The point of this blog is to share my understanding of the CDC consultation issued by the DWP. Please feel free to disagree and help me along where I am lagging. Please use the template of the 25 questions at the end (but delete my answers) if you are responding for yourselves.
I note this “CDC consultation” is entitled “Delivering collective defined contribution schemes” and is not a document on the rights and wrongs of collectives rather than individuals.
My response is made as a 57 year old 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.
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 as ongoing advised solutions – such as drawdown, look too expensive while locking into annuity rates – with the prospect of 30 + years till me and my partner’s death, looks equally unattractive.
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 and specifically not the following statements that define what the CDC means to deliver; 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
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.
(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.
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 more
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.
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).
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.
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.
Do you agree that the initial CDC schemes should be required to meet the conditions described above?
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
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
Are there any additional TKU requirements that should be placed on the trustees in CDC schemes?
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.
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.
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.
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.
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.
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.
We would welcome feedback on how best to manage risk generally going forwards.
The PPF is probably the best model to look at!
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
We would welcome thoughts on appropriate wind up triggers and how best to manage associated risks.
No doubt draconian triggers will be discussed. As a rule, a CDC scheme should only consider winding up if it is the subject of catastrophe – think football clubs.
Are there any elements of the proposed regime that it is not appropriate to apply to CDC schemes?
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
Are there any other investment requirements that should be required in addition to those proposed above?
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.
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.
Do you agree that CDC benefits should be subject to a similar cap to the automatic enrolment charge cap?
Yes – reluctantly.
Do you agree with the proposal that charge cap compliance should be assessed on the value of the whole scheme’s assets?
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
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.