Nuts and bolts of CDC

con cdc JRMy twitter account is currently heavy with reproach from  John Ralfe and his followers who are demanding I deliver documents, statements and reveal confidential information about collective pension schemes; (I am also under fire for quoting Hamlet). To some this would be harassment, to me it is annoying as it is distracting me from other things to no good purpose.

My blog will continue to publish information, opinion and comment on CDC and indeed other kinds of collective schemes. It will continue to try to improve DC and I will try my hardest for the  people who have been ripped off by scammers.

The purpose of having a debate, is so that both sides can put their points, the views of John and his colleagues are different from mine but no less important for that. I welcome his views but not his questions repeated time and again. What’s more, the debate is not helped by people calling each other names or taking offence when a request is not met.

One of the requests from John, is for more nuts and bolts. Here are some nuts and bolts from the keyboard of Con Keating. His views (not mine) but helpful in the context!


 

Comments on inter-generational risks in CDC

A number of commentators have objected to CDC pensions on the grounds that they have the potential to over-disburse funds to current pensioners to the detriment of subsequent beneficiaries. Of course, this may happen if trustees are not vigilant in the execution of their duties. However, it is quite simple to avoid over-disbursement, and for that, it helps to understand the elementary arithmetic of scheme funding.

The first point to note is that problems may only arise when there are payments being made from the scheme. The decision criterion is the solvency or funding ratio and it is only when this is in deficit that problems may occur. In essence, the solvency or funding ratio is to be treated as if it is a binding constraint for payments. However, when there are no payments being made, any deficit may be treated as random variation of the asset growth process, and no action taken.

It is worth noting that this exposes a weakness of the required rate of return on assets metric. Random variation of the original asset return process can be expected to return this to full funding with the passage of time (asymptotically) while the required return metric will suggest that a much higher return on assets in now needed.

The analysis this far considers the asset and liability projections to be well-specified. Persistent and growing deficits are indicators of misspecification, in which case the promised benefits should be cut. Such a cut would be to all future benefits.

It is with payments to pensioners that difficulties arise. Obviously, if the scheme is fully funded, then pensions may be paid in full. However, if the scheme is in deficit, say 80% funded, then only 80% of the current payment should be made. If the payment is made in full, the pensioner is in receipt of more than appropriate. In this situation the assets of the scheme are depleted by the amount of this excess payment, and most importantly the fund will no longer be expected to return the scheme to balance. The excess payment changes to location about which the random return process operates.

Moreover, this payment is inequitable to non-pensioner members. In order to restore equitable balance, it is necessary to increase the equitable interest of those members in similar proportion. The equitable interest of a member or class of members is simply their proportion of the liabilities of the scheme. This adjustment will increase the total liabilities of the scheme.

So, over-disbursement to pensioners lowers the assets of the scheme and increases the liabilities. It also changes the distribution of claims, or the equitable interests, of members going forward. The pensioner member’s claim on fund assets is unchanged, but non-pensioner members has increased.

This is equivalent to an increase in the pension benefits originally promised and has the effect of raising the contractual accrual rate, or investment return, promised at the time of contribution. The magnitude of this rise is small and directly related to the deficit. It is likely to be well within the confidence intervals of asset portfolio return projections

This is the rationale for limiting the total support available to pensioners from non-pensioner members. On the other hand, it is also desirable that the term over which support may be available should be sufficient to encompass the full financial cycle.

With equitably organised support, risk-sharing, cuts to pensions should prove rare events.

 

 

 

 

 

 

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in CDC, pensions and tagged , , , . Bookmark the permalink.

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