Collective Defined Contribution schemes are back in the news, with a Parliamentary inquiry under way. This has provoked an outpouring of commentary. Unfortunately, much of this appears to be misinformed. It is well-known that I am an avid and vocal fan of the approach, but I will say that if half the objections raised held true, then I would not be a supporter of their introduction. In two earlier blogs, I offered my vision of CDC and CDB.
This blog examines some of the common objections and misconceptions.
Professional Pensions recently conducted a survey – with a solitary question on CDC, among many in its weekly questionnaire. It read: “The Work and Pensions Committee has launched an inquiry into collective defined contribution(CDC). Is it time to think to introduce CDC?”
The respondents to the poll are, as usual, a cross section of the professional pensions world. The results were 30% answering yes and 45% no, with 25% not knowing. The survey encourages respondents to make short comments. This article examines these comments, of which there are just 22, for those responding negatively.
Several appear resigned to the idea that it is too late: “The CDC boat sailed long ago. The concept is dead in the water”. This is bizarre as the concept has never been fully fleshed out. The 2015 Pensions Act enabled the concept but the critical and necessary secondary legislation to implement a scheme has never been brought forward.
Some are based on complete misunderstandings, such as the need for an employer sponsor. Examples of these are: “There is no chance of employers being suckered into CDC.” And “No employer will want it.” These schemes are collective member mutual organisations – there is no role for any employer. In such a form of organisation, member interests are perfectly aligned. These are both their assets and their liabilities. This is emphatically not the case with ‘with profits’ insurance policies, even where issued by mutual companies.
Some see a precedent in the progressive destruction and cost of traditional db provision induced by successive government actions. The idea of government intervening at some later date is interesting. There are only a vanishingly small number of cases where such intervention, to protect people from themselves, are justifiable. We should not forget that the principal rationale for regulation is the prevention of harm to others. There are in fact no guarantees within these arrangements; they do operate under a system which is best described as equitable reciprocation. (See my earlier notes on CDC and CDB for a fuller explanation).
Some seem to believe in multiple issues, for example that it is necessary to lose the flexibility and choice of DC, that there is a need for immediate scale and that there are intergenerational risks.
Immediate scale is a recurrent misconception, for which there simply is no need.
While the earlier articles on CDC and CDB envisage collective investment, choice could be introduced, though at a cost in terms of monitoring complexity, and likely investment return outcomes. Access to or transferability of the pension pot itself is not a problem.
In pure CDC there are no intergenerational transfers of either assets or liabilities, the concern is without foundation. With CDB there are intra-membership transfers, but these transfers are immediately offset by reciprocating changes to the equitable interests of members.
One of the most commonly recurring criticisms of CDC is that it has been tried overseas and found wanting. This usually refers to the Dutch experience. However, these Dutch schemes are markedly different from what is being proposed here in the UK – no-one would be following other people’s mistakes. It should be realised that most Dutch schemes are not CDC – that nomenclature was simply a rebranding of an earlier inadequate DB model. Moreover, they are regulated as if they were insurance companies; a process which leads to far greater expense, inefficiency and inequity for members.
It is important to understand that CDC is not a repackaging of earlier models, even though it shares some common ambitions and characteristics with some of them. The model envisaged would simply not have been feasible in a world lacking today’s technologies.
Some of the response comments are just bizarre – “Big Brother is now controlling your pension. Smile at the camera in the corner of the room!” Others, by contrast, are open and well-reasoned, such as: “still not convinced about its merits.”, and “The first challenge is to determine from first principles whether CDC is better than the alternatives for the world of the future,” There have been many different simulations of CDC; all produce positive results. The case can be made in theory that CDC can be expected to outperform not just individual DC, but also employer sponsored DB.
There have also been several longer articles published which oppose the introduction of CDC enabling legislation, but indicate a willingness to reconsider this. In the remainder of this article, we address the issues raised by one such article.
