It’s a question posed by John Ralfe- to me – on twitter. It’s a serious question and one that Jeremy Cooper, doyen of the Australian Super system is clearly interested in too.
The question cannot be simply answered with reference to academic theory. Having just read a short and very understandable academic paper on the advantages of tontines over life annuities, I am in no mood for further academic wrangling. If all CDC was about was rearranging deckchairs, then I’d be looking to the lifeboat!
What is my answer?
If the answer doesn’t lie in actuarial science or in financial economics, perhaps we should look at what creates the inefficiencies’ in DC. What cannot be denied is that people pay a vast range of fees for having their DC pot managed. Last night I was with Quietroom , watching vox-pops of people being shown the fees they were paying, most of the people were not just unaware of these fees, they were unaware that there were charges on their DC plans in the first place.
The comparator two people used was with their bank
“I might as well take my money out and put it in the bank where I know what I’m getting and I won’t get charged”
One answer to the question is “governance”, individual DC plans, especially when they move away from employer funded to individual drawdown, have very little governance. It is easy for an advisor or a non-advised drawdown provider, to charge what they like. There is no-one to stop them.
Another answer is in the nature of a “trust”. If we consider the not for profit principle that has been at the heart of collective occupational pensions for the past sixty years, you can see it as the continuation of a benevolent paternalism that has persisted much longer. It is the paternalism of Joseph Chamberlain and the 19th century industrialists who built Bourneville and Port Sunlight. It is a cultural aspect of our British way of life, it is what is expected of our bosses.
This expectation that bosses will set up trusts for the welfare of their staff – run on a not-for-profit basis, has not gone away. It is implicit in relations between unions and employers and accepted by both sides. These collective arrangements are the inspiration for multi-employer schemes, the Pensions Trust, the Social Housing Pension Scheme, B&CE’s holiday plan – the People’s pension. The concept of the state as a super-employer lives on in the national acceptance of NEST as a good thing.
The alternative to the brutality of the market, is the protection of the trust.
So – for most people – the collective solution is a natural solution. It is part of our culture in a way that the American 401k system isn’t. The Australian alternative – where the state is all powerful and decrees the way Super is managed, is no alternative to the British system of “trust”. The fact that we trust each other and our employers and the Government to provide for us collectively, is of major advantage to the British pension system.
That – since the mania for personal pensions – we have done all we can to destroy that trust in favour of financial empowerment of the individual – has not made that trust go away. The system of collective pensions is still in place, it is simply looking for an upgrade.
Five practical advantages of the collective approach to DC
These five advantages are not specific to CDC, they are advantages that spring from the collective mind set talked of above and can be implemented through trustees because of trust. Those who don’t believe that trust exists will poo-poo these arguments, I would ask for them to show of proof that trust does not exist.
- The investment management agreements that can be negotiated by organisations representing billions, reduce the margins of fund managers and return that value to consumers through the not for profit mechanism – economies of scale in the purchasing of investment services
- The recording and documentation of records for a large group can be managed by repeatable processes (smart ledgers) which use straight through technology. The administration of collective pensions is cheaper than the administration of individual plans.
- The payment of pensions under a collective arrangement is considerably cheaper when everyone is being paid in the same way (a wage for life). The substitution of a rules based pensioner payroll for an individually driven drawdown plan, cuts down on payment costs.
- The communication of what is going on , is – in a collective DC plan – a one to many job, rather than an agonisingly difficult process of explaining on an individual basis. The advisory costs of CDC are minimal, the costs of advising on individual plans, especially in drawdown, makes drawdown unfeasible.
- Finally, CDC – by dint of it being run on a not-for-profit basis , is feeding less mouths. The cost of intermediation of a one to many scheme is intrinsically less than a great number of individual plans.
Can this be proved?
I think it can and will be proved. It cannot be proved in practice till we have CDC schemes and my hypothesis that we can tap into the great goodwill of trust to make CDC happen and keep it going – is just that.
Academics will point to risks in this approach and in as much as I am relying for my arguments on concepts like goodwill, I will be deemed to be airy-fairy by some financial economists.
But if we left the world to Newton, we would have no poetry, if we left the world to the financial economists, we would have no pensions!