The Flat Earth model is an archaic conception of Earth’s shape as a plane or disk. Many ancient cultures subscribed to a flat Earth cosmography – (both Wikipedia)
The distinction between Flat World and Flat Earth suggests how easily a simple idea can have binary engagement. CDC is much the same – I see CDC as progressive and a means of binding society together, John Ralfe sees CDC (and me) as bogus. Trump has proved that the insistence of the globalisation lobby can be checked and while I’d stop short of likening John to Donald, I suspect that both of them have an important role in keeping the world honest.
The point of this article is to explain that while it is fun to ridicule CDC, it is impossible to ignore it, like globalisation , collectivisation is not going away!
The recent conversion of St Guy of Opperman to CDC – suggests that the £2bn uplift in the Royal Mail share price, resulting from the CDC settlement – is a market indicator – even he could not ignore.
The Price of Freedom
No one has costed “freedom and choice”. The Treasury tried in their various impact assessments. If they had gone to consultation over the changes in the tax laws on the payment of DC pots, we (as Friends of CDC) would have pointed out
- That paying a wage for life is difficult and requires scale
- That managing a wage for life with any certainty – as an individual – requires an annuity
It would not have been enough for us just to have said this, Kenny Tindall asked on Twitter yesterday what proof there was that CDC provided more certain pension outcomes and I’ll start by showing how expensive it is to manage a typical drawdown
The model above is only one of a number knocking about, but it fairly represents the kind of costs you can expect to pay for an efficient drawdown product.
Paying 0.5% of your fund for financial advice – is akin to paying somebody to look after your car, you could do it yourself, but most people will pay a mechanic.
Investment Management costs are what you pay upfront to people to manage your money, typically in a fund. They’re business as usual costs – the price of fuel. They do of course come down where a fund grows in size as is evidenced from this article on Prufund .
Platform fees are payable to those who manage the technology and in car maintenance terms , they represent routine maintenance charges – including MOTs!
Finally there are the occasional costs of running a cost which include the cost of parts when things break and the cost of labour to fit the new parts. As always in these things, these costs are underestimated as unknown and could be called the hidden costs of running a car or fund
The price of freedom, in this model is 1.65% of the amount invested, a considerable amount compared with the “rule of thumb” 4%pa drawdown.
Put simply , for most people, the price of freedom is a high price; it is too high to make drawdown sustainable for most people. Drawdown is not a mass market solution because even for 1.65% pa- you are unlikely to get sufficient value to meet your need for a satisfactory income that lasts as long as you do.
So simply in terms of defining pensions freedoms in terms of an alternative, there is no mass market alternative to the discredited annuity.
The three arguments for more certain collective outcomes
A collective approach can do three things
- It can bring down the cost of pension management by disintermediating advisory fund management , platform and hidden (transactional) costs .
- It can improve value by investing in more appropriate assets (for the purpose of paying a wage for life)
- It can manage the problem we have of not knowing when we are going to die.
These are the three reasons I give Kenny Tindall for why CDC gives more certain outcomes. But I am aware that so far- I have only dealt with “1”.
Collectives add value
Collectives aren’t just about reducing the impact of costs and charges, they add value in their own way.
It’s long been known that pension schemes can take certain kinds of risks , other schemes cannot – and be rewarded for those risks. Taken together those risks give rise to an “illiquidity premium”, a measurable amount of out-performance resulting from a scheme investing in long-term illiquid assets which give favourable long-term returns,
However, the illiquidity premium has lately been squandered – because pension schemes of all types have chose to de-risk rather than take a long-term view. Exponents of de-risking point out that there are other risks that their “de-risking” avoid that make missing out on the illiquidity premium worthwhile. That may be the case if DC plans are forced to de-risk prior to buying an annuity and if DB plans are put on a similar “glide path to buy-out. But handing over your assets to an insurance company for the payment of an annuity was never an essential end-game! I find myself in agreement with Ed Truell who writes in the FT
“As a co-founder of Pension Insurance Corp, I know better than most the strictures of an insurance regime that is ill-suited to the long-term nature of pension asset and liability management.”
He added that insurance was an expensive way to secure pension liabilities when employers ought to be devoting their attention elsewhere.
“British companies need to be freed up from their legacy liabilities to invest in their businesses, restore productivity and continue to boost employment and growth,” .
The original point of running a pension scheme was to keep it going for future members.
CDC schemes have the opportunity to restate that original aim and avoid de-risking altogether, they can take a long-term view and invest in assets that give them an illiquidity premium. They do not have to sell these assets to pay pensions (as has to happen in the individual DC model). They can rely on future contributions and income from existing assets to meet the target pensions.
Certainty of income from longevity pooling
The third and most obvious advantage of a CDC scheme is that it can insure longevity risk from within its pool of members. As Abraham puts it in his recent book,
Instead of having to rely on super-outperformance or an outsourced insurer (either traditional insurance or capital market solutions), a CDC scheme relies on pooling the mortality experience of all members, those who die soonest within the scheme subsidise the pensions of those who live long.
This process is abhorred by libertarians who consider any form of cross-subsidy, the spawn of the devil. But it should be pointed out that this kind of social insurance is the basis of all mutual movements, there is a solidarity between people based on our fundamental insecurity about our capacity to survive.
We all know that there is a general underestimation of how long we live and this appears to be particularly the case among people who live longest. Ironically, those who stand to gain most from guaranteed pensions are those who are most wealthy. These wealthy people are most likely to leave a longevity pool – making things that much the easier for those with genuine short-life expectancy!
This is why I think CDC schemes should offer the door to all members who want to transfer out, including those who are receiving pensions, for every pensioner who lives on the grounds of ill-health, there will be twice that many leaving for reasons or wealth (typically inheritable wealth).
CDC will I am sure, benefit from it being spurned by those wealthy enough to live forever.
Flat world or flat earth?
I hope in this article, I have put up a reasonable argument for considering CDC as a more certain source of income in retirement than either drawdown or annuity purchase. I’m aware that this article is not splattered with numbers, I’ll leave that for my actuarial colleagues.
I hope too, that I am seen to be talking sense, and that through reading this far, you have inched closer to the “CDC is “flat world” – rather than “flat earth” thinking”.