How does #CDC help the individual saver in a falling market as you claim….? @henryhtapper https://t.co/PbsnbcXwku
— John Ralfe (@JohnRalfe1) December 26, 2018
When I wrote this blog on Boxing Day about “coping with falling markets” – I did not explicitly make the link with CDC. The chart at the bottom of John’s tweet talks about the cost of closing open collective pensions and this is what John is picking up on.
Over the Christmas period I walked along several sections of the Somerset and Dorset Light Railway, some of the track closed down by Dr Beeching in the 1960s. It was a line that carried families down from Manchester to Bournemouth on the Pines Express.
Alan Pickering told me of travelling on to Weymouth and so to Jersey by pubic transport. Today we look to drive or fly, we have closed the rail option for good. Houses now are built where the lines were, stations converted or destroyed. It cost a lot to close the railways but the cost of getting them back as they were is too high to be considered.
I am nostalgic for the days when you could buy back your DC benefits for what was called a “scheme pension”, you either bought added years or you just swapped your DC pot for a pension , the rate of exchange being determined by trustees with the help of actuaries.
The cost of doing this is as prohibitive as reopening the lines Beeching shut. Some things are gone and no amount of nostalgia can bring them back.
But how does CDC help a saver in a falling market?
The reason why a trustee will not grant a guaranteed scheme pension for a cash input ( a transfer in) is because the grant of the guarantee is made at the expense of the scheme sponsor who will pick up the cost of the guarantee if things go wrong. This isn’t what employers are for- they provide jobs – they do not act as pseudo insurers, there are limits to the liabilities they will take on and universally employers have stopped paying scheme pensions on transfers in.
However, the same need not be said of a DC scheme, which can take transfers in without increasing the liability to the employer. In individual DC arrangements , a member currently has the choice of individual buy-out – swapping the pot for an annuity – or individual draw-down- where the individual is on the hook for managing the “nastiest problem in finance”, an income for life.
This is where CDC could help. CDC could pay scheme pensions to people transferring in DC pots. The scheme pensions would not be guaranteed by anyone, not by the scheme or a sponsor or by the member, the CDC scheme pension is prone to fall as well as rise – though by judicious management – the CDC trustees can protect members from the most heinous risks of drawdown and the scant annuities offered by insurers.
In direct answer to John’s question, CDC can continue to provide scheme pensions at times of falling market on the mutual principles on which it is set up. The mechanism for paying scheme pensions is typically the allocation of cash in to pay pensions out. Cash comes into a collective pensions from dividends, bond coupons, rents and new contributions. Cash flows out of CDC plans through the payment of cash sums (commutation) , the payment of transfer values and the payment of CDC scheme pensions.
Professor Leech is making the same point in his comment to the blog John’s reposted
The answer is that asset prices are characterised by excess volatility. Market prices – determined by the irrational exuberance of the stock market rather than economic fundamentals – are many times more volatile than the economic fundamentals such as dividends. An open pension scheme can ride out (short term) market volatility because it is the economic fundamentals in terms of investment income flows that matter.
This fundamental principle of collectivism, is what makes an open collective pension scheme so attractive. As with Dr Beeching and his railways, the problems for open collective pensions is when they become closed collective pension schemes.
The only time that assets would need to be realised from a CDC arrangement, was when there was insufficient coverage from cash-in to meet payments out. This is what’s known as a run on the fund.
We will not see CDC schemes taking transfers in any time soon.
The Friends of CDC are a patient lot. Some of us (Derek Benstead in particular) have been voices crying in the wilderness the best part of 20 years already.
The CDC consultation – on which many of us are working – does not allow for transfers in or the setting up of schemes specifically to pay scheme pensions from DC pots. Both John and Andrew are right.
The consultation document recognises there may be other proposed types of CDC arrangement and intends to provide sufficient flexibility in regulation to accommodate alternative models and providers. (Para 74/75)
— andrew young (@glesgabrighton) December 26, 2018
It may be that savers like me have to wait a decade to have scheme pensions paid from our DC pots. We may never get there!
But if we do not going on pointing out that at times like this (the S&P 500 was up 5% yesterday and has fallen many times that in the first part of December), people are being ruined by drawdown. CDC pensions , paid from a CDC fund at a rate determined by trustees on advice from actuaries are a half-way house between the perils of individual drawdown and the perils of a sponsor taking pension guarantees onto a balance sheet.
We may not see transfers in , any day soon; but logic suggests that the we will see them within the next 20 years. Anyone who is following the debate about default decumulation options from DC, will understand that the alternatives aren’t much more palatable than what’s on offer today.
Keep on pushing
Despite the obstacles to achieving CDC legislation, I am hopeful that in 2019 we will see the writing of the rules that in the next decade will allow the Royal Mail to run a CDC scheme. It is a start – and a decent start- but it is not the end.
There is no end – that is the message about pensions. We do not have to close collective schemes and when we do so – we cannot reopen them. We will keep on pushing to keep those schemes open – which are open, and open new schemes to replace those that are closed.
In the meantime we will keep on pushing to make sure that DC schemes run effeciently and they they are as well funded as can be. We do not just need need dramatic reform, we need better practice with what we have got.
A recognition that there is necessary risk in pensions
We cannot afford to run pensions on the yields we get from gilts – we can’t now – we never could. Providing pensions is not risk-free.
We need to find the correct balance between risk and reward. right now we are offering people only the binary choice of annuity and drawdown, we are not offering a balanced option.
For people to take a balanced pension, they must accept some of the risk, and market risk is part of it – but they do not have to suffer the extremes of annuity penury or the pounds cost ravaging of drawdown gone wrong.
(but you’re on your own!)