This blog was first published on mallowstreet by the inimitable Kevin Wesbroom, whose bouffe is only matched by Ros Altmann’s and whose intellect is matched only by his integrity. Think big – think Kevin!
CDC – the case Against – and the Refutations
Huw Evans, the director of Policy at the ABI wrote an article called “The ABI’s 10 problems with Steve Webb’s collective DC plans”. This article could well win an award of the highest index of EPCI – errors per column inch! It does however recycle a number of well rehearsed arguments against CDC. A response to each of the 10 points is set out below.
CDC does not guarantee higher retirement income
CDC’s fan club repeatedly state that it could deliver higher pension income than workplace GPP schemes. But CDC schemes are no more immune to lower than expected investment returns than other pension schemes. The Dutch system has recently seen unilateral cuts in the level of benefits paid. By April 2013, two million active members, a million pensioners and more than two million deferred members in The Netherlands had faced a reduction in benefits.
Correct – it does not and we have never asserted that. What we have said is that on average retirement outcomes from CDC plans will be higher than conventional DC plans, and more predictable. That is the inherent smoothing nature of the plan design, and its ability to take risk for longer. If you are lucky enough to retire at the end of the 1990’s, after a huge stock market rally and when interest rates were still reasonable, you would have done better than a CDC plan. But if you retire today, when the market has not gotten back to even pre crash levels, and when annuity rates are at the lowest they have ever been, you would not do so well. Are you sure you will be able to choose when to retire, and when to cash out? Our analysis – where is the ABI analysis ? – over the past 70 years and prospective outcomes shows that CDC smoothes out market fluctuations and delivers a higher – on average – more stable outcome, where members do not have to take investment decisions. One third higher benefit on average and more predictable – but shall we stick with the current lottery?
And please – can we stop going on about the terrible cuts to the Dutch system. The Dutch Regulator showed that on average for those schemes that had cut benefits, the cuts were around 1.9%. Those cuts will be restored, as and when markets improve. What will happen to the thousands of people in the UK who have bought annuities from ABI members in the past five years? They are locked into those rates forever – rates that are about 30% lower than five years ago. So let’s try a fair comparison – temporary 1.9% or permanent 30%?
2. CDC can hurt the young
CDC schemes work by sharing risks between all members, pooling the investment in one fund. This brings down overheads but involves transferring risks from old to young, with younger scheme members bearing the risk of reduced future payouts to ensure the benefits of older members are preserved. That is why the youth wings of three major Dutch political parties recently agreed a cross-party campaign to ditch the Dutch model and move to a UK-style system of individual pension plans.
Really? How about the mass closure of expensive DB schemes and their replacement by low cost DC schemes – surely that is by far and away the most significant intergenerational unfairness we can witness? A CDC scheme does NOT have to force the young to take on risks so that the benefits of older members are preserved. It can be set up to be generationally neutral. The Dutch are grappling with this – but not surprisingly the older generation are pretty savvy at protecting their benefits at the expense of younger voters – who are generally apathetic about politics and so vote less. That is realpolitik – it is not a feature of CDC scheme design.
3. CDC would require UK pension savers to give up their current rights.
Under CDC there are very limited options for a saver to choose the contribution level, risk profile or investment strategy. Everyone is treated the same as a ‘collective entity’ not as a group of individuals. This is similar to the ‘with-profits’ model which is disliked by UK regulators for the lack of transparency it affords the individual.
Utter rubbish! Presumably the “right” here is to choose an investment policy for the investment of one’s retirement funds. It would be perfectly feasible to have CDC scheme with subsections to cater for different risk profiles – but in all honesty how many people would be interested? What happens under current DC schemes where members have all of this choice? They universally go for the “easy option” – the default fund selected by the provider or the employer. That is because the overwhelming evidence is that members do not want to take responsibility for something as complex as investment over a 70 year time horizon – they would rather leave it to somebody else. We have never proposed that CDC should be mandatory – those individuals who feel savvy enough to take their own decisions can opt out into conventional DC. The evidence from the behavioural economists is that they will under-perform, but that is their choice.
4. CDC requires a collective labour market
Unless the Daily Mail has had a Damascene conversion to collectivised labour markets, it may want to look more closely at CDC. CDCs in The Netherlands are built on the collective model of employers, unions and employees agreeing all major labour market decisions together. CDCs are heavily unionised with senior union officials having more say over how an individual’s contributions are invested than the employee.
