Navigating Uncertainty in the Pension Industry
Perspectives I shared with the ACPM's Prairie Council
I was honoured to be asked by the Association of Canadian Pension Management (ACPM) Prairie Council to share my perspective on navigating uncertainty in the pension industry with their membership on 7 April 2022. There’s a lot of uncertainty out there – my comments touch on the issues I find pertinent, from pensions to geopolitics, Covid to climate change – but there are also tools we can use to chart our course: I described one of my favourites, scenario planning. I am sharing my remarks here in the hope that they will fire your curiosity and build your confidence in the face of uncertainty!
In our time together, I am going to ask you to consider two sets of challenges – those facing our industry and those facing our world – and what they mean for the future of pensions and the work that you do every day. I am going to share with you a powerful tool for navigating uncertainty, scenario planning, and examples of its use. And finally, I’d like to share my thoughts on why I am optimistic about the role and potential impact of Canadian pensions.
Fundamentally, a pension is the promise to make regular payments during a person’s retirement from a fund made of contributions by the individual and their employer throughout their working life. And, as we all know, the original assumptions made in the design of that promise are under strain.
To begin with, Canadians are living longer – according to Statistics Canada, women can expect to live to age 84 and men to almost 80, a phenomenal increase of 5 and 8 years respectively gained in the last 40 years. And while authorities generally acknowledge a slowdown in the pace of mortality gains since 2010, the question of whether or not there is a ceiling to human life expectancy is still hotly debated. Advancements in healthcare have meaningfully improved longevity while social and political determinants of health – from pandemics to inequality – have introduced instability that makes population health increasingly difficult to predict. Further, innovations in personalized medicine, virtual care, intelligent prevention and future breakthroughs in the science of aging all offer the potential for step change in human lifespans. Consider that mapping the human genome originally took over 10 years and cost $3 billion – today, you can have your genome sequenced quickly for about $1000. The potential for that personalized information to revolutionize your healthcare is profound.
And while we are busy living longer, we are having fewer babies. In 2019, Canada’s total fertility rate hit an all-time low of 1.47 births per woman, down from 3.94 in 1959; this is well below our population replacement rate of 2.1 births per woman. And in 2016, the number of seniors (aged 65 and over) in the total population surpassed the number of children (aged 14 and under) for the first time in Canada’s history. This trend is expected to continue and poses obvious challenges for the pension industry: we will have fewer workers supporting more retirees who are living longer.
Canadians are also working differently. While Statistics Canada reports two-thirds of Boomers entered their fifties in long-term employment, having been in the same job for 12 years or more, research shows a pattern of job change in the millennial generation every 3 years. Before the pandemic, 1 in 10 Canadians was employed in the gig economy. Post pandemic, it is estimated that 40% of jobs can be done remotely.
Increasingly, workers are demanding alignment of values and positive impact from their employers, alongside traditional elements of compensation. And jobs like contact tracer, blockchain analyst, podcast producer and driverless car engineer didn’t exist ten years ago. The future of work – what jobs are done, where, when and by whom, enabled by technology and shaped by social change – is impacting how pensions are valued in the employment relationship and how they operate as organizations. I am watching to see how long before our foundational lifecycle – born, accumulate, decumulate, die – is broken as working and not-working become increasingly less binary states.
Canadian families are also evolving in ways that are meaningful for the pension promise. 20% of Canadian children lived in a lone-parent household in 2016, according to Statistics Canada, and the majority of those are lead by women. Same sex couples increased 60% in the decade between 2006 and 2016, with two-thirds of those couples remaining common law. The years from 2001 to 2016 saw a 37.5% increase in multi-generational households, that include at least three generations of the same family. At the same time, the 2016 census revealed one-person households were the most common type for the first time in Canadian history.
Each of these formulations is different from the legacy concept of the nuclear family that informed pension design and has implications for earning, saving and investing behaviours. And regardless of family status, we are learning that individual’s view retirement as a community achievement. Fuse has recently completed an ethnographic study into the meaning of retirement with Canadians and found a disconnect between a pension as an individual product and the member’s desire to benefit their community, however they might define it, in retirement.
Our study also provided fascinating insight into how Canadians’ view their retirement needs. We found that retirement has a very consistent brand – I think we can all picture that happy older couple on a yacht – but we also found that vision of retirement is irrelevant and discouraging to many Canadians. Our research found a stark difference in the experience and behaviours of those who believed retirement was attainable, and those who believed it was unattainable. And these two groups need very different things from their pensions, from ways to give back to ways to make ends meet, leading us to investigate what changes might make the pension value proposition more relevant for these diverse stakeholders.
