As anticipated (in blogging), yesterday’s article on CDC attracted some vitriol, not just from my friend Con Keating, but from the inter-web of things.
— John Ralfe (@JohnRalfe1) September 13, 2019
John’s rather extreme reaction came over the top of a slightly more measured response from Sam Pickard
The CDC pension truths slowly start to come out… taking money from new entrants, taking external loans and gearing up in the tough times. This won’t end well, and it hasn’t even begun. https://t.co/bFo6gK7R0E
— Sam Pickford (@pickfos) September 13, 2019
I think it worth saying at this point that the statements objected to came from Adrian Boulding, which is important as he knows rather more about the financing of DC than me (and I suspect John and Sam).
But let me explain what I mean about the “financing of DC”. To start a DC plan – all you used to need was a licence from HMRC and away you went. If you wanted to run an authorised personal pension, you need to set up with the FCA and you are subject to the various solvency requirements laid down by that Regulator and probably the PRA too.
To bring DC workplace pensions in line with these solvency requirements, the DWP have insisted that commercial occupational pension plans are also tested for solvency and this forms part of the master trust authorisation regime. Non commercial DC plans – set up by employers for their staff, are not subject to these solvency requirements but they are still monitored to ensure they are properly supported by their sponsor- the employer.
So all DC plans, whether personal or occupational – whether privately funded or funded by employers as workplace pensions, are in some way tested for solvency and need to show they are sufficient. Hopefully gone are the days of the rogue DC plan set up to scam members out of their savings, which set out to be financed out of the savings with no regard to anything but commercial gain for the provider. These plans soon found themselves anything but sufficient and are typically in special measures under the expensive stewardship of professional insolvency trustees.
What is common to modern DC plans is that they need to have credible business plans which pass the scrutiny of external auditors and the solvency requirements of regulators.
To meet these solvency requirements, all commercial DC plans need to set aside reserves against which they can draw when things go wrong. Things go wrong with DC – errors are made, money spent that should not be spent – and this is when the reserves may be drawn on. When they are drawn on, the reserves must be replenished by the provider of the plan- and this can either be done by recourse to the provider’s reserves, by cash calls to the shareholder or by the issue of debt.
The only way that the providers of DC services can be repaid this amount is from the ongoing charges levied by the scheme, or on scheme wind-up, at which point the residual reserve is repaid to the provider, following the payment of outstanding debts to everyone else and – most importantly – the payment in full of member’s pension pots to other pensions or to the member.
So it is clear that most of our DC plans is subject to financing. The majority of DC plans are loss making in their early years and this means that DC plan providers have to wait for the repayment of the money they have sunk into the scheme. The most famous example of a DC scheme borrowing money to finance this debt is NEST- which is enjoying a subsidised loan from the Government which is anticipated to reach £1.2bn by 2026. This loan will be repaid from the fees generated by the scheme and NEST hopes to pay it off by around 2040. This does not make NEST a DB scheme.
If a CDC plan has taken out a loan then it is in deficit and must be DB by definition.
— Sam Pickford (@pickfos) September 14, 2019
NEST is not a disgrace
It’s a disgrace pic.twitter.com/QbM47zfUvl
— Sam Pickford (@pickfos) September 13, 2019
The financing of CDC should be no different than the financing of DC – CDC is a subset of DC. So far, we have only thought about CDC in the context of Royal Mail, which intends a sponsored CDC scheme where all costs are picked up by RM including those of running the scheme and meeting the defined contribution level. In such a situation , there is no need for a reserve and my understanding is that RM has decided to run the scheme distributing 100% of the smoothed return over time to members.
This is fine and not what Adrian was commenting on.
But for schemes like NEST and NOW and People’s pension, which may in time want to pay scheme pensions to members on a collective basis, the situation is rather different. There is no sponsor behind the payment of scheme pensions, the defined contribution only creates an obligation on the employer to pay while the member is in service, not when he or she is retired, so necessarily there will have to be some form of protection for members to ensure that the income in retirement is stable.
There are stabilising mechanisms in place which include conditional indexation (where pension increases may be held back in years of financial stress) but what Adrian was talking about are the occassional years of extreme stress – such as 2008/9 and I think he is right to consider how a commercial CDC scheme might meet its obligations were it only running scheme pensions as an option for members – rather than as part of an integrated accumulation/decumulation program.
I may have jumped ahead of my readers here, but I firmly believe the way that CDC will develop beyond the fully sponsored model to be offered by Royal Mail, is as a retirement income option available to people looking to spend their retirement savings. I see maser trusts like NOW and NEST and Smart and Salvus and Peoples paying scheme pensions from a collective pool that insures the risks of some living longer and some dying sooner. I see this pool managed sufficiently with those joining the pool replacing those who die. I see people choosing a CDC pension over an annuity or drawdown where a middle way is preferred.
I don’t see anyone having to opt for CDC but I suspect that when presented with the option of a wage for life, Aon’s estimate of 62% saying “yes” wouldn’t be far out. I think that optional CDC might be popular with 6 out of ten cats.
Financing optional CDC
And if that is the case, we need to start thinking of how we could set such optional CDC schemes up and how they would be financed. Which is why I welcome Adrian’s thinking. Adrian has of course worked with NOW on getting it straight to be a workplace pension beyond November this year when its authorisation extension runs out.
He knows the financing requirements on master trusts backwards and he’s now thinking about the financing requirements of CDC. He is not shameful for doing so, he is not a disgrace and what he’s thinking is certainly not #bollocks.