on each annual increase - 2.4% for 5 years, then 2.5% for ten years.  This follows from the algorithm, which ignores inflation above 4% for 5 years, above 5% for the following ten years.  If inflation remains within these bounds then the new algorithm is not dramatically worse than before - the 1% value loss per annum that retirees have been absorbing will increase but not double.  (30% of inflation loss becomes 40% for 5 years, 50% for following 10 years).

However, if inflation exceeds the bounds the effect could be dramatic.  The fifteen year period 1975 through 1989 saw high inflation.  If the new algorithm had been applied to pensions then, the value of the pension at the end of the period would have been about 1/3 of the value at the beginning of the period.  (What actually happened was that the 70% algorithm was approximately followed and the pension dropped to 2/3 of the outset value).

The message from these numbers is that the percentage changes are a modest certain degradation, while the introduction of RPI limits risks a devastating impact on life styles.

Few people could absorb without life style changes a move to having a pension that was one third of what they used to have.  For some scheme members it would surely move them into means testing.  Thus, by shifting the risk from the company to the scheme member, the company also shifts risk from the company to the taxpayer.

The "Comparator"

IBM has provided a tool that compares some aspect of choosing whether to switch to the degraded Final Salary plan or to the enhanced Money Purchase plan.  (The tool itself says "the two options from which you currently need to choose - i.e. stay with final salary benefits or switch to defined contribution benefits for future benefit accrual. " which is somewhat misleading since both choices are a switch from what you had before the redesign, and there are more choices such as leaving the pension plan - but these two are the choices most employees will be forced into.)

The mechanism is that the tool is available to everyone with web access.  Employees will receive through the post the password to use the tool and some data about themselves taken from Pension Services' records. If the user fills that data and more into the web forms provided, the tool will calculate something about prospective pensions.  The tool says "You are responsible for ensuring that all data supplied by you to Watson Wyatt is accurate and complete" but that cannot mean much - most employees cannot know if their retirement date is "accurate".  So the tool can be used for "what if" calculations.  "Accurate" means accurately the value you intend the tool to use.

What would you expect from a program that compares choices financially?  One would not reasonably expect some of the big future issues to be addressed.  Given IBM's worldwide plans to get out of final salary schemes will those who opt for final salary now find their scheme degraded further in the future?  Given IBM's trend to be the low benefits employer will those who opt for enhancements find the enhancements reduced (which would be fairer to those on the standard DC scheme)?

You might have expected the program to accept your view of inflation and let you try different rates of inflation. (This program does not - the assumption is fixed at 2.7% p.a.)

One would reasonably expect the program to tell you what the alternatives cost.  This program doesn't.  It could, because it knows your contributions (under the assumptions) and it tells you in words how you might calculate your national insurance contributions.

One would reasonably expect the program to tell you the value for each of the alternatives.  This program doesn't.  It gives a number for the pension at retirement (without bothering to also give it in today's pounds) but doesn't compute how the value of the pension will progress over the decades of most retirements.  The words it uses about this are misleading:

The tool does not say what increases are assumed in the final salary pensions when making those statements.  The only (relatively) sure increases are those built into the redesign.  These make the C-Plan increases less than the basis for the M-Plan projections.  In a year when inflation was the 2.7% assumed, the M-Plan increase would be 2.5% and the C-Plan increase 1.6% or less.  (Possibly zero percent in later years.  Given the consistent IBM trend for delivery to be below promise/expectation, it would not be prudent to assume more.)

One would reasonably expect the program to attempt to get close to real-world figures.  This program doesn't - it excludes voluntary contributions.  Hence the user who is concerned about replacement (the pension as a percentage of final salary) won't be able to use the program as a planning tool.  The program is also unworldly in assuming that salary increases have a constant percentage - in practice they are usually bigger earlier in an individual's career than they are later.

You might expect the program to provide results in a form that could easily be used as input to other calculations.  This one doesn't - it makes anything but printing difficult.  (The panel contents can be saved by right click, "Select All" and "Ctrl-C" followed by "Ctrl-V" to put them in a Word document.  The diagrams can be saved by "Save-As")

Overall, a weak program that doesn't do what the user wants and has misleading prose.  These are the hallmarks of a program developed with inadequate user inputs.  Perhaps the program has met its IBM objectives - it has had a dampening effect on better programs being developed, and allows IBM to suggest the employees are being well informed.