May 1, 2020

Managing Pensions Through And Beyond The COVID-19 Pandemic: How Scenario Thinking Can Help Us

“To turn something unknown into something known is alleviating, soothing, gratifying, and gives a feeling of power…...Any explanation is better than none…..”

Friedrich Nietzsche“Twilight of the Idols”, 1889


 “Our current thinking about ‘finance’ and risk has its roots in the 1950s and 1960s…..What started out as a well-intended thought-experiment to use numbers to capture uncertainty in financial markets, slowly but inexorably developed into a new paradigm; a dogma even…..The interesting thing is that the practical failures of this approach have not led to its abandonment…..confirming Nietzsche’s observation that any explanation is better than none…..”.

 “One of the most important tools for creating resilience in a world of fundamental uncertainty and complexity is scenario thinking. It is partly an analytical exercise and partly a conscious mental process envisioning the future, engendering organizational adaptivity and resilience.”

Theo Kocken“Memento Futuri”, 2018


From Knight, Keynes, Kay, and King to Kocken

Last month’s Letter referenced John Kay and Mervyn King’s new book “Radical Uncertainty”. They in turn referenced the contributions to making good decisions under uncertainty by early-20th Century economists Frank Knight and John Maynard Keynes. The Letter applied the insights of the four ‘K’s to the current COVID-19 crisis by addressing the question ‘what is going on here?’ and then constructing a forward-looking ’reference narrative’. That narrative converted our ’what is going on here’ assessment into realistic expectations and actions consistent with those expectations.

The April Letter received a good deal of feedback, including from ‘K’#5: Theo Kocken, Founder of the Cardano Group and Professor of Risk Management at VU University, Amsterdam. He wrote: “You present a reference narrative. In a fundamentally uncertain world I would use two, possibly three. The world won’t necessarily unfold exactly according to one of the narratives, but should at least move in the direction of one. The benefit is that we will have already thought about that scenario and its implications, which will foster flexibility, adaptiveness, and resilience.” To expand on these views, he attached a 28-page document titled “Memento Futuri” (‘Memory of the Future’) from which we quote above.

This sequel May Letter takes Kocken’s advice. It starts by updating last month’s responses to the important ‘what is going on here?’ questions. From there, rather than crafting one narrative, there are now two. The Letter ends by assessing the implications of the two narratives for the generation of retirement income and the management of retirement savings in the years and decades ahead.

What Is Going on Here?’ The Medical Perspective

Much has happened medically over the course of April:

  • On the one hand, the number of cumulative reported COVID-19 cases globally increased dramatically from 750K at the end of March to 3.2M at the end of April. On the other hand, the number of people that have recovered from the virus has also increased dramatically from 100K at the end of March to 1M at the end of April. However, COVID-19 has also led to 225K deaths thus far.
  • Importantly, the hoped-for bending of the curves tracking the pandemic is coming into view. For example, the number of new daily cases in the three countries with the highest numbers of cumulative COVID-19 cases (USA, Italy, Spain) dropped from peak numbers of daily new cases from 30K, 7K, 10K respectively to 20K, 2K, 2K new daily cases at the end of April. 
  • There is broad consensus that the surest path out of the crisis is a new COVID-19 vaccine, but that is at least a year away, possibly longer. A quicker strategy may be to repurpose one or more already-approved drugs. At least four separate university research labs (Alberta, Chicago, Cornell, Oxford) are reporting promising progress on this front. Quickly identifying an effective repurposed drug could see it in mass production by this Fall. Providing equitable access to it will be an important challenge. Longer term, ending the ever-closer human-wildlife interactions is another important part of controlling future pandemics. 
  • There is less of a consensus on the best way to re-open multi-national, national, and regional economies by relaxing current social distancing rules. The broad outline of the trade-off is well understood: it depends on the respective weights assigned to the medical versus the economic perspectives. What are appropriate trade-offs between public health and financial well-being? Even without broad consensus, this re-opening process has begun and will continue to roll out in the weeks and months ahead. Will COVID-19 continue to decline or make a major come-back? This seems impossible to predict today…only time will tell.
  • There is broad agreement that extensive random serology testing and contact tracing strategies must go hand-in-hand with these drug/treatment development and economy re-opening strategies. For example, recent random testing for COVID-19 antibodies in New York suggests a much-higher asymptomatic exposure to the virus than originally assumed.

‘What Is Going on Here?’ The Economic Perspective

The economic perspective too has evolved rapidly over the course of April:

  • The expected dramatic declines in GDP, employment, and corporate cashflows are rapidly becoming reality, with service sectors such as retail, hospitality, entertainment, travel, hardest hit. The fossil fuels industry is battling the dual problem of under-demand and over-supply at the same time.
  • The unprecedented levels of ‘whatever it takes’ financial support promised by governments and their central banks are also rapidly becoming reality. This means putting money in peoples’ pockets either directly or through funding the ability of employers to continue to  employ them. 
  • The monetization of these aggressive government actions by central banks continues to be controversial and many commentaries remain confusing. The use of terms like ‘printing money’ and distributing ‘helicopter money’ suggest there is something nefarious going on, as does the common question ‘how will all this new debt be paid back?’ The simplest way to clarify this issue is to recall that ‘money’ is both a medium of exchange and a store of value. In times of full employment and rising inflation the ‘store of value’ role dominates, requiring  central banks to pull excess purchasing power out of the economy. The current crisis requires a ‘medium of exchange’ focus. Unemployed people need money to be able to exchange it for groceries and roofs over their heads, and governments must provide that money. The central banks’ role is to create it until more normal economic conditions return. At that point, monetary policy must once again turn to a ‘store of value’ focus. A corollary of all this is that low, or even negative interest rates will likely be with us for quite some time yet.
  • As predicted by the Pricing Model Uncertainty (PMU) hypothesis, stock price volatility has been extreme. This will not change until we get a better handle on the duration of the medical side of the COVID-19 crisis.

