It being early on a Sunday morning, the coots playing around Lady Lucy and a wind rustling through the willows, I’m minded to turn my mind yet again to John Ralfe’s queries on CDC.
— John Ralfe (@JohnRalfe1) September 15, 2018
They are all fair questions – though any answers will be dismissed by the Financial Economists as #smokescreen #bollocks etc. It’s not the FE’s that I want to convince, I’d like the non-expert pension enthusiast who reads this blog to know that there are answers to these questions which make CDC a viable option for certain people and certain employers.
We don’t live in a command economy, CDC will not be imposed on anyone, there should always be an opt-out. In my opinion, there should even be an opt-out for CDC pensioners.
But to the questions
- I would say that CDC is more certain than DC, since DC offers the higher risk in retirement. Pooling of longevity , of market risk and of the operational expenses of paying an income for life, makes CDC more attractive to people like me – who don’t want to manage our wage in retirement. This does not mean that someone who wants to DIY isn’t better in DC – those people will avoid CDC
- For a CDC member transferring into CDC 5 years before drawdown – the remarks above are particularly applicable. They will find life considerably easier in retirement and – unless they like managing their own money – will see CDC as very convenient. It is of course impossible to put a percentage on the advantages of the pooling of risks, because there will be winners and losers (see below). But for most people CDC should be a very attractive way to consolidate DC savings in the years leading up to retirement.
- CDC need not be less attractive for someone who is 35 years away from NRA. There need not be any cross subsidy between young and old in CDC – though scheme design will play an important part in the way CDC works. I suspect that some CDC structures will try (post Brexit) to introduce age-tiering into contribution structures , while others will find other ways to balance the interests of each age group. Again, it would be extremely foolish to put numbers to the answer without having a context.
- I cannot see any reason why youngsters should be happy to sponsor older people’s pensions. It happens – it may be happening now – and it can happen in reverse. We should strive for inter-generational fairness, recognising that inter-generational solidarity is what pensions are all about. Both equality and solidarity are desirable. If people are determined to account for their own shares and not participate in a pool, they could and should opt-out of CDC.
- It’s true to say that – using the definition of risk that FE provides, CDC is “riskier”. Most DC drawdown strategies work on a glide path towards the purchase of an annuity that provides the guarantee of an income for life. This glidepath is inexact, it has to assume things about individuals that may or may not happen, so people can find risks in the timing of the de-risking. If individuals choose not to -de-risk and stay in growth assets, they can find things going wrong quickly. This generally happens in the later stages of drawdown when people are generally less lucid in their financial thinking, but it can also happen in the early stages – due to sequential risks. CDC provides protection against all this, by pooling longevity and market risk collectively!
- Actuaries decide the expected returns on assets and Trustees will generally take their advice. It is possible for Trustees to decide for themselves but this very rarely happens. The business of predicting expected returns is of course an inexact science, but best estimates are generally accepted as being just that.
- Best estimates are constantly being refined in the light of experience. This is a function of “big data”, the bigger the data set, the more accurate the best estimate.
- No CDC scheme sets out to wind-up, CDC is by definition an open collective scheme which is designed to last as long as their is need for it – potentially for ever. If however the scheme has to close, then it may well be wound up. There are a number of scenarios, a benign wind-up may simply see assets and promises transferred to another scheme. In a less benign world, where something has gone wrong, then assets will have to be distributed to DC pots or a haircut on the target may be offered from another CDC scheme.
- Transfer values can be calculated as regulations allow. It is possible to imagine a shadow fund approach where people get a value based on the timing and incidence of contributions (based on a unit value created by the CDC fund) or it could be that a CETV is calculated in a manner similar to the way DB CETVs are calculated. With the latter method, there would need to be a means to protect the fund in adverse circumstances (similar to the operation of insufficiency reports).
- It might be desirable for a CDC scheme to build in protection for families – such as a Death in Service , spouses pension , dependent lump sum or a combination of all of these. This is a question for individual scheme design and not for regulators (other than the cost of any dependent benefits need to be targeted not guaranteed (unless the scheme intends to insure them – in which the cost of the insurance policy will become part of the target benefit formulation.
I appreciate that I cannot give better answers at this stage , than these. The Financial Economists will no doubt see my answers as woolly and that I have not consulted a financial model when giving them.
I am on a boat and about to spend the day with a group of people who may never have spent a day on a boat before. I imagine they are looking forward to the adventure, as I am looking forward to CDC -with a mixture of excitement and trepidation!
However, I have the benefit of some experience at boating, and I have the benefit of some experience of pensions. I firmly believe we will have a great day on the river and I firmly believe that CDC will be a great success for those who choose to use it.