Once again – rubbish! Just because you adopt ideas such as CDC does not mean you have to behave like the country where they exist. Surely we can be smart enough to work out that a good pension system can be copied without the cultural background. Otherwise how would it be that as well as Holland this type of plan design has found favour in some Scandinavian countries – and in Canada, where some of these plans have been operating successfully for decades? Try as I might, I cannot see any examples where Canadian university staff and forestry workers have decided that they have to wear orange shirts, build windmills and grow tulips? It is a patent nonsense that we cannot extract the best thinking from one location and adapt it to our own societal norms.
5. CDCs are regressive
It is puzzling that so many on the centre-left of British politics are fans of such an obviously regressive system. In CDC schemes, low-earners, who tend to have below-average life expectancy, subsidise the high earners who tend to live longer. Unlike in the UK, there is no scope for those with low life expectancy (often the poorest) to receive higher retirement income through enhanced or impaired annuities.
Am I understanding this right? The ABI are concerned that some people might have been able to buy better annuities? Well amazing – I am delighted to see that the ABI are saying that many people have bought the wrong annuity – will they be proposing a mass compensation program, retrospectively for all of their customers who failed to exercise the open market option (let’s ignore impaired lives as a truly second order effect). The evidence is that people underestimate how long they will live – by between two and five years – and so think annuities are bad value or not for them. Most people have no idea how to budget for retirement savings. CDC takes sensible average decisions. No compulsion again – people can opt out if they wish. The poor savers with low life expectancy may struggle to get competitive annuity rates with their tiny pots, but they would still have the option.
6. CDC are less transparent and more complicated than workplace pensions.
The UK pension debate in recent years has – rightly – focused on the need for greater transparency and simplicity, especially in workplace schemes used for auto-enrolment. Yet CDC schemes are notoriously opaque and complicated, with members unable to be certain how the total pot will be distributed and its risks managed, a key concern for UK regulators in recent years.
Interesting – how can they be less transparent if we have never had any in the UK? Our proposals have argued for extensive public disclosure – all relevant financial information to be in the public domain. Not that the average member will flock to this website – but informed commentators will be able to, and together with a strong regulator, can ensure that CDC plans who are acting inconsistently with their published objectives can be corrected at an early stage. Under our proposed model for disclosure, there would be greater disclosure of CDC schemes than of conventional workplace pensions – as anybody who has ever tried to consolidate ABI and tPR statistics on DC schemes will readily agree.
7. CDCs increase the risk of market concentrations.
For CDC schemes to work economically, they need scale; to be as big as possible. Yet for pensioners, very large pension schemes carry risks as well as cost savings; a strategic mistake by the trustees, actuaries or investment managers would have an impact on a much bigger number of savers than those saving through a UK-style Group Pension Plan. If CDCs begin but do not grow significantly as Steve Webb has alluded to, it will be difficult for them to achieve economies of scale to deliver their promises of lower costs and better investment returns.Ralph
So if a CDC scheme makes a “mistake” – whatever that means – that will have more of an impact than if a major insurance company makes a similar mistake. Not sure that some of those who suffered through the with-profits debacle would agree. But no doubt the ABI will be able to reassure us here.
8. CDC places a much greater burden on employers
With CDCs employers not only need a collectivised bargaining structure (see above) they also have to take a much greater role in explaining to employees the choices they face, including the fact that future project retirement incomes may not be delivered. At the moment, employers need only facilitate their workers joining a GPP and even that has been a monumental struggle in some places.
Nonsense. This is all about the role of an employer in explaining the consequences and potential outcomes to an employee of joining – and remaining in – their chosen retirement plan. If an employer thinks all they have to do is explain to somebody they have to join a GPP then that’s all? What if the member asks questions? What level of contribution should I pay? Where should I invest my money? Which of the 200 fund choices in this GPP is right for me? What do I do at retirement – annuity, drawdown, impaired life, enhanced, indexed? Yes, a GPP can be a model of simplicity if the employer is totally hands off. But engaged employers recognise theory have a greater role to go rather further. It would probably be easier to do this in relation to a CDC plan than a conventional DC plan – but many good DC plans go further than the norm and balance up this particular fight. Is the ABI onside with further (sensible) communication strategies?