Where to from Here? Two Possible Scenarios

Asked how things could play out in the months and years ahead, the common medical expert response is that it depends on where the COVID-19 trajectory takes us. At the same time, economists have been offering alphabetic responses. Last month’s V-shaped economic recovery predictions have been replaced by a now more plausible U-shaped scenario, although W and L recoveries are also being increasingly mentioned. It seems to us that we can reduce this range of views to two possible scenarios for the rest of 2020 into 2021:

  • COVID-U: the bending of the COVID cases curves continues through the Summer into the Fall. These improvements are buttressed by extensive testing protocols and the discovery of a repurposed drug/treatment that mitigates the negative medical impacts of the virus. At the same time, economic activity revives, slowly at first but accelerating with the passage of time. Stock prices continue to recover with the improving visibility of future revenues and profits. However, the recovery is uneven with some economic sectors leading the way (e.g., technology, health, communications, renewable energy) while other struggle to stave off bankruptcy and regain profitability (e.g., retail, hospitality, entertainment, travel, fossil fuels). 
  • COVID-W: the economy reopening process is interrupted by one or more new virus outbreaks. Social distancing measures have to be reintroduced. No suitable repurposed drug/treatment for mass production and distribution is found. Gaps in testing protocols remain. Economic activity continues to sputter with the media reporting a continuing stream of bankruptcies in the industries most impacted by the COVID crisis. Only the mass roll-out of a new COVID-19 vaccine towards the end of 2021 saves the globe from further medical and economic trauma, and eventually leads to a recovery of the stock prices of companies with sustainable business models from levels materially lower than today.  

Simply visualizing these two scenarios leads to an obvious first conclusion: hope for ‘U’ but plan for ‘W’. Four more conclusions specifically for asset owners are: 1. Maintain adequate liquidity until the ‘U’ or ‘W’ path becomes clearer, 2. Invest only in sustainable business models, 3. Support all actions large and small that help get us to ‘U’ rather than ‘W’, and 4. Identify a series of indicators (e.g., drug trial failures, widening credit spreads, breakdown of cooperation within and among countries) that suggest we are heading for the ‘W’ scenario, and determine appropriate organizational responses to these indicators.          

There is also the longer-term question of what may lie beyond 2021. In his April 16 article in The Economist, former Bank of England and Bank of Canada Governor Mark Carney lists four longer-term  impacts COVID-19 may leave us with:

  1. Greater economic fragmentation: local resilience will be prized over global efficiency.
  2. Greater state enmeshment in the private sector: will there be a state exit at some point from this new COVID-19-driven enmeshment or will this be part of a ‘new normal’?
  3. Greater organizational attention to resilience: too much micro efficiency can be fatal.
  4. Financial individualism has a cost: only collective action can deliver good healthcare, financial security, and a transition to a livable planet for all.

In short, we have been moving from a market economy to a market society. A lesson of COVID-19 is that the time has come to reverse the trend from ‘we’ to ‘me’….back towards ‘we’ again.

Retirement Income Through and Beyond COVID-19

There is plenty of evidence that ‘financial individualism’ does indeed have a cost. Today it is forcing millions of boomers without strong workplace pension plans to reassess their financial futures. The math is not difficult. Lower stock prices have made their modest retirement savings accounts even more modest. At the same time, the prospective returns on safe investments continue to be negligible, and will plausibly remain so for years to come. That leaves only one realistic option for these boomers today: keep working if you can.

The COVID-19 crisis also means we should take a closer look at the design of our retirement income systems (RIS). How effective are they at generating reasonably predictable and adequate flows of post-work income for all? A sound RIS does this by combining a sustainable, universal, pay-go Pillar 1      component with a more flexible, adaptable, pre-funded Pillar 2 workplace-based component. Leaving retirement savers to figure it out on their own in Pillar 3 (i.e., practicing ‘financial individualism’) is a bad idea in both theory and practice. So how do we get entire workforces participating in well-managed Pillar 2 pension plans? The COVID-19 crisis heightens the importance of this question and providing a thoughtful answer to it. See our February Letter titled “Rethinking Retirement….Davos Style” for more on how it might be answered.

‘Future Makers’ Needed!

A final thought. Critical to the success of any country’s RIS is the quality of the organizations that design and manage its Pillar 2 retirement savings/pension plans. Collectively, the globe’s Pillar 2 pension assets amount to a massive $50 trillion pool, mainly managed by a relatively small number of large asset owner organizations. Historically, most boards and senior managers of these organizations have been ‘future takers’ with mindsets that they must passively accept and play the cards the financial markets deal them. This needs to change by taking Mark Carney’s ‘financial individualism’ lament seriously. A $50 trillion retirement savings pool managed with ‘future maker’ mindsets can help make pluralist ‘stakeholder capitalism’ a reality. And only pluralist ‘stakeholder capitalism’ can foster the collective actions needed to deliver good healthcare, financial security, and a livable planet for all. More on this in future Letters.

Keith Ambachtsheer


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The information herein has been obtained from sources which we believe to be reliable, but do not guarantee its accuracy or completeness. 


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