We aren’t all Thatcher’s children
Ros Altmann has put a resolute defense of the status quo as a comment to my recent blog “barriers to CDC”.
Nobody would accuse Ros of lobbying for the vested interests of the pension industry, nor of a lack of emotional intelligence into the way people think, I simply think that on collective DC pensions she has a blind spot.
Here is her comment, which I thank her for.
Could I suggest there are at least three other very big barriers to the sustainability of collective pensions, which mean they may be more like DC with added risks, rather than akin to DB.
In particular:
1. Pension Freedoms (which allow people to transfer out and potentially select against the remaining scheme members by taking a value that could be inflated in the short-term – either because markets have done very well, or because they know they are in poor health, or they are just fortunate in their timing and prefer to pass on an individual fund to next generation without needing much pension income
2. Inter-generational risks, where the young may find the fund does not look after them in the distant future – this extrapolates from the problems of DB sustainability, with schemes looking well-funded in the early years, as few pensions are being paid out, while plenty of contributions are coming in, however over a series of market cycles those who have already taken money out or received early pensions may have received more than was sustainable in the long-run
3. Lack of inflation protection – DB became so expensive and ultimately unsustainable partly due to the requirement to add inflation protection. Especially after QE and the ultra low negative yields on inflation-linked gilts, there are concerns that this could result in large problems for those who lock into fixed incomes for 20, 30 or more years. That was part of a problem with the old mandatory annuity rules, where people looked for ‘best rate’ without realising the product itself might not be suitable for their long-term future
I do worry about the long run here, even if there are short term attractions to pooling. It seems to me that much of the benefit of CDC, relative to DC, is more about economies of scale which can lower costs and improve investment performance in theory, rather than hugely improved pensions being sustainable for many decades.
The individual flexibility and adaptation to individual health circumstances is important as people get older, but are not yet factored into CDC as proposed. There are not even any risk margins foreseen which could avoid some of the selection bias for those transferring out.
Of course, others will disagree, but just thought it might be helpful to air some concerns at this stage
All best wishes
Ros
Why I disagree
- Freedom for those who want it. In a further comment, Bob Compton makes an interesting suggestion ““as I understand CDC as promoted by Con and others a truly effective CDC scheme would only ever an individual member pensions or transfers out based on their individual share at any given point. I appreciate however CDC schemes would be available with different structures, where Ros’s concerns would be real.
The future for CDC has to be Master trust based with the creation of CDC sections in those Master Trusts that will dominate the DC AE world over the next 10 years as the AE market evolves and matures. Stephen Timms committee I hope will see this is the way forward for all AE members to have a new choice to be able to have at least a part of the later years income to be as dependable as their state pension, with drawdown for any balance being the raining days pot”.
- Intergenerational issues; I remember going to a lecture given by Bryn Davies, who also comments on this blog. Bryn talked about intergenerational solidarity and of how pensions could be supported on an unfunded basis by a covenant to pay tax and see taxes paying pensions. CDC is not unfunded (though you could say that Serps and S2P were unfunded CDC schemes to an extent). Younger people have , since the war, had an expectation of having more than their parents and for the first generation in a while, the millenials don’t feel that way. Whether it be the climate or the economy, job or pension prospects, there is a lot of fear among the young that they are being shafted by the boomers. I get there frustration, but I don’t think it does society or pensions any good to pander to it. The alternative to CDC looks a whole lot worse than the intergenerational solidarity that CDC plays to. While there is a risk of one generation taking the money and leaving the next to pay for nothing, this risk is inherent in any long-term plan and can only be mitigated by dumbing down – which is what the current mania for de-risking does.
3. Lack of inflation protection Few but actuaries understand the value and the cost of inflation protection within DB pensions. I can be as much as one third of the total funding cost for a DB scheme. So when CDC actuaries like Kevin Wesbroom explain that CDC can manage all but the most severed market downturns through fiddling with the rate of indexation, they’re playing with a pretty big dial. The difference between getting the indexation and not isn’t felt in the early years of payment but towards the end when the compounding effect of increases is most obvious.
Critics of CDC for paying too little up front and too much pension when people are too infirm to spend it, may argue that indexation is a bad thing. What is clear to me is that indexation acts like a weir on a river, regulating the flow of returns through sluices turned on and off by people who do the maths. Defined Benefits lost the ability to control the flows when indexation became mandatory, annuities have generally been bought without indexation.
If CDC schemes wanted to offer optionality, they could offer differing levels of indexation to members as a choice at outset. But are people wanting to make such choices? Ros is right to say that CDC is not the “gold plated” benefit of a fully inflation protected DB scheme but that is very much the point, if CDC offered this guarantee, no one could afford it.
Final thought- CDC is not one of Thatcher’s children
The opt-out of CDC is vital. No-one should be required to stay in a CDC and I do believe that CDCs in payment should have a transfer value. Ros is worried that CETVs in payment would risk those with reduced life expectancy diminishing the pool’s longevity pooling and I’m sure that some people would transfer out on medical reasons with a hope of boosting their income or leaving more for the kids. But this is assuming a pension savviness of which I see little evidence today. All the evidence is that those who would most benefit from pooling of longevity risk, shun the pool. Rich healthy people prefer drawdown increasing the pension prospects for those with smaller entitlements (who statistically live shorter). The assumption that people behave rationally is not born out by people’s behaviour.
Actually the unions , as Bryn points out, have much to say about CDC because it is a unionized product. Here is Bryn commenting on the blog
You miss the biggest barrier, which is convincing employers that there’s something in it for them in the absence of effective trade union pressure.
But Bryn misses Bob’s point. it is not the employer who needs convincing, it’s the funder of the commercial master trust. Unions can and should be turning their attention to lobbying the schemes that are increasingly the guardians of our pension benefits and many of them are mutuals (Evolve, Nest and People’s Pension). The principles of mutuality on which both unions and collective pensions were founded, have never been so important.
Ros’ blind spot is that she doesn’t get mutuality, she is Thatcher’s child and that is her great strength but also (when it comes to this issue) her weakness.
Margaret Thatcher and her children