9. CDC will need someone to guarantee outcomes
As John Ralfe has pointed out, CDCs rely on a higher proportion of equity holding than normal DC schemes to deliver the returns its advocates promise. Yet the cost of insuring against underperformance will rise over the option period, meaning a guarantee will typically be needed from an investment bank, insurance company or government to reassure savers that they are not entirely in the hands of the long-term equity markets.
No – categorically not. There are no guarantees, so there is no need for somebody to provide them. John Ralfe’s tired argument about the cost of insurance rising over the option period is irrelevant here.
10. CDC would take a generation introduce.
Deciding the future shape of the UK pensions system is not like playing Lego – it can’t be taken down and rebuilt every day to suit the whim of the moment. Pension systems tend to reflect the long-standing cultural preferences of the society they operate in which is why the UK now has a largely individualistic system (replacing the more collectivist post-war DB model) while our Dutch neighbours have traditionally had CDC reflecting its highly collectivised labour market and employment model. If we understand this, it should make us even more wary of assuming that any transition to such a radically different model would be anything other than hugely time-consuming, counter-cultural, opposed by regulators and potentially oversold by politicians needing to demonstrate ‘vision’ or another ‘silver bullet’.
There is still much to be done to build confidence in the UK pension system and UK workers need to continue to be encouraged and incentivised to save more and save longer for their retirement. We in the pensions industry have more to do too.
But raising false hopes that if we all go Dutch, the Land of Milk and Honey awaits is as misleading as it is irresponsible. It is certainly not what many people in The Netherlands think about their system.
Let’s concentrate instead on making the current reforms work effectively for employees and employers to deliver good retirement outcomes from low-charging workplace schemes.
Why – let’s start now! Let’s not even talk about the vested interests in maintaining the current system. CDC does not require a collective labour market and employment model – the Canadian experience shows that – of which the ABI seems unaware. It does require some trust between generations and that has to be earned – by older generations sharing the pain along with younger colleagues. That is a societal change that we have to face – read the excellent book called the Pinch (David Willetts) about how the older generation have stolen from the young in the UK and you realise it’s not sustainable.
We are not saying that CDC is a silver bullet – it has issues and challenges that need to be worked through like any pension system. What we are saying is that it deserves to be given a chance to show it can sit alongside other pension options and deliver higher, more stable outcomes for the vast majority of people who do not want to get involved in pension investment. We have done the modelling – it’s in our 80 page analysis. We would be delighted to share with the ABI and compare our modelling with theirs.
Our modelling shows that CDC schemes can can deliver good retirement outcomes from low charging workplace schemes for the vast majority of UK employees. We would be delighted to discuss the facts – as opposed to the suggestions, incorrect allusions and innuendoes – with the ABI. What do we have to gain – jobs for the (actuarial) boys and girls ? Maybe, but given there won’t be many of these schemes it’s not exactly a brilliant job creation scheme for actuaries. On the other hand, will there be be commissions in it for the thousands of IFAs associated with ABI members? Interesting question.
many thanks Henry – good work!
Thanks David and good to see you today!
I found myself quietly cheering on reading each of Mr Wesbrooms’ responses – well said sir.
That sound like how I felt too!
Henry is the 80 page analysis mentioned available, if so a link would be appreciated. I would like to hope most of us in the provider space have the customer at the heart of what we do and want to explore this opportunity. Look forward to the read and / or future opportunities to explore the facts and options to implement.
I don’t have the analysis Matt- suggest you contact the author
Thoughtful response by Kevin (as ever). One of the problems with CDC is that it can mean many differenty things to different commentators – the Aon Hewitt paper is unsual in so much as it puts a genuinely balanced viewpoint across without over-selling the case.
Almost by definition CDC makes economic sense as a more efficient vehicle than DC. My biggest concern is the fairness angle. It’s true in practical terms to say “not surprisingly the older generation are pretty savvy at protecting their benefits at the expense of younger voters – who are generally apathetic about politics and so vote less. That is realpolitik”, but that still leaves open the possibility of future members claiming miss-selling if they think they have been short changed. Given we are talking about workplace pensions, it is unlkely members will have the option to opt out of CDC and into equivalently funded IDC.
