Henry Tapper’s response to the DWP’s consultation on delivering collective defined contribution schemes.

The Pension Plough

As this is a private response, I want to talk about how CDC could help me (and people like me – who I know are struggling with how to spend their pension pot).

I am very supportive of CDC schemes and pleased that the Government are trying to help Royal Mail establish a CDC scheme for its staff. The needs of the 140,000 postal workers are primary, but the legislation must consider the millions of UK workers, saving primarily into DC pots, for whom CDC could be equally welcome.

To illustrate the needs of these people, I will talk about my own situation- the choices I have taken to date and the decisions I am deferring in the hope that I can exchange my DC pot for a CDC pension in due course.

We need a default way to spend our retirement savings.

My response is made as a 57 year old man with a DC pot, hoping in time that this pot can be paid to me as a wage for the rest of my life. This perspective may prove helpful in the shaping of regulation as there are many like me.

During the calendar year 2018, my DC pot fell in value by 14%. On one day in December my pot fell by 3.5%. Because I have not crystallised any of my DC savings, these are paper losses. However, many of the people who I have met through helping the Port Talbot steelworkers are now reliant on their DC pots for income, many have stopped work and are using their pots – transferred from the British Steel Pension Scheme – to drawdown the income they no longer get from work. Most are too young to receive a state pension.

in 2017 – nearly £37bn was transferred from DB schemes to private pots. If people wanted to buy back the guaranteed income they have given up using current annuity rates, they would find their pots woefully short. Collective schemes are more effecient at providing pensions than individual annuities. Those who have transferred out of DB pots have given up a lifetime benefit – often without proper consideration of what they have lost.

When I reached 55, I had the chance to draw my DB pension or to take a transfer. I chose to draw my pension and did not take commutation. During the calendar year 2018, my DB pension increased according to scheme rules, I have an inflation protected wage in retirement, paid as long as I live and beyond – to my partner.

Had I taken advice that I was given and transferred my DB pension into my DC pension pot, I would be now sitting on a paper loss of a further £200,000.

I know the value of a wage in retirement. I see pensioners who have regular income from a pension.  But I also see those who have given up DB pensions and I see people who have never had a DB pension. A recent study by Demos for Legal and General shows that people with certain income in retirement are happier and better able to take financial decisions.

I expect, as I grow older – and I have a life expectancy of around 30 years – to value my pension more each year.

As for my DC pot, I will almost certainly take my tax free cash entitlement but I am expectant that at some future point, I will be able to either purchase an annuity or transfer my money into a CDC pension. I do not want the responsibility of providing myself with a wage for life from my pension savings.

From the quotations I am being shown from people who are looking to transfer, I can see that an annuity will be too expensive a way to provide me an income. Were I in a position to choose between an annuity and a scheme pension from a CDC scheme, I would almost certainly choose a wage in retirement from a CDC scheme.

I say this as a “pensions expert”, but you do not have to be a pensions expert to know that income drawdown from an invested pot is perilous and swapping pot for annuity is expensive.

Despite having pension freedoms, people are baffled by the choices they face at retirement. The options of annuity and drawdown are often replaced by “cash-out”, where people – frustrated by the complex problems they are presented with simply put their pension money in a bank account – and pay a great deal of tax in the process.

According to recent FCA surveys, only 6% of Britains are taking financial advice at retirement. I have studied the Pension Advisory Service’s inquiries and find that around a quarter of injuries contain the word advice while only one in fifty contain a request for guidance.

The message from people of my generation – those most in need of an urgent solution to the problem of how to spend our savings, is that we need to be advised of a default retirement solution

Whatever this consultation enables, it must not disable the ability of people like me to transfer in benefits in due course.

Immediate ambition of the consultation

I am very pleased with the consultation. CDC should

Provide a savings and income in retirement option within one package that is potentially attractive to those people uncomfortable making complex financial decisions at the point of retirement

and

Enable the sharing of longevity risk between members, thus providing each individual member with an element of longevity protection without the cost of accessing the insurance market

This is precisely what is needed; the consultation continues

A CDC scheme

May achieve greater scale than some non-pooled schemes and be able to invest at lower cost as a result. The recent emergence of master trusts in the individual Defined Contribution (DC) space has already shown some of the benefits of scale.

and

(A CDC scheme) may allow the trustees to adopt an investment allocation which is tilted towards a higher proportion of higher return assets over the member’s lifetime than may be usual in an individual Defined Contribution scheme, although the emergence of the draw-down market may see trends in the individual DC space follow a similar path over time.

I have some comments on the following statements regarding delivery.

Scope for discretion

In addition, given the complexity of CDC schemes compared to individual DC schemes, we feel it is appropriate for the former to be required to appoint a scheme actuary.

The judgement on “the complexity of CDC schemes” is made from an operational perspective. From the perspective of an individual, CDC schemes shouldn’t seem complex. I would prefer the language to focus on the ambition of CDC schemes. CDC schemes aim to help people to spend as well as save, this increased ambition is why CDC schemes need an actuary.

