CDC works because DC and DB pensions don’t.


My blog yesterday, praising Willis Towers Watson for having the courage of its convictions has received considerable attention, with comment generally being unfavorable , ranging from the politely skeptical

Through frustrated disbelief

To outright hostility

Collective DC works because individual DC doesn’t.

So what is the bar that CDC has to beat – what have been the outcomes of DC over the past 20 years? The question has been posed by Andrew Young @glesgabrighton.

I’m happily in a position to provide answers to that question with over 1m data points as evidence. But rather than swamp this blog with data, let me show you evidence from two anonymised data sets, representing rates of return achieved by savers going back to the start of the millennium.

Here is an example of an excellently managed group of workplace pensions that have delivered substantial excess value over the average returns for nearly 32,000 contributions.

The average return achieved by this group of savers was just over 6% against a benchmark (representing the return invested in the Morningstar UK Pension Index) of 3.29%. This data set represented contributions from 2004 to the present date and shows what  very good DC schemes can do (this one was rated close to top decile with a score of 87 out of 100)

By comparison , here is another data set of just over 11,000 DC savers with contributions going back to 1997.

In this case, the average return (including the glory years of the late 1990s) was nearly 6% pa per year, but this scheme barely achieved half that. For this group of savers, the average achieved return was just over 3%.

I have many other data sets I could point to but the picture will be the same, returns on DC savings are typically in a band of between 3% and 6% after all deductions.

The bar is not a high one for CDC to beat.

How to beat the bar.

Extract from SJP Value Assessment (2020)

This chart shows what is being taken out of a DC pot in charges by a variety of providers and shows that the investment return of 5% would at best have left an internal rate of return (IRR) of 3.3% and at worst 1.2% pa. The SJP return (which would have compared favorably) would have been 2.6%.

I suspect that most people are still thinking of getting a rate of return on their contributions to DC of 8% or so, but the reality is nothing like that. The grim reality of DC is that it delivers miserable returns after charges and that is because even if you deduct 1% pa from the return on a typical balanced fund since 2000, you are unlikely to get more than 3% on your money.

The best way to beat the bar is to pool resources, keep admin costs to a minimum, invest professionally with minimum transaction costs and only take from the fund what is needed to sustain the product. This is in essence how a CDC scheme adds value in the accumulation phase over individual DC plans.

For a full analysis of how CDC creates efficiencies over DB, I suggest that you go to this WTW landing page , download and read the two reports that WTW have put in the public domain. The landing page is here

The main gains on DB are created by not having to build in what is typically a 15% prudence margin in assumptions on distributions and to enjoy exposure to growth assets on a much higher proportion of the fund. This is mistakenly considered taking on greater risk. It is no such thing, it is taking advantage of the risk premium that can be enjoyed by open pension schemes that are not guaranteeing pay-outs.

CDC has structural advantages in terms of outcomes over both DB and DC and this is the basis of Simon Eagle’s claim that CDC will give you 57% more than the guaranteed income of an annuity or the safe drawdown rate.

No doubt this will enrage the bearded one and his acolytes but the attractions of CDC are clear and should be shouted about. Well done Simon Eagle for shouting about them.

Postscript – a word about modelling

Actuaries like modelling and a number of CDC modelling exercises have been carried out. Here is the work of Aon published in 2015 which is in the public domain.

More recently, WTW have provided us with the results of their 2020 modelling

Collective Defined Contribution pensions would on average be 70% higher than traditional DC and 40% higher than typical DB,’ Willis Towers Watson

The reality is that both DC and DB pension schemes are poor at distributing wages in retirement in terms of value for the money spent on them. CDC is not some wonder kid, it is simply doing the job that DB and DC pensions aren’t. The bar isn’t set that high.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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5 Responses to CDC works because DC and DB pensions don’t.

  1. Peter Tompkins says:

    Well your comments box will be full today.

    You say that “to enjoy exposure to growth assets on a much higher proportion of the fund” … “is mistakenly considered taking on greater risk. It is no such thing, it is taking advantage of the risk premium that can be enjoyed by open pension schemes that are not guaranteeing pay-outs.”

    I’m sorry but there are no free lunches. If you go into a market and buy something with higher expected return it will have higher risk. If it were not so the market would arbitrage the difference away.

    Of course it is difficult to estimate the values of these two and extra reward looks different from extra risk. But you can’t get something for nowt.

    CDC is going to bring back the spectacle we had in with profits. That circle was only squared by the tontine effect where loyal long term savers got a higher capital bonus than the traitors who lapsed their policies.

    For an impending pensioner just go for a low cost self-managed SIPP with income drawdown and control your costs further by using ETFs and the like. It’s the unnecessary admin charges which damage DC. And of course your withdrawal rate is as much to do with whether you want anything left in the kitty when you pass away as it is with not running out of money.

  2. henry tapper says:

    The chart supplied by First Actuarial shows how collective pension schemes when allowed to stay open provide value by enabling exposure to riskier assets where the risk provides return over time. In the short term, those risks can create real losses when assets have to be sold but if the assets can be held over time – value is created. DB doesn’t work anymore because the Long Term Outcome (the payment of pensions) has been exchanged for a glide path to buy-out. DC pensions are proving themselves bad at managing the spending of pots on a wage for life. CDC doesn’t have to be that great to be greatly better than what we have today.

  3. ConKeating says:

    CDC is indeed a form of DC. Like DC scheme members will be able to ascertain their equitable interest in the scheme at any point in time – for individual DC that is just the current value of their pot. This eliminates any possibility of disagreement or disappointment over the distribution of the scheme assets.

    Andy Young is correct is saying that the pot is basically DC and one starting point for modelling may be this. However, the risk-pooling and risk-sharing among members of CDC greatly moderate the variability seen in individual DC for CDC members – and that on purely technical grounds raises compound multi-year returns.

    John Ralfe’s risk-adjustment objection is a nonsense. The returns quoted for DC above are risk-experienced – and this is what matters – it is what happened. I have modelled a range of possible CDC designs using historic data – the outcomes of which would also be risk experienced – and I find similar orders of magnitude of gain to those reported by WTW and Aon.

  4. henry tapper says:

    As regards your DC solution, I wish that people would do just what you recommend, but they don’t! They pay huge amounts to wealth managers and run out of money because they don’t get the growth they planned for. There are 700,000 people reaching 55 a year and most of them haven’t got a clue about being smart with the management of their drawdown.

    • Eugen N says:

      I agree that many people do not have a clue. For the minority who pay a wealth manager, for some the cost of wealth management is not justified given the outcome. For others, it is.

      I am not certain that a CDC scheme will manage to harvest the whole market return, a problem that I saw with with-profits in the past.

      Risky assets are just risky. You take the risk first and the payout is variable. As a result, there are luckier generations, and not so luckier generations. This is not going to change. Only a DB scheme could change this with the support of the employer.

      CDC is mainly a DC scheme which has low charges and which will try in retirement to pool life expectancies. As a result the outcomes could be 10% to 15% more compared with a similar DC scheme (investment return + charges). Obviously when comparing with higher charges, the outcomes could increase to 30% to 40%.

      As a wealth manager, I am glad to have competition, this makes us better. It allows us to differentiate, to focus on our high net worth clientele with wider needs than retirement, and to offer market beating returns.

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