DC’s de-risked DB? – that is the question

The argument that defined contribution pension schemes were just like defined benefit pension schemes grew out of the reluctance of corporates around the developed world to fund promises with a blank cheque book.

I agree with capped and pre-determined pension funding, one of the reasons I consider CDC a more sustainable way to provide pensions than employers picking up the balance of costs for defined benefits.

But I don’t agree with the way our pension system is presenting DC pensions as a DB replacement and that goes for everything from Statutory Money Purchase Illustrations, through lifestyle to the way we explain a DC scheme’s value for money. Everything is designed to make a DC scheme look like a DB plan – which it isn’t.

Listening to a Morningstar podcast featuring Jeffrey Brown yesterday, I was struck by one statement “we never designed 401k as anything other than a DB top-up”.  That resonates with me. I started work in a world where  money purchase AVCs could be exchanged for more pension purchased at set conversion rates. That pension had built in indexation and spouse’s benefits. Quite literally, your “money purchased” pension.

When companies woke up to the fact that their trustees were actually acting like insurance companies and taking on all kinds of unwanted risks, they put a stop to that. AVC top up schemes had to be exchanged for an insurance company annuity or (for benevolent schemes) be used to fund tax free cash. When people started purchasing annuities they started getting choices about how their annuity was paid and the vast majority of people chose to have an annuity that paid as much up front as possible and had minimal (eg no) indexation.

When Royal Mail sorted the design for their collective (CDC) pension, they chose to provide members with CPI+1 indexation on the pension payments. This may have been to give the actuaries wriggle room to downgrade indexation in bad years (rather than cut the nominal pension), but it is more likely because people in pensions think that a wage for life needs to increase year on year to meet member’s needs.

But in retirement member needs don’t increase year on year, Covid has taught us that as our capacity to get out and about decreases, we spend less. So it is in our old age. The Royal Mail CDC plan is a reversion to the received actuarial view of what a pension is, but I’m not sure that the popular view of what retirement saving is about, includes inflation protection of benefits. The popularity of pension increase exchange schemes suggests that many people want a different shape to their wage for life than the conventional actuarial model.

The link between what money purchased and the defined benefit was broken and this trend has continued. Now we have the freedom to use our pension savings as we like, hardly anyone uses them to buy a fully indexed pension with proper spouse benefits.

DC is not DB – so why the question?

But that is what a statutory money purchase illustration supposes we all do and that is because DC design is still aping the DB schemes DC replaced. The same goes for many lifestyle strategies which still target protection from the volatility of annuity rates. The same goes for value for member assessments that still consider value as the trustee’s view of  scheme management, rather than what the member gets.

One of my actuarial colleagues at First Actuarial was fond of the phrase “it’s only DC” which was ironic because he was in charge of the DC consultancy at the time. DC is – to actuaries – still a top up to DB and actuaries are right. In the world they live in , DC is the 15 minute discussion at the end of the trustee meeting after the 3 hours discussing the discount rate at the next valuation.

But the world is changing. The 10m people who are now saving as a result of auto-enrolment are unlikely ever to receive a penny of scheme pension – unless it comes from CDC.

These people do not expect  a guaranteed pension, let alone a pension that increases with inflation and pays out to their spouse or partner. They expect to have a sum of money coming to them in later life but beyond that they have no expectations of how that will pay for their later life. They vaguely trust their trustees to sort it out for them

Their expectations aren’t being met. That is because most occupational pension schemes make no provision for their DC benefits to be paid to them as a wage for life. They simply offer a transfer value at retirement to a personal pension or a transfer to someone’s bank account.

Amazingly, most DC trustees have no idea what their members do with their pension pot and yet they continue to issue SMPI statements that ape DB and run lifestyle plans that assume members buy annuities and produce value for member statements that sound like they are running a DB scheme.

Why?

I think it comes down to this. The people who run pensions, trustees, funders, sponsors and most of all fund managers, are still living in a world where the purchaser of the services is the risk-taker. Fund managers sell to trustees as if the trustees were managing the risk on behalf of the sponsors. But that is not what is going on, the risk is not the sponsor’s but the member’s. It’s the member who has the tough choices at retirement, the trustees just write the cheques and wave goodbye.

This triangulation between the service providers to the schemes, the fund and platform managers, the administrators and all the advisers simply mirrors the old world of DB. Members get chair statements that they never read and nothing at all about the success or failure of the various strategies entered into by their trustees and those delegated to take decisions on their behalf.

This afternoon I will be in a value for money conference with employers and trustees and fund and platform managers as if pension value for money was consistent across DB and DB.  We are still measuring DC

This is because the mindset is still about giving members a benefit and not about facilitating the use of that benefit. Jeffrey Brown’s podcast (which inspired this blog) is called Saving for Retirement ‘Only Half the Puzzle ,he suggests that the American workplace pension is only doing half the job of a DB plan because it does nothing for the member once he or she stops saving.

He is pointing to the truth. Workplace retirement savings plans, whether in Australia or the US or UK are still being promoted as pension plans when they clearly are not. In the UK the SMPIs and lifestyle strategies and the value for money statements are all aping DB which is not the truth.

It is time we came clean with those saving for their retirements. If we want to take on the responsibility of managing their money to and through retirement, which most commercial DC schemes do, then we are going to have to do rather better than we have till now. It’s time for some serious thinking within the great DC schemes in this country about just what they think they are.