CDC – flawed in conception

Steve Webb told me that when he spoke with Andrew Young, the former Government Actuary for the DWP, Andrew advised him to “think big”. Steve did and he will be remembered not just for the scope of his vision but for some big ideas that have made it to the statute book. Steve was not the architect of pension freedoms but he supported them as free-market liberal.

His final months as pension minister saw the publication of the Pension Schemes Act 2015 which contains the framework for collective DC schemes. The secondary legislation to make the framework workable , was being drawn up , until the announcement last week by the new Pension Minister- Ros Altmann.

In this article, I will explain what use I – and some like me- wanted to put CDC to, why the need exists for a collective means to decumulate savings and how I hope we will (one-day) get things back on track.

This ties into three recurring themes in what I’ve been saying lately

1. That Britain has Pension Freedom and nothing to do with it
2. That the traditional connection between employer and worker’s pensions has to change
3. That some intervention is needed as the financial services industry cannot provide an answer from its own resources

“Freedomed up” with nowhere to go!

220,000 people have exercised the right to take their money but less than 20% of that number have taken guidance from Pension Wise , around 12,000 used the money to buy an annuity and as many again set up an income using “income drawdown”.

But 62% of those asked by a recent Aon survey what they’d like from their pension pot described something very much like the state pension, or an annuity – a certain stream of payments paid until death.

So clearly the public want something quite traditional but not from annuities or drawdown!

The current “big idea” does not come from the DWP or its regulator but from the Treasury and the FCA. The idea, expressed in the consultation within the Financial Advice and Market Review is that given the right access to advice, the general public will manage their post retirement financial affairs with an adviser- or at least with a robo-adviser.

This is speculative and nothing I’ve seen since I became an adviser over 30 years ago suggests that most people want to manage their retirement income with the care and attention needed for drawdown – or pay for someone else to do it for them. As Paul Lewis puts it, they want to fire the gun and live with the consequences.

The previous big idea was that you could do just that- using an individual annuity policy purchased by someone at the point when they exchanged their pension pot for a pension . People got fed up with this idea and that’s why Pension Freedoms were so popular.

We have got rid of the old big idea, are groping for a new big idea but we aren’t there yet!

A solution looking for a problem

When CDC was introduced by Steve Webb, it was proposed as a third way between DB and DC. Unfortunately Webb did not test the market to see whether a third means to build up a pension was required.  It wasn’t needed or wanted and not one employer has stepped forward to trial CDC for its workforce.

Worse, Steve Webb included a range of other ideas as part of his Defined Ambition project. These muddied the waters and CDC  lost any focus in the “pension’s eye”, let alone the “public imagination”.

So CDC became a solution searching a problem.

We need a new “big idea”.

So we have Pension Freedoms with nowhere to go and CDC as a solution searching for a problem. The third leg of this stool is the public’s wish to have a non-advised pension solution providing more than annuities without the fuss and bother of income drawdown.

For this to happen , we need a genuinely new “big idea” which does four things

1. Provides a problem to the issue of people not knowing when they are going to die
2. Gets round the issues to do with guarantees that force annuities (and defined benefits in general) to cost so much.
3. Provides staff with a “fire and go” solution without heavy upkeep costs
4. Provides employers with something to signpost retiring to – which solves the problem.

A help not a hindrance to employers

It’s currently thought that there is a silver bullet for this problem – the master trust. NEST and the large pension consultancies are touting solutions to decumulation which involve “to and through” investment strategies culminating in the purchase of an annuity at some yet to be determined age.

These solutions have two problems.

Firstly the timing of the annuity purchase, which looks very problematic, not least because we become cognitively impaired as we get older and are less able to deal with difficult financial decisions like annuity in our pensions in very later life.

Secondly, when someone joins a master trust they do so because they are an employee of a participating employer of that master trust. This link between employer and employee may be broken when an employee retires, but it remains in the pension trust, so long as the employer participates in it. Clever lawyers point out that employers are therefore potentially on the hook for the outcomes of these master trusts and risk avers employers are extremely nervous of the implications of this residual liability.

Of course the problem is even more acute if you are an employer with your own DC trust, which is why employers are so resistant to running decumulation schemes using their own DC pensions.

How CDC could have brought everything together.

My idea for CDC was always different from Steve Webb’s. Steve wanted a third way product, I wanted something that was

1. Able to provide an easy way to provide mutual insurance for those worries about how long they lived. CDC provides mutual insurance within the pool of membership
2. Gets round the issues of expensive annuities and uncertain drawdown, by taking out the layers of intermediation, not having guarantees and so providing more pension (albeit with a little less security)
3. Is a set and go product that does not need management (but has limited property rights for those who want a transfer)
4. Provides a clean break solution for employers wanting to signpost a default “spending” option for those entering the decumulation phase.

Of course CDC would not provide perfect solutions, all of the aspects of the product outline above have their own problems and many people would have preferred the total certainty of annuities (or buying extra state pension) or the freedom of drawdown.

A step back to go forward

What I’m describing is pretty close to the kind of DB contract between member and trustee of a pre 1987 Defined Benefit Plan, funded by the pots build up in workplace pensions and (for those willing to lose the guarantees) from DB.

The big difference is that instead of this being employer sponsored, it is sponsored by individual transfers and instead of employers setting up the trust, the trust is set up by an independent third party.

This kind of structure does not currently exist (current master trusts need participating employers). That is why we need the DWP to sort out the secondary legislation and why it is a shame that this work is now on hold.

I’m confident that we can make anew the old way of making pensions and look forward to doing just that – just not now!

The battle has been lost , the war may yet be won

We were never going to get the legislation to build the product tomorrow. The latest estimates we got from the DWP was 2018. No product would have been ready till 2019 (IMO). What we are seeing is an unfortunate stalling in already slow process.

Ros Altmann has made it clear that CDC may be dead but it is not buried. I suspect that the third way product envisaged by Steve Webb may not arrive for much longer, but that the need for the simple in retirement version I am proposing will emerge before too long.

We cannot have pension freedoms with no default way of spending our money. We shouldn’t expect there to be a revolution in behaviour making us all want to get advice. Annuities are not due a comeback any time soon and drawdown doesn’t look a mass market product.

The need for innovation is there and will grow. The financial services industry is not showing much sign of meeting that demand. When the current mania for the “new advice” has passed and we accept that neither Pension Wise or robo-advice is the solution…

then we will return to collective decumulation models.