We also know that many Canadians are in a precarious financial position, with 46% of Canadians reporting they are $200 or less away from not being able to meet their financial obligations each month. Canadians historically low savings rates increased meaningfully during the Covid-19 pandemic, but the gains were unevenly distributed. Economists at RBC estimate more than 30% of overall pandemic savings were accumulated in higher-income households, compared to 10% held by the lowest income households. Canadians are experiencing a decline in purchasing power – in January of this year, inflation surpassed 5% for the first time since September 1991, while wages rose only 2.4%. Meanwhile, at the end of 2021, household credit market debt as a percentage of household disposable income reached an all-time high of 186%. We are likely all familiar with the housing market challenges in Canada, but it is staggering to think that the average time required to save for a down payment in Canada has increased from 3 years in 2000 to 6 years in 2021, with urban markets like Toronto and Vancouver requiring 26 and 29 years to save, respectively. And while housing is considered a pillar of retirement savings, to be rationally liquidated to fund the later years of life, the reality is proving different with relatively low adoption of tools like reverse mortgages and instances of downsizing among retirees.
And while individuals face these structural challenges to retirement saving, workplace pension coverage in Canada has seemingly plateaued at around 37% of the population, having declined precipitously from the 1980s. Of those with a workplace pension, two thirds are in the defined benefit model, with the remaining third split between defined contribution and hybrid pensions.
As we know, defined benefit coverage is highly concentrated in the public sector and expanding private sector pension coverage has been an important area of research and product innovation. If you haven’t read the recent report from HOOPP and Common Wealth The Value of a Good Pension I’d encourage you do to so. It articulates the benefits of workplace plans, as well as the systemic and behavioural barriers challenging coverage today and what policymakers, employers and the industry can do to remove them.
But innovators are not waiting – firms like Common Wealth and pensions like OPTrust and CAAT are productizing their offering for not-for-profit and private sector organizations, expanding coverage while growing assets to further access the benefits of scale in investment performance. The question of industry consolidation cannot be far behind, as the increasing needs of members, value of every retirement dollar saved or earned, and benefits of investing at scale converge.
No doubt more change is coming, but how ready are pension organizations for change? Innovation has been called “a bug, not a feature” of the pension industry, where everything from mandates to metrics moderate creativity and risk-taking. We are governed by a patchwork of statutes and guidelines that do not easily enable change. Most organizations are operating on aging infrastructure, processes and technologies run by specialist teams that do not adapt quickly or easily, and routinely spending 20-100 times more on manager fees than they are on their own technology systems and people.
If this presentation were in person, this is where I would ask for a show of hands to see who was operating a core pension technology system or investment management solution that was less than 5 years old? 10 years old? 20? In most cases, meaningful investment is required in the tools and capabilities to organize our data, use it in decision-making, and protect it from all-too-common cyber threats. Technology transformation can be a long and expensive undertaking, with significant risks and costs that must be carefully managed – but they are imperative.
In his book The Technologized Investor, Dr. Ashby Monk argues that “embracing advanced technology can empower institutional investors to innovate in ways that let them capitalize on their ability to take a long-horizon view of the world.” Changes like – giving technology and a CTO a real seat at the table, reallocating budgets to technology tools and talent, focusing on gains in speed and inference, and building partnerships with start-ups and peer organizations – can power pensions ability to innovate in governance, risk management, product design and service.
I know that in many of your organizations, daily operations feel like a steady diet of change on top of the basic requirements of managing a pension. But we must take the time to ask, how effectively are we changing? Is our rate of change keeping up with the opportunities available and the expectations of our stakeholders? And is it delivering an ability to innovate for the future?
As we navigate these structural challenges in our industry, we are doing so against a backdrop of extraordinary uncertainty in our operating context.
Let’s begin with technology, so pervasive in our personal lives yet so difficult in the professional context. I would be willing to bet that most of us have a smartphone within arms reach right now, if not in our actual hands. We’ve likely ordered, tapped, banked, ubered, streamed or ‘grammed something in the past couple of hours in a way that would not have been possible a few years ago. You’re in touch with friends and news from all over the world, with countless algorithms personalizing the information and reminders you receive according to your preferences. Some of us can turn on our lights, cars, appliances and home security systems with our phones. None of us need to remember our passwords. But we struggle to deliver this kind of seamless, relevant and engaging experience to our employees and customers.
