Con Keating sent me this outburst after reading John Ralfe’s article on CDC – “Royal Mail workers should see red over CDC pension plan” . You can read the original article on John’s blog – here.
This morning’s Times saw the latest outbreak of Ralfe syndrome. It took the form of warning us that the uniform pension award structure, familiar from just about all UK DB pensions, will result in massive mis-selling litigation. The obvious question is: if this is such a heinously inequitable arrangement, why have we not already seen any such lawsuits?
Not content with this, he asserts, baselessly, that claims will extend to “the government itself, with taxpayers on the hook to pay compensation”.
Ralfe’s objection stems from fact that the contribution of a 25year-old member is invested for far longer than that of the 64year-old but both receive a uniform benefit of, say, 1/80th of final salary as the pension award. There is the first and most obvious defence of this form of benefit award, which is that younger members will themselves benefit from this arrangement as they age. Over a member’s lifetime, it is fair.
Of course, there is a very significant difference in the term for which the pension will be paid. The 64year-old might have an expected life in retirement of 20 years but, based on recent trends, for the 25year-old this will be 30 years. This difference is made all the more significant by the indexation of benefits both in accrual and in pensions payment.
What we observe when considering the pension holistically is that when returns are high relative to the scheme indexation, we can observe subsidy of the old by the young, but, when returns are low relative to the indexation, then it is the old who subsidise the young, and do so for far longer periods than was the previous case.
This is a classic form of insurance. Not only are the benefits expressed in terms of future pensions, and with that future standards of living, but they are immunised against the poor investment returns which might threaten that. Ralfe’s “solution”, age related benefits awards, is no solution at all.
By way of ending on this aspect, there is a further point to consider. In decumulation, we prefer low discount rates as this maximises the capital value of our pension cash flows – transfer values are then high.
Ralfe finds fault with the expected return on assets approach to valuation, preferring instead a “prescribed bond rate”. His assertion: “this understates the value of target pensions and means that pensioners will be paid more than their share of assets — another structural transfer from young to old.” In fact, the expected return on assets approach to valuation may over or understate the value of pension liabilities. This would also be true of his prescribed bond rate approach, and that could be expected to be more volatile.
The structural flaws are not in the design of CDC but in John Ralfe’s analysis.