That article states: “However, instead of each member having a separately identifiable pot of money that is “theirs”, all the pots are managed together. When you come to take “your” money out, the people running the CDC scheme would pay you what they think is fair, based on what you paid in, the returns achieved, and their need to be fair to everyone else as well.” This is incorrect. An individual’s ‘pot’ in terms of both equitable interest and share of the scheme assets is well-defined and clear. There is no question of any management discretion in the payment made.
That article continues with: “What this means, in practice, is that if returns have been really good, you won’t get the full benefit of that return: the people running the CDC scheme will hold some money back to help protect people who might be drawing benefits at a time when returns have not been so good. Market bumps get smoothed out, with the idea that most people should get something reasonably close to what they were expecting.
It seems wonderfully egalitarian; pooling resources for the common good; very Dutch; very innovative. “
Neither CDC nor CDB need operate in this manner; CDC will distribute all, CDB will distribute the amount promised, the member’s equitable interest in the scheme. This is not egalitarian, but it is equitable among members. It is, in fact, Dutch in a wider colloquial usage: each member receives and pays for his or her share of the lunch.
The article continues with a discussion of the problems and issues of ‘with profits insurance policies’. It states: “The decision on what to pay out is an actuary’s tight-rope walk. You have to balance a known past with an unknown future.” As even the most cursory reading of the earlier two vision articles makes obvious, this is simply untrue. CDC (or CDB) is not a ‘with profits insurance policy’.
“Telling a pensioner you have to cut their retirement income helps the mathematics of risk-sharing, but is hardly palatable in the real world. Even in the Netherlands, the home of CDC, cutting benefits does not go down well.” With CDC the pensioner knows the coverage of their equitable interest in the scheme; they will have seen this vary over time. If they wish to smooth their drawdowns over their expected lifespan, they may do so. What does not happen is that there is no external agency imposing cuts or changes upon scheme members. Cutting benefits in the Dutch instance should not have gone down well, based as it was on an extremely flawed form and detail of regulation. The question of cuts is only relevant only in CDB, where it is clear that this may be avoided in all but the most extreme (and improbable) of circumstances.
The article asserts: “Its advocates also need to show that there is demand from employers, in this day and age, for a product like CDC. It is far from clear that such a demand exists.” Yet again, we see this grossly inadequate comprehension of CDC – beyond paying the initial contribution, no further employer involvement is necessary.
In the UK, there are a wide range of scheme arrangements currently possible within the polar extremes of DC and DB. However, these do not include or even represent close surrogates for CDC. While CDC was originally promoted by the Pensions Minister as Defined Ambition, it was a mistake to position this within that DB/DC continuum; CDC introduces equitable risk-pooling and risk-sharing among members which do not exist there.
The positive comments in the Professional Pensions survey were far fewer in number – just six. They include: “CDC is what our DB schemes were designed to be before the government interfered. Carefully designed, they will provide a valuable niche in UK retirement provision as future DC pots fall short. Naysayers are mostly driven by self-interest.” It really is not true that CDC was what the intention was under the traditional DB model, but the sentiment around the role of government in destroying DB is well-founded. It is also an over-generationalisation to attribute all opposition to self-interest, but that motivation is quite widely evident.
One response observes that “collective solutions work better than individual solutions” – a truism that underlies civil society, and indeed human evolution. Two others state that: “It is overdue” and “a helpful additional option” – with which I concur.
Credentials of the blogger
Con Keating is a member of the steering committee of the financial econometrics research centre at the University of Warwick and of the Societe Universitaire Europeene de Recherche en Finance.
As a research fellow of the Finance Development Centre he published widely on the regulation of financial institutions and pension systems. He has been Chairman of the committee on methods and measures of the European Federation of Financial Analysts Societies and is currently a member of their Market Structure Commission.
Con has also served as an advisor and consultant to the OECD’s private pensions committee and a number of other international institutions, including the boards of a number of educational and charitable foundations and as a trustee of several pension schemes.
He is currently Head of Research for the BrightonRock insurance group.