Following a great deal of lobbying, it would appear that this week's Queen's speech will announce the intention to ease legislation so that Collective Defined Contribution (CDC) schemes can be established in the UK.
These 'miracle' schemes apparently offer 30% or even as much as 50% more pension for the same level of contributions, when compared to traditional UK DC schemes. It sounds too good to be true to me, but maybe I am just getting old and grumpy?
What is CDC?
In simple terms, it's a DC scheme where members (and their employer) pay contributions in return for a targeted level of income in retirement that will be paid direct from the scheme. The actual pension can be altered up or down depending on actual returns. The continued pooling of funds after retirement means that those who die early get back less and subsidise those who live longer. The payments are actuarially calculated, so if too much or too little is paid out to one tranche of members, other members could lose out or benefit.
So what problem is CDC meant to solve?
These CDC schemes, that have been popular in The Netherlands for years, aim to offer a target pension for a set level of contributions. According to Steve Webb, that 'certainty', when combined with higher pension for the same contribution, is what appeals. But, the target is just that - a target. When markets fall, you might get back less than you were expecting. This has happened in The Netherlands and as members have been disappointed, they are now looking to our existing DC schemes as a possible solution. So despite the promises, they are no more certain than a normal DC scheme.
What other benefits are there?
Well, scale is a big benefit as really large schemes have been established and that has driven down costs per member for administration, governance, etc. That is great, but isn't that what MasterTrusts are meant to do? Well, it was until everyone decided to set up their own version as all the providers wanted to take their cut of the fees. Who is going to stop the same happening again here?
Isn't there some pooling of risk as well?
Apparently so, but the cheerleaders might have you believe that there does not need to be any intergenerational transfer of wealth. How can that be the case? Even if all the other actuarial assumptions are perfect, if markets don't do what you expect, you may have underpaid or overpaid pensions to one group of people to the benefit or detriment of another. Pooling of risk might be perfectly acceptable to you as a member, if that is what you expect and you understand the potential consequences. You might end up being better off, but you might end up worse off.
So, will any employer want to set up a CDC scheme?
For employers who have moved from DB to DC, do they really want to move back? Especially as another change to be announced in the Queen's Speech will introduce full flexibility for members of DC schemes when they reach age 55. CDC doesn't work anywhere like as efficiently as some would have us believe if members who have built up a pot then take it away at retirement and do something that works for them. Maybe there will be actuarial reductions, or an MVA to protect members who stay in the scheme? Unless they have no option, will a member in ill health just accept the lower level of income from their CDC scheme if they can secure something better for them and their family elsewhere?
Why not just get DC right?
This is just one point of view. I don't know what the Government is planning for pensions, but I do know that lots of people were hurt by the with profits debacle. ‘Promises' from financial institutions that policyholders could not lose, vanished when things turned bad. I'm not suggesting that the position of CDC in the Netherlands is anything like as problematic as with profits was in the UK, but there are enough people who were let down to make them look to our existing DC schemes as a potentially better solution, despite their flaws.
Shouldn't we therefore try to:
- create real scale in DC provision;
- ensure high quality and decisive governance is the norm;
- communicate with members so that they understand what they are paying in, the risks associated with the investment choices they are making and the likely level of benefit, and;
- have contributions set at a level that increase the likelihood of meeting members' retirement income needs.
When combined, these should reduce costs, increase returns (on a risk adjusted basis), and ensure that employers and members pay contributions that are more likely to deliver the level of outcome that they require. If we can achieve that, then why do we need to introduce CDC? CDC might work well in good times and can deliver better benefits to some members. But, it is a potentially opaque structure that doesn't solve the fundamental problem with DC schemes, which is that in bad times, members get back less than they had hoped for as they are the ones who are carrying the risk.
I wonder whether CDC is actually the unspoken solution to the public sector pensions crisis. Rather than a move to existing DC, it would mean that a target level of income could be introduced, without all the gold-plating that now accompanies DB schemes. This introduces a pressure release valve that allows benefits to be scaled back in really bad times. Also, with the introduction of a ban on transfers out of public sector schemes, the risk of people selecting against the scheme might be removed.