One of the most surprising developments in retail financial services has been the return of with-profits as the way to drawdown a pension.
The with-profits drawdown market is owned by the Prudential (though Aviva has recently launched a copycat fund).
Prudential’s with-profit fund had £32.6 billion of assets under management in September 2017. And it had a share of around 30% of the advised income drawdown market at the end of 2016, according to the Association of British Insurers.
If the Prudential’s with-profits fund was an occupational pension scheme, it would be among the ten biggest in Britain.
All of which begs the question, just what do people want that Prudential can offer. According to advisers, Prudential offers a certainty of income derived from the size of the fund , its investment strategy and the capacity of the Prudential to reserve against market down-turns through “smoothing”.
But Prudential’s with-profits fund does not provide pensions; while investors can drawdown at a steady rate with a reasonable confidence that they can keep a steady income going, the fund does not provide protection against the problem of living too long.
This problem has been described by one economist as the nastiest , hardest problem in finance.
It is so hard that it has brought the 140,000 postal workers and the Royal Mail to the point of striking. Throughout 2017, the postal worker’s union , the CWU argued for their members to get a pension scheme that paid them a “wage for life”. Royal Mail didn’t want to have the stress of insuring 140,000 workers’ longevity on its balance sheet. Instead of a wage for life, they offered their workers a guaranteed cash sum at retirement.
Eventually ACAS moderated an agreement which had elements of both a DC workplace pension and a defined benefit occupational scheme. The new scheme looks like being the first to be written as CDC of “collective defined contribution” plan. It can best be thought of as a with-profits fund that pays a regular for as long as the member lives.
This has interesting implications for payroll. If a CDC scheme is taking on the obligation of paying a wage for life, it is setting up a pensioner payroll. But this pensioner payroll is different. In any other kind of pension , including an annuity and the state pension, the pension is guaranteed to be paid according to certain conditions. These guarantees would not apply to a CDC pension which will pay out according to the profits of the fund. It is effectively working on a “with profits” basis and if the scheme makes no profit, pensions may remain level of even go down.
The second difference is that a CDC pension gives members rights to the pension, as if it were their property. CDC has “property rights”. This means that CDC schemes could give full or partial transfers to pensioners, something that is not available to occupational scheme pensions or annuities.
Thirdly, people can join a CDC pension and immediately draw a pension, as they would do if they were to purchase an annuity – but an option not available from an occupational pension scheme.
Finally, a CDC scheme, being a variant on workplace pensions, can use the tax concessions available under the pension freedoms. For instance CDC members might be given the opportunity to take their tax-free cash sum before commencement or have it paid as an additional element of each periodic payment (an “Uncrystallised Funds Pension Lump Sum” -UFPLS).
All of which sounds very different from a technical point of view and will undoubtedly present those running CDC pensioner payrolls with a new set of challenges.
However, from the perspective of a CDC member, a CDC pension will provide a very similar experience to an occupational pension scheme. Money will be transferred from the scheme to the members bank account in a series of payments (typically monthly) and adjusted periodically (typically annually) at the discretion of those running the scheme. In an emergency, a scheme might need to change a payment mid-year but modelling suggests that such events would be very rare.
Breaking the guarantee that a pension cannot go down is radical and it is likely that there will be plenty of controversy surrounding the setting up of the Royal Mail CDC scheme.
So far, I have seen no discussion of the implications of such schemes for payroll so this article may be breaking new ground. It is certain that to incorporate all the bells and whistles of the pension freedoms , a CDC scheme would need to incorporate a number of processes and controls available to people using “pension drawdown”, together with the normal features of pensioner payroll, including PAYE and RTI reporting.
There is no certainty that Royal Mail and its workers will get its CDC scheme, but the alternative ( a protracted industrial dispute) looks less appealing to Government than the conclusion of secondary legislation started in 2015 and abandoned a few months later, (following that year’s general election).
If Royal Mail pioneers CDC, it is likely that others will follow, 87% of Royal Mail’s pension membership were keen enough on a “wage for life” to be prepared to go out on strike to get it. The University Superannuation Scheme and British Telecom are both likely to close to future accrual in the next few months. Meanwhile, people are taking pension transfers in unprecedented numbers from DB schemes. Add to this the growing demands of those retiring with mainly DC pension accrual and it’s clear that demand for CDC is unlikely to diminish.