Technology is changing exponentially – a concept that is incredibly difficult for human minds to comprehend or predict. The growth of exponential technologies – those whose functionality doubles while cost halves in each period – starts out looking linear but eventually hits a bend in the curve that accelerates impact in an unprecedented way. Technologies like artificial intelligence, augmented and virtual reality, blockchain and robotics are converging to redefine our world socially and economically. Why does this matter for pensions? Well, it impacts who we serve – the health of our regional economies, the investment decisions of our sponsors, the job families of our employers, and the service expectations of our members. It impacts how we operate – the speed and security with which we can transact and engage. And it impacts how we invest – as existing industries and business models are disrupted, and new ones emerge and create value.
Technology played a role in helping us adapt more quickly than we would ever have thought possible to the demands of the defining event of the 21st century – the Covid-19 pandemic. It is now a near-global shared experience to remember your last shop, commute or visit with friends before the world changed in March 2020 and to lament the number of Zoom calls, lockdowns and missed milestones since. At the time of recording this session, the Johns Hopkins Coronavirus Resource Center was reporting nearly half a billion total cases of Covid-19, with over 6 million deaths globally but also nearly 11 billion doses of vaccine administered, the result of an incredible achievement of public policy and modern medicine – moving in just 326 days from genomic sequence to an authorized vaccine. This is a photo of my 6-year-old daughter in May 2021 making a coronavirus out of her breakfast bagel, which is sweet but also so very sad because she knew what a coronavirus looked like.
The pandemic has touched all areas of our lives – disrupting the global economy, motivating unprecedented government support for businesses and individuals, highlighting the fragility of our supply chains, changing how we work and interact, and exacerbating inequality. It has disproportionately impacted the poor, the diverse and the young; among McKinsey’s ten core lessons of the pandemic are the profound observations that: work will never be the same; agility and speed will be the new basis for differentiation; government policy matters but individual behaviour sometimes matters more; and, schools are the true fulcrum for the functioning of our society. This map shows school closures around the world in June of 2021 – it is clear that the impacts of this experience on our mental health, decision-making and relationships will play out over generations.
Less obvious is the path of economic recovery – will pandemic savings be unleashed as pent-up demand? What is the right balance of interest rate moves to manage inflation and the crushing load of public and private debt? How quickly can supply chains recover or be reshaped? What changes in the labour market will result as shortages are felt?
In the 2021 CIO Sentiment Survey, global Chief Investment Officers expressed increasing confidence that they will reach their return targets; active strategies are gaining favour as market volatility is expected to continue and the diversification offered through alternative asset allocations remains key. The Economist’s fascinating Global Normalcy Index shows overall activity in transportation, recreation and work at 78% of pre-pandemic levels.
However, experts caution that any recovery remains fragile – sensitive to new variants and geopolitical shocks – and unequal. The UN reports that more than a quarter of developing countries have yet to achieve their pre-pandemic levels of output and the number of people living in extreme poverty is projected to increase into 2023 in vulnerable economies. While lower vaccination rates and limited stimulus spending hampers growth in the developing world, developed nations face challenges with labour supply, inflation and supply chains. It will take time for households to recover their confidence. Even as the Canadian economy appears to be recovering to pre-pandemic levels, there is a widening gap between GDP and GDP per capita, or economic output per person, meaning that individual Canadians are not yet feeling the economic gains.
What Canadians are feeling is the inflationary impacts of geopolitical uncertainty, most recently exacerbated by the Russian invasion of Ukraine. While this humanitarian crisis has shocked our morality, with over 6 million Ukranian refugees or displaced to date – it has also resonated through the interconnected global flow of people, resources and money. In March, the Chief Economist at the OECD predicted a reduction in global GDP of just over 1% and an increase in inflation of almost 2.5% as a result of this crisis – the impact to the Canadian economy will be softened somewhat by our status as a net energy exporter and an exporter of wheat, with the OECD predicting similar results to those shown for the US in this chart.
Like the pandemic, the OCED also predicts this conflict will be interpreted by governments and businesses as another proof point in favour supply chain fragmentation, lowering the risk of interdependency. Consider that food makes up 40% of consumer spending in sub-Saharan Africa, where many low-income countries receive more than half of their wheat imports from Ukraine and Russia; a recent report from the UN Conference on Trade and Development included a reminder that political instability has been highly correlated with increases in food prices over the past 15 years, warning to expect unrest as a result of this conflict, particularly in the developing world.