The role of an actuary should be limited to ensuring that the mechanism of the CDC scheme is working properly. Most importantly the mechanism governing the distribution of income and adjustments to it. As the consultation points out, this mechanism should not be based on actuarial discretion but clearly defined scheme rules

To help ensure this operates in an impartial way, our view is that this adjustment should be based on a mechanism set out in scheme rules, rather than trustee discretion.

These rules – as I understand it – would be based on actuarial assumptions and these assumptions can be adjusted from time to time. This is what gives a British CDC approach, the capacity to operate without buffers.

On balance, we favour a ‘best estimate’ approach with no in-built buffers which potentially dilute decisions on benefit adjustment.

A scheme actuary acts as a weather forecaster and the tone of the document is precisely right when it outlines this role as follows

Once a CDC scheme is up and running, we will expect the annual actuarial valuation process to consider emerging risks and threats, and to look at whether these risks significantly impact on the probability of projected benefits being met to an extent that calls into question the viability of the scheme

In Section 54 of the document , I find the following statement

Clearly, actuarial assessment and estimate is central to the provision of CDC benefits.

On the face of it, making a CDC scheme “rules based” and mechanistic, reduces the role of actuarial discretion. The central thrust of the communication of how CDC works must be to explain why the expertise of an actuary is still needed. The essential message is that from time to time the assumptions embedded in the rules will need to be changed, but the rules themselves are designed to endure. This is the communication challenge in essence

Scope for decumulation only schemes?

The consultation makes clear that there are relatively few employers who will consider CDC an option immediately. It offers hope to smaller employers and a little hope to the people who need a way to convert savings to an income for life

We recognise that interest in CDC provision may expand beyond the large employers that are likely to establish and sponsor the initial tranche of CDC schemes, so we will include provision in the legislation to enable us to make provision for such additional requirements as might be needed.

but…

We do not intend to permit decumulation-only CDC schemes at this stage, although this is something we may consider in future

This is unfortunately worded. It supposes that CDC schemes are inherently tied to the workplace. However – most people – as they approach retirement, see little link between their DC pot and their employer. The majority of their savings will be outside the workplace.

The consultation suggests that the Royal Mail scheme will allow “transfers in”, but only to those accruing benefits. 

But what of those postal workers who have left service and want to bring their retirement pots to Royal Mail, the reason for them not to take transfers into the CDC scheme is unclear.

Farcically, somebody like me, could take up a contract with Royal Mail, be enrolled into the CDC after a month’s service and then aggregate all my pensions to the CDC scheme. I could leave a month later.

I don’t think the paper properly explains the link between the payment of benefits and time at work. I don’t see any particular reason for a CDC scheme to demand that someone has to be actively accruing to transfer in pots from elsewhere, and I don’t see any practical reason why Royal Mail couldn’t admit people to its CDC scheme who aren’t employees of Royal Mail.

Scope for investment

Imposing a charge cap on CDC will come as a blow to some investment managers who might consider the provision of patient capital, an opportunity – not just for members – but for their firms. 

I can see the argument for an unconstrained approach to investment but I don’t think that it stacks up in the context of a scheme where members are expected to take the downside risk of non-performance, lack of liquidity and the failure of an investment.

I also see a strong argument for CDC schemes to be normalised as another workplace pension – suitable for large employers auto-enrolling their members.

I am pleased to see that the charge cap would include the cost of actuaries. Not only will this mean that actuarial fees will need to be disclosed to members, but it means that they will be subject to commercial pressure. They will be sharing a share of a limited budget and competing for that share

I am also pleased by the consultations intention to test charges accross the scheme rather than to particular parts of the scheme. While there will be some groups of members who will benefit more (from professional fees for instance) than others, the nature of a CDC scheme is to pool all risks – in this case costs are risks

We therefore intend that charge cap compliance as it applies to CDC schemes should be determined by one test applied to the whole of the scheme’s CDC benefits

Scope for transfers out

Transfer out will be worked out as a notional share of the fund

The member’s ‘best estimate’ share of the total fund would in effect be determined as part of each annual valuation, adapted by the scheme actuary to determine the transfer value

I am comfortable with this approach. The scheme would have discretion to establish some kind of money-purchase underpin (a nominal value for the share of the fund) or base the CETV on the present value of the target benefit (using the standard methodology applied in DB)

Scope for people to change their mind

What the paper doesn’t cover- but should – is the opportunity for people to transfer benefits out of a CDC scheme – when in payment. As this is not currently possible for DB in payment, the consultation may have overlooked this point. But a CDC Scheme is not a DB scheme, there are good reasons for allowing people to transfer-out in payment, though schemes rules must be written to ensure that this does not damage the fund

These are the questions the DWP are asking. Each question is answered.

Question 1

Are there other ways in which the introduction of CDC Schemes would give rise to different impacts on individuals in relation to one of the protected characteristics?

The scope of the consultation could have been wider, it could have covered opportunities for smaller employers and for individuals not in employment that has a CDC scheme. However, the paper is about delivering something in short order and people like me – who want more now – will have to wait!

