CDC – sharing risk in a bear market

Bear 5

This post is by the author of “launching CDC into a bear market” and again shows how CDC delivers a robust return in a bad times (a bear market). It does so by sharing risk and informs modelling by Aon which resulted in this chart (thanks Kevin Wesbroom)

kevinw. jpg


Risk Sharing

CDC Early days” considered the early stages of a small scheme under adverse development of the investment portfolio. This development is actually highly unlikely to arise in reality as it has a likelihood of occurrence of less than 0.3%. That analysis considered only cuts administered as a result of failure to cure deficits within an arbitrary time span- in this case cure within a period which is 1/deficit.

That analysis is incomplete in that the first pension albeit small is paid in year 2, when there was a deficit and risk-sharing rules would have operated. A second much larger pension commences payment in year 7.

If we consider first the effect of equitable risk sharing with no cuts to pensions. This involves paying the full amount to pensioners even though the scheme is in deficit, and the sharing of risk is achieved by crediting all other scheme members with an amount equal to the overpayment to pensioners. This has the effect of raising the equitable interests of those members and of the aggregate scheme. Table 1 shows the revised equitable interest of members

Con CDC 7

The effect of risk sharing is to raise the overall scheme liabilities, over the 10 years, by 5.2%; the interests of non-pensioner members increase by 5.98%. The required rate of return on assets rises from 5.57% to 6.68%. A comparison of the liabilities illustrates the development over time – table 2.

Con cDC 8

 

The total support afforded to pensioners over this ten-year period was £6,013, and the interests of non-pensioner members have been increased by this amount. The second retiree in this scheme, who receives support, actually benefitted from his/her prior support of the initial pensioner to the extent of £911, approximately 1.3% of their interest.

As can be seen from inspection of Table 1, deficits are persistent in the presence of risk sharing, and it is the cure-period which binds. Table 3 considers the position when there is risk-sharing prior to year six and that the scheme then undergoes a cut at the end of that year.

Con CDC 9

Again, it is obvious that full pensions may be reinstated. During the period during which the cut applied, the two pensioners in payment received £964 and £6,910 less than their target pension. If we now reinstate pensions fully, these cuts need to be rectified.

One of the points which arises from this simple analysis is that there is some disturbance to the required rate of return arising from risk sharing. It is minimal when the numbers of pensioners and non-pensioner members are equal. This may provide an incentive for schemes to take on decumulation only members.

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in CDC, pensions and tagged , , . Bookmark the permalink.

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