While globalization has improved living standards, political liberalisation has faltered. The Economist estimates the autocratic world represents 30% of global GDP, and rivals democracies in investment and innovation. One-third of democracies goods imports come from other political regimes; investors from democracies hold over a third of the autocratic world’s total stock of inward foreign direct investment. Both autocracies and democracies have reasons to decrease their exposure to and dependency on one another, but this will be hard to achieve. Amid these tensions, will global collaboration endure, will we see so-called slowbalization, will nations refocus on regional alliances, or will isolationism become the dominant political and economic response?
Among the business community, organizations have acted quickly to align with international sanctions against Russia and to support Ukraine – many, including Canadian pensions, have issued clear statements of support and taken steps to divest of any exposure to Russia. This level of engagement is indicative of the seriousness of this situation, but also evidence of how the social justice movement has changed expectations for institutions. Thankfully, diversity, equity, inclusion and reconciliation is increasingly front of mind for organizations of all kinds. But sadly, the incredible response to Ukraine’s plight has made hypocrisy all too real for many who feel a similar response is merited to all instances of refugee crises, racially motivated violence and war. Has the response to the invasion of Ukraine raised the bar for action on similar crises?
This is an example of the kind of complex environmental, social and governance issue that pensions face today. And your responses will define you in the eyes of your stakeholders – from employees to members, sponsors to investment partners.
Another example is the complex issue of climate change. Experts predict that, without swift reductions in C02 emissions, we are on track to exceed 2 degrees of global warming in the 21st century – resulting in a catastrophic level of damage to our planet. We have not been exempt from the floods and fires that have characterized these impacts in recent years – Canada’s Changing Climate Report, published in 2019, noted that Northern Canada has warmed and will continue to warm at more than double the global rate, as shown on this map. For pensions, climate change introduces physical, transition and liability risks in the investment process, as well as impacts the safety, employment and cost of living of our members.
Globally, pensions can play a critical role in financing the response to climate change, bridging the approximately $2-4T gap in mitigation costs and $180B gap in adaptation costs required to limit negative effects. “Green” investment opportunities are expected to yield $2.1T, while the cost of inaction in the investor community is calculated at almost $11T by the World Bank. The heatmap on the right-hand side shows their estimates of potential pension fund exposure to climate change risk.
“Net zero” commitments are increasingly common as pensions and their investments strive to understand and control their climate impact, but these goals are not without their implementation challenges. The data required to set and monitor ESG targets is still largely voluntary, inconsistent and difficult to compare – although innovators like Net Purpose, LookThrough and many others are building businesses around data standardization and transparency.
In the same Pension Systems and Climate Risk report, the World Bank also highlights the importance of a supportive regulatory environment to enable climate action by pensions. And this is no small ask, as the range of climate and ESG reporting standards and bodies can seem like alphabet soup! Here in Canada, regulators are actively working to provide clarity – OSFI is expected to release a draft guideline on climate risk management later this year and has recently published the result of their own climate risk scenario pilot project with the Bank of Canada.
Managing the many risks of climate change requires clear structure, relevant information, and effective governance. For pensions, who are mandated to achieve investment performance, responsible investing is widely accepted as an accelerator of financial returns. However, there is active debate on how to implement change: through ESG integration, an outside-in view of mitigating risks, or impact investing, considering inside-out materiality, or both? Is engagement sufficient, or is divestment required?
And stakeholders have strong views – while a legal interpretation holds pensions to their responsibility to maximize financial returns, social pressure to prioritize climate outcomes is increasing. The 2021 Responsible Investment Association Investor Opinion Survey found Canadians of all ages are increasingly aware of responsible investment as a lever for change, and 80% of those surveyed wanted their fund manager to encourage Canadian corporations to reduce their carbon emissions. Respondents also exhibited a high-level of skepticism about responsible investing claims in the industry, with 78% indicating they were somewhat or very concerned about “green-washing.”
Late last year, environmental activists at Shift and Ecojustice collaborated with beneficiaries to remind Canada’s ten largest pension fund managers of “the fiduciary duty fund managers have to act decisively to address the climate crisis in the best long-term interest of their beneficiaries.” Even though most of the pension regulatory jurisdictions in Canada do not have requirements relating to ESG, stakeholders are increasingly holding stewards of capital accountable for climate change results.
So, this is a lot to take in and to deal with in the course of our work. Typically, we see two common responses to uncertainty: being overwhelmed and being overconfident. Both are bad. When you are overwhelmed, you recognize uncertainty but cannot deal with it, delaying decision-making and suffering from analysis paralysis. When you are overconfident, you discount complexity and risk making choices on superficial evidence or gut instinct.
