As the election season is in full swing, some reflections on the ideological conflict inherent in the pension changes in the air for 2015.
From April, we will see the abolition of compulsory annuity purchase and, with it, the introduction of a regime bringing individualism, flexibility and freedom of choice to a whole new level. Hard on its heels, we may also see the introduction of Collectivised Defined Contribution (CDC) schemes, which, as the name suggests, requires individual choice to be subjugated for the overall greater good.
Proponents of CDC argue their efficacy on the grounds of economy of scale, lower running costs, the ability to generate higher investment returns by creating more diversified portfolios, utilising illiquid asset classes, being able to take a longer term view and investing beyond members’ retirement dates. All valid aspirations, but equally, achievable within the existing pensions framework when proper standards of governance and decision making are applied.
I don’t believe for one moment CDC returns will be 30% higher than traditional DC arrangements as argued by some analysts, unless the benchmark is a poorly governed, ill-equipped scheme, as deficient in its market awareness as it is in its decision making. In all likelihood, the returns will be comparable to those of any well governed DC scheme, however the means of distributing these returns to members will differ.
It is this distinguishing feature of CDC, namely the smoothing of investment returns through cross-generational subsidy, which will prove most problematic in the prevailing ideological climate characterised by the greater flexibility being introduced to the pension landscape in April.
It is not merely a case of members swapping a degree of investment risk in return for an exposure to demographic and pooled mortality risk. Members will surely have to forego the individual freedoms facilitated by the forthcoming changes. For the inter generational ‘pact’ to remain intact, flexible retirement dates, transfer values, exchanging total benefits for cash will have to be restricted if not forbidden if the risk of selection against the CDC scheme is not to undermine its viability.
Members may well find the prospect of having difficult decisions about investments taken out of their hands and the greater predictability of their prospective pension (both inherent features of CDC) attractive during the accumulation phase but when it comes to the timing and format of accessing their pension I suspect the restrictions of the ‘pact’ will be unappealing.
So, two pieces of pensions legislation in the same year, each from opposite ends of the traditional political spectrum. Another sign perhaps that in the post-Blair era, pragmatism trumps ideological zeal!
Eamonn O’Connor is a Director of City Noble and has been a personal friend for over 30 years. I’m really pleased he’s blogging on this site and hope we get more!