I see this as fair (but unfortunate).

Question 2

Do you agree that CDC benefits should be classified in legislation as a type of money purchase benefit?

Absolutely yes! Anything else would make the risk of CDC benefits reverting to an employer’s balance sheet too great for any employer to consider it over other existing options.

Question 3

Are there any other areas where the current money purchase requirements do not fit, are inappropriate or could cause unintended consequences?

Not as far as I am aware.

Question 4

Do you agree that the initial CDC schemes should be required to meet the conditions described above?

Yes

Question 5

Is there a minimum membership size for CDC scheme below which a scheme could not be viewed as having sufficient scale to effectively pool longevity risk to the benefit of the membership?

There probably is, but we are unlikely to ever test this. I see no reason to prescribe on size, the market will do that for Government

Question 6

Do you agree with the proposed approach to TKU for CDC schemes?

Yes. CDC requires less rather than more pensions knowledge and understanding, hopefully TKU will be more based on common sense than specialist knowledge 

Question 7

Are there any additional TKU requirements that should be placed on the trustees in CDC schemes?

No

Question 8

Are there any TKU requirements that should be relaxed for the trustees of CDC schemes?  

Yes – many of the issues relating to accounting for schemes on a mark to market basis, fall away.

Question 9

Which of the 2 AE tests would be more appropriate for CDC schemes, and how might either test best be modified to better fit CDC schemes?

The DC test is more appropriate. CDC should not operate with contributions below the AE threshold. Setting the test against benefits opens the door to unintended consequences.

Question 10

What issues might arise from having no in-built capital buffers in the scheme design?

Financial economists will moan that at given times, schemes may look inadequately funded on a mark to market basis. These same economists will lambast CDC for inter-generational inequalities if buffers exist. It’s a case of not being able to please all of the people all the time.

Question 11

How can schemes best communicate with members to ensure they understand the risk that their benefits could go down as well as up, even when in payment?

By being quite transparent and making this agility the strength of the scheme – not its weakness. Think bridges.

Question 12

What additional issues may arise from using a best estimate basis for valuation, and how should those issues be addressed?

Best estimates are entirely appropriate for the valuation of proposed benefits. The arguments will be around assumptions used, but this is what pension experts do. As far as ordinary people are concerned, the best estimate approach is intuitively right.

Question 13

Should we restrict CDC scheme designs to those schemes which would be sustainable without continuing employer contributions?

No – to do so would be to lock the door on decumulation only schemes. These won’t happen right now – but shouldn’t be excluded by primary legislation.

Question 14

We would welcome feedback on how best to manage risk generally going forwards.

The PPF is probably the best model to look at!

Question 15

Does the proposed CDC scheme framework, as set out in this consultation document, address concerns about risk transfer between generations? We welcome thoughts on any other measures that could also address this.

The document does a good job on this

Question 16

We would welcome thoughts on appropriate wind up triggers and how best to manage associated risks.

If a CDC scheme is to be wound up, it should be up to the members to decide how the scheme’s assets are distributed.

Question 17

Are there any elements of the proposed regime that it is not appropriate to apply to CDC schemes?

No

Question 18

Are there any additional authorisation requirements that should be placed on CDC schemes?  

Yes – most of the DB rules and almost all the guidance on DB solvency

Question 19

Are there any other investment requirements that should be required in addition to those proposed above?

No

Question 20

Are there any other disclosure of information requirements that should be required in addition to those proposed above?

The important thing is to test membership knowledge and understanding, this is the TKU that really matters.

Question 21

Do you agree that CDC schemes should be administered under the requirements for money purchase benefits, but with added requirements to appoint a scheme actuary and carry out annual valuations?

Yes – they should be administered using rules based systems. Smart ledgers and other features of the blockchain will take over from centralised databases in time. We will watch with interest how the RM CDC trustees go about this.

Question 22

Do you agree that CDC benefits should be subject to a similar cap to the automatic enrolment charge cap? 

Yes – reluctantly.

Question 23

Do you agree with the proposal that charge cap compliance should be assessed on the value of the whole scheme’s assets?

Yes.

Question 24

What would be an appropriate approach to handling transfers out of or into CDC pension schemes?

It should be left to the schemes discretion whether to allow transfers out in retirement, but this should not be prohibited by legislation. 

Transfers could be calculated with reference to notional asset shares or with reference to targeted benefits

Question 25

Should transfers be restricted in any way – for example, to take account of the sustainability of the fund?

They should be subject to the same kind or reductions that happen in DB schemes – if being paid with reference to prospective benefits.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Henry Tapper’s response to the DWP’s consultation on delivering collective defined contribution schemes.

  1. Henry, I think you may be misreading Q13. It sounds to me like they’re asking whether the regulations must be such that the scheme would be sustainable even if the employer goes bust or otherwise closes the sponsored scheme to new members. If that’s the right reading, I would answer No, since I fear that the upshot of such a restriction would be regulations that are inappropriate for an ongoing scheme whose employer is very unlikely to go bust.

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