In the “grand scheme of things” – pensions will go on
“In the grand scheme of things” is a very much over-worked phrase. It’s up there with “all will come out in the wash” as a means of dismissing today’s problem/delight in a wider context and generally infers authority on the utterer as having the bigger picture in his head. I deliberately use the masculine gender as us men seem particularly prone to this kind of thing.
“In the grand scheme of things, a market fall of 20% is not likely to trouble the payment of pensions”
If you are sitting on a six figure drop in the value of your DC pot (as I am), then 20% seems like an awful lot. However, the modelling done by actuaries Willis Towers Watson suggests that for an equity based CDC scheme, the impact of the March market correction in the value of the model CDC scheme – will work out to a cut in future increases of 0.5%.
Let me say that again. The market correction in March would not lead to pensions being cut, only a reduction in the next increase of 0.5%. It’s because of the overall scheme of things – or more specifically it is because CDC acts a massive dampener of short term shocks , meaning that when you hit the big pot-holes , you carry on in the same direction of travel undisturbed.
Spreading the load
The model scheme in question is of course the model that Royal Mail is using and is what specialists call a “whole of life” scheme. The shock of the impact of March’s market correction is felt accross everyone in the scheme – from the youngest to the oldest but since only the older members of the scheme are getting paid by the scheme, everyone takes one for them. In good times it’s the other way around. Younger people are building up entitlements because older people aren’t maxing out the fund, they’re passing back the love they got in times like this.
This is why actuaries like whole of life CDC schemes, the dampening is much more effective when spread over generations of savers. But now actuaries are looking more ambitiously at whether CDC can still dampen things down , if the spreading is accross a generation of savers, rather than generationS.
Kevin Wesbroom has confirmed that he is working with the PPI on modelling the value of collectively spending one big pot, “on a defined contribution basis”. This work may never have been done before and should be of huge interest to all DC savers and to the providers and regulators of DC savings. It should be as interesting to the Treasury (and the Government Actuaries) as to the DWP (responsible for pensions in payment).
If it can be proved that CDC can provide more stable income streams than individual drawdown policies and better overall outcomes than emerge from the purchase of annuities, then we may be on the way to solving the great conundrum created by pension freedoms. We may have found a way of getting people to pay themselves a wage for life while “never having to buy an annuity again”.
I will tease Kevin a little by reminding him that a few years ago he was telling me that the pension freedoms would be the death of CDC. He will smile grimly and accept that he is now saying quite the opposite.
If he is right, and his actuarial modelling proves there is value in CDC as a simple way to spend our pension savings , then “in the overall scheme of things”, one of the great actuarial pivots will be forgotten in the general rejoicing!
CDC for everyone?
I am talking of “CDC pensions” in an abstract way, but let me explain what the implication of Kevin’s research could be. If it is possible to create a “spending only” version of DC from a pension pot then the implications are enormous. Because the only pot in town will be the one big pot that pays the pensions, not the estimated 60m disparate pots that clog up the pension world today.
Everyone with a DC pot would be able to tip their pot of money into the big DC pot (the CDC pot) and exchange it for a wage for life, a series of future payments that would go on as long as you do. Payments that would be pre-determined and that would vary only when markets consistently did better or worse than expected.
What is so exciting about this work is that it could unlock a door for the 90% of us who do not pay for financial advice and just want our pension sorted. It could give us a standard way of doing things (I try not to use the word “default”).
The establishment of these great CDC pots doesn’t prevent people managing their savings as “flexi-access drawdown”, nor does it stop those who value certainty – buying an annuity.
But for the people in the middle – “Middle Britain savers” – as Billy Burrows calls them, the option to spend their pension pots as wages, is likely to be hugely attractive. It is of course what people always thought they were buying, when they started saving.
In the grand scheme of things we are targeting a decent way of life when we retire and if Kevin can show us how to set that target, it will be one of the greatest pieces of work that the PPI will have ever done.