Hot on the heels of Kevin’s rebuttal of CIDC, here are his comments on Hargreaves Lansdown’s submission to the Work and Pensions select Committee.
Kevin is writing in his capacity as a consultant for Aon. His comments are in bold and italics, Hargreaves Lansdown’s comments are in plain type.
Comments on written evidence from Hargreaves Lansdown
HL’s key conclusions are:
- CDC increasingly incompatible with changing work patterns
- CDC would result in higher contribution rates or lower payouts
- CDC risks exacerbating intergenerational inequality
- CDC would require onerous regulatory oversight
The first part of their evidence is largely occupied with defined benefit plans – gold plated pension scheme, and their comparison with DC schemes. It is not obvious how or why this is relevant to CDC schemes.
“CDC has an admirable intention. Sharing risk across multiple cohorts to smooth returns. However, this smoothing of returns principally benefits members who are close to, or in the process of, drawing from their pension. The asset mix to deliver these smoothed returns is likely to fail younger savers who have the potential to take a higher risk approach at the start of their career.”
CDC offers the potential for higher investment returns than conventional individual DC plans, because of the longer term time horizon for investment. In simple terms a scheme can take a longer term perspective than one individual member, and so deliver superior returns to all. Aon’s modelling (Ref 1) demonstrates this
On a more subtle basis, it would be possible to have a non-uniform (but still equitable) bonus policy for a CDC scheme that allocated greater rewards (and corresponding risk) to younger members, and greater certainty and lower potential returns to older members. We describe – and model – such a process in Appendix D of our first report (Ref 1).
“We believe the concept of CDC works best if people are members throughout their entire saving career, however we know this is impossible in practice. Once people start opting out, or worse still asking for transfers out, then it all gets harder to control and administer. ”
“We should also remember that collective risk sharing already exists in DC pensions, it is called With Profits and has equally admirable intentions … These types of funds worked reasonably well in a rising stockmarket, but were generally terrible when the market fell heavily as providers levied a ‘market value reduction’ to reduce peoples pension pots if they wanted to transfer away.
“No evidence is offered for this assertion. Aon’s second modelling paper (Ref 2) shows how a CDC design can be made to work for a scheme starting up, for a scheme subject to a major membership change, and for a scheme running down. Transfer values would be available, based on an equitable share of the fund, so that leavers and stayers are treated fairly.
An interesting recollection of how with profits performed in a very different environment. A market value reduction was in most cases necessary to bring the face value of a member’s account back to a fair share of the underlying with profits fund – a principle, we would advocate for CDC plans. The intention is to give bonuses to reflect a fair share of the actual returns generated in the plan.
“Through the lens of CDC, trying to offer the smoothing of returns when access is required across a wide variety of ages, is likely to result in a conservative asset mix acting as a drag on long term returns. This will further impact on younger members who have not benefited from DB schemes in their early career heightening intergenerational inequality.”
Younger members generally have less invested in their plans, and so returns are much less important than the level of retirement savings. For reasons described above, the investment mix of a CDC plan will, on average, be more return orientated than the investment mix of an individual portfolio, so delivering higher potential returns to all.
“Speaking to members when With Profits funds were at the height of their popularity, there was a general mistrust towards insurers who were managing the money.”
We agree the issue of trust is central to generating a strong savings culture. Do members trust financial services companies nowadays? Or the government? Or their employers? The governance regime that we advocate is centered on independent trustees, who have no motivation other than to ensure fair distribution to each generation of members of the scheme.
“Given the move towards greater transparency in workplace pensions around fees, it would be odd to introduce an extremely opaque pension solution. Above all else, the pension system is crying out for greater simplicity.”
Do members value transparency and simplicity – or do they value something that just does what they want it to do? Do we insist that members understand the way an internal combustion engine, before we allow them to purchase a car (which statistically is far more likely to kill them, and other innocent members of the public) ? A CDC scheme cannot be that transparent and simple to a member of the public. But it can be understood by the independent trustees – and by the Regulator and the sophisticated pensions intelligentsia, who can see the entire workings of the scheme via the Public CDC Website.
“There is a huge risk that people will misunderstand CDC. Imagine the person who has been told their pension is targeting a certain level of pension, but it ends up falling short. This person will still be disappointed and resent the fact that their retirement aspirations have not been met.”
Disappointment is part of the CDC process. Fortunately, our modelling suggests that true disappointment – a reduction in the level of pension in payment – will be relatively rare. Regular communication to members will stress that their benefits are Targets not entitlements, and point out the possibility of lower benefits than those illustrated.
“We don’t believe there is appetite from employers to embrace CDC pensions.”
We do – and have their names.
“Hargreaves Lansdown research also points towards increased appetite for annuities as people age, which would have to be factored into any design.”
We think what this means is that people want greater certainty as they age. We agree. A CDC Target Lifetime Income can be an important part of later life retirement planning – offering higher returns than a conventional annuity, but still giving a solution to longevity.
Aon Hewitt – the Case for Collective DC
Aon Hewitt – CDC Stability and Fairness