In this article , first published in Pension Expert, Con Keating explains that while CDC is promising very little – which is why it is a concept of our time.
The inquiry into Collective Defined Contribution pensions announced by the parliamentary work and pensions committee has led to a welter of objections to the concepts. Among these concerns, misconceptions abound. Indeed, some are even evident in the introduction to the inquiry offered by that committee.
The critical element to understand is the role of the “promise” in the design and construction of both CDC and CDB arrangements. This defines and quantifies the equitable interest of members in the scheme. It is determined by contributions made and the projected values of “promised” pensions that would ultimately be payable for each and every member.
The initial public problems with DB arose from an inequity – pensioners in payment had priority over active members. All of the regulation and interventions we have seen since have not resolved this problem fully, or satisfactorily, and have introduced another set of inequities – in this case between the stakeholders of a firm. CDC resolves all of those issues.
The equitable interest of a member, relative to the totality of member interests, is the proportion of scheme assets which may be transferred or withdrawn at any time. It enables all of the flexibilities of Freedom and Choice.
For CDC, as for ordinary DC, if the assets have outperformed (relative to the equitable value) then the pensioner may draw their entire equitable share. If the assets have underperformed, then again, they may draw their fair share. The “promise” made defines a default pension payment schedule, resolving the point in time uncertainty of annuity purchase on retirement.
If scheme assets are above the equitable value, the “promised” payment or more will be made, a member option. If scheme assets are below this equitable value, the pensioner may choose to ‘top up’ their current payment, though at the cost of lowering their residual equitable interest in the scheme. This may be attractive to the pensioner from a consumption smoothing standpoint. There are no transfers or subsidies among members, intergenerational or other, in this action.
By contrast, with CDB, as with DB, the “promise” defines the maximum which is expected to be paid. If scheme assets exceed the totality of members’ equitable interests, the excess is not distributable. These are orphan assets which serve to enhance the security of the scheme. The “promise” with CDB is, in a sense, harder. Here pensions will be paid even when the scheme assets are below the aggregate equitable interests of members. In this situation, in order to maintain equitable balance, the interests of non-pensioner members are raised to reflect the excess payment made to pensioners. The pensioners’ claim on the assets of the scheme are unchanged, while the non-pensioner members’ increase. There is no intergenerational inequity.
Such misplaced concerns are unfortunate, as they distract from the advantages and gains from the other risk-sharing and risk-pooling properties of collective mutual schemes. Some entirely new possibilities arise. For example, it is even possible for CDC and CDB to co-exist, with transfers between them taking place at the value of the member’s equitable interest. CDC is very much a concept for our times.