I am fairly confident that before the end of October, before even next week’s budget, the DWP will consult on CDC. We are told by the Pensions Minister , that the test case is Royal Mail but that legislation will be designed for a larger number of employers, perhaps even for ordinary people who want a pension paid by a scheme and not managed by themselves.
CDC in context
But before we get anywhere, the Government will need to feel that CDC has the confidence of a groundswell of people who get it and would- given the chance – use it. The Friends of CDC is a start, but it is still a group of around 100 enthusiasts. Work is being done on CDC by the Royal Society of Arts (David Pitt-Watson) and organisations like the PPI continue to support its development. But the PLSA conference largely ignored CDC (or indeed the concept of open collective schemes in general). It is fair to say that CDC has not won general consent.
When I was in Holland last week, CDC wasn’t much discussed either, despite the Dutch having a pension system built upon it. There, the public are disenchanted by CDC pensions that have not increased as much as experts predicted. There are many in Holland who want to turn away from collective provision and go it alone as individuals.
In my view, the challenges facing CDC should not be ducked, but should be faced. There is no system of collective funded pensions in Europe that has not been challenged by the new normal of low interest rates, low equity returns and increasing longevity. The problem isn’t UK wide, or Europe wide – it is global- the same problems re-occur in North America and Canada.
CDC cannot change the world, but it can a bad situation better
CDC relies on three unique features to make it viable
- It is collective and therefore creates economies of scale, it can deliver more for less. It can self-insure longevity risks , absorb market risk and operate at a cost that individual DC cannot match.
- It is guarantee-free and is not subject to the reserving requirements of solvency II or the prudence that needs to be built into DB – it can distribute more and keep back less
- It is legacy-free; CDC will arrive at a time when new technologies – such as the distributive ledge (aka blockchain) are becoming available. The smart ledger is ideally suited to CDC record keeping and payments.
It is the third of this trinity, that is perhaps least understood. It is the smart ledger that could and should deliver CDC with confidence.
Most people are by now, familiar with the blockchain as a technology. In other areas of finance, reinsurance and land registry for instance, distributive ledgers are being used as a way of formalising what were manual processes using digital processes instead.
The power of the blockchain as a way of recording transactions is that it is permanent, immutable and utterly transparent. By contrast, the centralised databases on which we have relied for decades are prone to human error and opaque – we find it hard to trace and reconcile what has happened.
The argument for using smart ledgers to record CDC transactions (money in , money invested and money out), to ensure that the rules of the scheme are followed and the capacity of this technology to be verified by all stakeholders – makes it ideal for CDC.
This matter is discussed at length, and with great clarity by LongFinance. You can read there excellent paper “Smart Ledgers and Collective Defined Contribution Pensions” here.
A rules based approach
A CDC scheme has to work on assumptions and those assumptions have to be agreed on initially and regularly revisited. Assumptions are only guesses and even “best estimates” are only partially right.
As my colleague Derek Benstead puts it “I expect to be wrong 100% of the time!”. Being wrong all the time isn’t wrong in itself, it is infact – exactly right. The capacity of CDC schemes to understand where they have missed their targets and re-set for the future , is what makes CDC viable. It is at the heart of risk-sharing. Those who enter into a CDC contract are not sharing the risk with a sponsor (employer or tax-payer), they are sharing risk between themselves.
Depending on the rules of a CDC scheme, the contract can be established as fair at outset or unfair. I would hope that CDC schemes would be set up with rules that are seen as fair at outset, if not – no-one will use that scheme!
What I fear is happening in Holland and in other places where CDC has replaced DB is that people still see CDC as defining the benefit in an infallible way. The harsh reality is that actuaries are wrong 100% of the time and the best actuaries – Derek being one- recognise this.
What the smart ledger does, is tell us how wrong the assumptions are and – assuming that the rules have been properly established at outset, it tells everyone – including the actuaries – what the risks are of continuing with distribution approach that may be paying out too much in claims (principally pension payments) or too little.
Kevin Wesbroom, another actuary who gets CDC – has made the case for total transparency on exactly this basis. We need to give clear signs of what a scheme can and cannot do , before changing distribution strategies, people need to see good news and bad news coming.
Why CDC wins as a mass market pension system
This is where CDC really does gain over other types of collective provision. I don’t think that the Friends of CDC have made these points clearly and loudly enough.
CDC really does give people the opportunity to have their pension back. It represents an attractive alternative to annuities and drawdown and – provided the governance is properly established at outset – it should aspire to public confidence.
Of course it will hit hard times, there will be cuts in pensions, not just pension indexation. But- provided assumptions are prudent, there should also be windfall distributions to compensate for the bad-times.
It is always nicer to be guaranteed things, but if you can’t have guarantees, you should have transparency. Technology , good governance and a pragmatic and honest approach to communicating future pay-outs, is critical.
The rules based approach , advocated by top lawyers such as Phllip Bennett is surely right. Actuaries should not do no more than trim the sails of the ship, its course should be consulted on and agreed by all stakeholders.
CDC with confidence
We aren’t the first that ever burst into that silent sea! there have been many attempts to create a sustainable system of funded pensions. There is currently a low confidence in the collective approach (see above) but that is because of failings in DB systems which have been identified.
CDC in the UK is an opportunity for us to get collective pensions right. Perhaps the best argument for getting it right this time, is that we in Britain have got it wrong in the past.
That is why I do not get angry with the CDC detractors. I think they are right to be sceptical.
But past performance is no guide to the future.
If at first you don’t succeed, try, try, try again.
You might say I’m a dreamer – but I’m not the only one!
Ok – enough platitudes! I think you know where I’m coming from!