And one area of greatest economic advantage is in sharing risk post retirement. The fairness problem here isnt cross-gernerational but rather cross-relative wealth – the relatively poorer retiree liiving in Tamworth (lowest life expectancy in the UK) will be subsidising the richer retiree from stockbroker belt Surrey. Unless of course we intoduce underwritten incomes – in which case the efficiency savings disappear very quickly.
As Kevin says, “We are not saying that CDC is a silver bullet – it has issues and challenges that need to be worked through like any pension system”. but we need to accept that sometimes mless flexibility, less choice and even marginally less fairness can produce significantly better outcomes for everyone. The first step is to get all of those competing objectives out on the table.
This is a criticism that could equally be made of the basic state pension and all defined benefit pension schemes.
These inequalities are baked into the tax reliefs on pensions that favour the rich over the poor.
In fact it’s hared to see any system of longevity pooling that doesn’t favour the long living- the rich.
I agree that a non-pooled fully underwritten system may be fairer- but does it give better outcomes? In my view it makes it a little worse for the poor ,much worse for the rich, but no better for anyone!
Henry
I agree that the criticism can be levied against State and DB benefits, that doesnt make itv invalid. And it was exactly my point that most individuals might be better off (and the “average” person, markedly so) – but some, a significant minority, might be worse off.
Because we are no so much more aware of the differences in longevity expectations (broadly 15% annuity variation between 25th percentile and 75th percentile, based on proxies such as postcode and purchase price) I dont think we can get away with saying “yes it’s unfair but it always was”.
Nor should it be about “views” bui about hard numbers – how much better/worse off are members at each, say, decile of expected longevity. Some if the specialist annuity providers/bureaus say (and, yes they would, wouldn’t they) that more than half the people they quote for can obtain enhanced annuity terms based on health. If you add that to the demographic variables and accept that the 20% to 35% outperformance of CDC is based on modelling that may or may not be using accurate assumptions, there could be a significant minority who lose out.
We can mitigate these issues, at least a little, in the same way the Dutch do by only aiming at nominal (no revaluation) career average accrual and level pensions in retirement (which don’t favour the long lived so much) and allowing members to exchange level for lower escalating retirement incomes if they wish.
If there was an easy answer we would have found it by now. It’s possible that, we will decide (to misquote Winston Churchill) that CDC is the worst possible sollution -apart from all the alternatives. But we do need to listen to the arguments -financial, social and practical – from all sides before we commit generations of members, not to mention design resources, to a design that could have its own problems.
Pingback: Defending CDC pensions | ToUChstone blog: A public policy blog from the TUC
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I appreciate Henry’s effort on CDC. There are certainly some good features that CDCs could provide like life expectancy pooling and cost.
The concerns are real, intergenerational issues expecially, unions involvement etc. Even life expectancy pooling is an issue, when putting together blue collars and white collars workers in the same pool. Probably this could be sorted by paying some death benefits on early deaths, like a discounted value of benefits up to age 80.
There was also the with-profits saga, where we had smoothing, where the promisses made by the marketing teams were unrealistic. When capital adequacy rules came in, the majority of with-profits funds stopped taking investment risk and everything went downhill. Regulation risk exists.
More important is that people are retiring diferrently these days, lots work part-time, even doing diferrent things than they did before. There is a book named the New Retirementality which explains this. Also spending paterns in retirement for many have changed significantly, more and more people would like now to have an active retirement period at the start.
In terms of outcomes, I believe that a lifestyling DC fund with matching charges would deliver a higher fund at retirement due to higher risk taken over the accumulation period. A CDC fund cannot take more than 60% equity risk and even if some “notional” buckets for diferrent age groups are created, people in accumulation will receive a lower cash equivalent transfer value than if the invest in a normal DC scheme.
But I can see this as a solution at retirement. For example Nest may be able to design a retirement fund (taking 40% equity risk) which pools life expectancy, but some underwrtiting is needed as well, so people with shorter life expectancy get a higher pension. It can probably offer outcomes 20% higher than a pension annuity.
Last I am not sure there is appetite from the consumer. “Flexibilty” is what you hear everyday.
Thanks for your comments Eugen which are well thought out. I think you are right that people want flexibility and the right to transfer gives people freedom to do as they please. However, there is a silent majority of people who want no more from their pension than a wage for life. That majority are being ignored in favour of those who need and want to do things themselves.