CDC (Target Pensions Plans) look likely to happen
If, as now seems likely, we get the easements in a Pensions Bill to run collective DC schemes then the pressure will turn on those (like me) who have lobbied for change– to deliver results. As Nick Clegg has found, it is easier to make friends when you don’t have your hand on the tiller, it will be even harder to win trust in CDC with the public than it has been with Government.
But it needs to win the public’s confidence
To understand where the distrust of a collective system of pension payments arises, we have to travel back to the mid 1980s. Britain was coming out of a dark place economically and there was an assumption of high inflation and high interest rates which made the cost of pensions look cheap. Without the need to guarantee anything, companies rushed to set up and over-fund defined benefit plans which were seen as a panacea for all HR and Finance ailments. Pension schemes could pay off workers early, recruit staff and reward the chosen few within a benign tax and national insurance framework.
Companies also used these schemes as a potential source of finance, as a tax shelter and even as a means to hide embarrassingly high levels of profit.
In fact the last thing on the minds of those managing the benefits was the long-term cost to the company, actuaries and regulators gave a green light and you drove the car where you wanted.
The failure of governance that evidenced itself in over-generous benefit promises, under-funding through the taking of extended “pensions holidays” and the reckless disregard for risk controls within the management of many funds, led to the downfall of what Frank Field called in 1997 “Britain’s economic miracle”. Indeed it only took a couple of years of poor investment returns in the early noughties, to expose the crass mismanagement of the past two decades.
If CDC is to follow the same path, I will have nothing to do with it
Another thing happened in the late 1980s, we saw the beginning of a mania to purchase houses, initiated by Thatcher economics and driven by relaxations in credit which allowed us all to borrow up to 100% of the value of the property.
It was also a time when insurance companies moved from guaranteeing the repayment of the loan, provided premiums had been paid (non-profit endowments) to sort of guaranteeing repayment (with-profits) to a total market dependency (the unit linked endowment).
In theory endowments worked well. In practice they were doomed to disaster. The high sales commissions paid to advisers meant that the net returns on investment within the with-profit and unit-linked sectors had to be heroically high. So long as stock-markets boomed , no-one noticed.
But as with the defined benefit schemes, the early noughties exposed endowments for what they were, inefficient and dependent for their survival on unsustainable actuarial assumptions.
If CDC is to follow the same path, I will have nothing to do with it.
If you read the tweets of John Ralfe and John Lawson, you will be offered comparisons between CDC and the failures of financial products such as endowments and defined benefit pension schemes.
For them, the certainty of a guaranteed annuity or a defined benefit scheme with liabilities fully matched by AAA rated bonds is the way to avoid the mistakes of the past. But the public know what these products mean. Annuities mean the certainty of poor outcomes while the cost of guaranteeing company pensions is felt in the loss of future productivity needed to provide pensionable employment.
This is the world of grey squirrels, where red squirrels are driven out and the forest denuded of value.
We must be ambitious, we need to define our ambition and meet the challenge of doing this funded pension thing properly. We must learn from the past and here are the ten lessons that the experience of the past 30 years can teach us
The ten lessons we must learn
- We cannot afford to pay for pension distribution; people must come to pensions not be sold them.
- We cannot afford to guarantee promises, we must accept a degree of uncertainty (as we do with our jobs)
- We must have a proper debate on risk and get people to understand the trade offs between risk and return
- We must harness the economies of scale that come from bringing large numbers together in a common endeavour.
- We must invest together , spend our savings together and enjoy common administration and common governance.
- We cannot allow those who govern our pensions to be conflicted – governance must put the members interests first.
- Putting member’s interests first includes taking long-term views and ensuring suppliers can do likewise.
- We must encourage people to participate in insurance pools, this means encouraging social insurance but does not mean exploitative risk transfers
- We must encourage people to think long-term and be mindful of future liabilities (such as long-term care.
- We must in all things balance the needs of the individual, the State and the financial services industry to provide a sustainable system which enjoys public confidence over time.
In my view, we are ready to set things up this way. Other countries (especially the Netherlands, Denmark and Sweden) enjoy greater public confidence in pensions than we do.
We have an enormous heritage of funded pensions. We must acknowledge that we have messed up along the way, but we don’t need to throw out the baby. Much is good. We have a properly functioning state pension , a sound welfare and healthcare system and we have come a long way towards having a world-class workplace pension saving system.
CDC- the final piece in the jigsaw
CDC can and should be the final piece in the jigsaw that allows those looking for an alternative to annuities, to optimise their pension spending. The idea is not complicated, the product need not be confusing. CDC can be integrated into our existing pension framework relatively easily. It is no more than a return to the vision of pensions that pre-existed the calamities of the past thirty years.