In the pension industry, these natural reactions are further exacerbated by very real capacity constraints and a traditional aversion to risk, to say nothing of mandates narrowly focused on investment performance and paying pensions – these issues, it might be argued, are none of a pension’s business.
While pensions may not be responsible for solving all the world’s challenges, they must operate in this challenging world – generating return and delivering on the pension promise in a context that is shaped by these uncertainties. As leaders, we are responsible for having an opinion and a plan to steward and modernize sustainable and relevant pension organizations. Thankfully, there are tools to help us do just that.
One of my favourites is scenario planning – a process that blossomed from its roots in military planning and the work of futurists at Royal Dutch Shell in the 1970s, where scenario planning was used to anticipate outcomes in the oil market. This is essentially how it works:
First, identify an issue to solve or decision to make, such as: what role might we play in industry consolidation or, how might we de-risk our multi-year transformation? Then, list all the things that can impact your success or failure – there will likely be areas you don’t know enough about that require research. Next, you separate trends (which are predictable) from uncertainties (which are not) – for example, demographics is a trend, while the preferences of each new generation are uncertain.
Choose the most important uncertainties – the ones that can have the biggest impact on your issue or decision – and combine them into scenario frames to make opposing versions of the future. To give a simple example using the question about consolidation, the most impactful uncertainties might be the pace of consolidation and the perspective of your stakeholders.
Next, you imagine what each of these futures might be like – describe the context they create for your issue or decision in detail. What is happening in each scenario to your talent, technology, processes, stakeholders, or in the markets, economy, politics, and society at large? Give your scenarios evocative names – trust me, it helps. Explore how you might act in each possible future – in our example, how would your strategy be different if you had stakeholder support, or not? Would the pace of consolidation put you in a proactive or reactive position, and how would you adapt?
Consider how your approaches in different worlds are the same, and how they are different, and what assumptions you are making about success. The similarities in each world are probably no-regrets steps that you can take no matter what happens. The differences might be big bets you’re willing to make that one scenario is more likely than another. Your assumptions become metrics that you can monitor to determine which way the wind is blowing.
Scenario planning is a powerful approach, but it isn’t always easy. It requires an investment of valuable time, an effort to think differently and can even involve facing our fears. It benefits from a diverse group of people incented to provide different points of view and engaged in the learning along the way. The amount of research required really depends on your burden of proof, but scenario planning should be an exercise in curiosity as you pursue new information and expand your insight ecosystem.
One of the most powerful things about this approach is that it does not require people to agree – you and I may feel very strongly that different scenarios are more likely, but if we can agree that all are plausible, we can align on what we would do if either scenario were to unfold. And the result of that is we are all better prepared. As the grandfather of scenario planning, Peter Schwartz, puts it: “the end result [of scenario planning] is not an accurate picture of tomorrow, but better decisions about the future.”
How much time does your organization spend thinking about the future? Do you feel like you have a clear view of the most impactful uncertainties around your big choices and investments? I would encourage you to invest the time to develop that view and practice processes like scenario planning that train us to open our minds – an incalculable benefit in our increasingly polarized world.
Scenario planning should be a standard decision-making tool for leaders, particularly those operating in long-term time horizons like pensions. I have witnessed the power of investing partnerships that are rooted in shared scenarios for the future of an asset class. I have seen mission-driven organizations accelerate their impact, powered by a clear view of their relevance in any future. One investor described the process to me as providing him with “scenario-coloured glasses,” a natural lens he used to filter the data and experiences of his working day into an understanding of how his context was changing. For him, this informed confidence and practiced curiosity became an operating advantage.
In fact, I believe scenario planning aligns perfectly with the unique advantages of pensions. We already think long term – a quarter in the pension industry, so the joke goes, is 25 years! We have access to a vast amount of data from a vast network – of investments, of stakeholders, of collaborative peers – we have the opportunity to hear signals in the noise. We are fiduciaries – practiced in good governance and mandated to reach the best outcomes for our stakeholders. These characteristics serve the industry well when it comes to sorting out the many plausible and best possible paths forward through the challenges that we face, as the pension industry and the world we live in changes.
I am optimistic about what pensions can do – from providing support to Canadians in retirement to impacting the wider world for good as stewards of long-term capital. I believe pensions have an important role to play, in evolving the pension promise and in advancing progress on the thorniest issues of our time. I hope my comments have encouraged you – not to be overwhelmed or overconfident in the face of uncertainty – but to invest your time and use the tools available to navigate successfully as leaders of sustainable, relevant and resilient organizations.