What do we mean by risk sharing?
My friend Con Keating has criticized me for advocating CDC as a scheme for pensioners only telling me that there is no risk-sharing between a 65 and 95 year old because they have a common problem. The 65 year old needs a pension as much as a 95 year old so all that a CDC pension is doing is averaging pain when increases or even nominal pensions are cut.
Con argues that for risk-sharing to happen, it needs to be between those with different problems. The problem of a pensioner is immediate, he or she feels a cut in their lifestyle from day one of a cut, while the saver has no pain from a drop in the purchasing power of his or her pot, till later- in most cases- much later.
Con says I am simply talking about risk-averaging, sharing the pain more evenly than happens with individual DC pots in drawdown. Con might say that squashing a problem does not change anything. I disagree.
Pure or hybrid?
I guess that a pure CDC scheme like Royal Mail’s could be described as whole of life and “pure”. A scheme which simply pays collective pensions is a mechanism to avoid annuitisation and the risks of drawdown but intellectually and philosophically less satisfying.
I would very much like to see pure CDC schemes developing along Royal Mail lines, but I would also like commercial DC schemes to consider the creation of pensioner only sections that attract pots and consolidate them into an “in-house pension”.
There are of course questions here of scale and solvency, how do you seed a CDC pensioners scheme so it is stable from day one? Does it need an anchor of money arriving from savers to create that stability? Can the default fund of scheme savers provide a reserve and what would be the price to Default savers, by way of lost returns in providing this protection. Would it infact create a whole of life CDC scheme by accident?
But these are challenges, not insuperable problems and the commercial imperative should mean that master trusts can rise to these challenges and work with regulators towards sustainable solutions.
A trouble averaged may be “good enough” for now.
One question that troubles me is whether most people care about having a pension pot or are simply interested in their income in retirement.
Nobody asks whether there is a money purchase underpin to the state pension, they trust the state to pay its dues according to the formula they’ve been presented (with personal state pension forecasts now easily accessible on-line).
But DC pension pots have become part of the business of saving and many would argue that an expectation of a CDC pension without the underpin of a DC pot, won’t be acceptable.
Con is not so sure, he thinks that an accrual of pension based around a Contractual Accrual Rate (CAR) is all that people need – the expectation is that the CAR is a guide and can be exceeded or not met depending on market conditions.
Certainly the pure approach makes it easier for a CDC fund to invest as patient capital (no need for online transfer values, unitization and detailed record keeping).
Would this lead to reduced engagement? I am really not sure how much engagement we have with the day to day value of our pension pots and whether having one does good or not.
But I am quite sure that the process of converting pot into a wage in retirement is not working at all. Bonkers drawdown rates of 8%+, people frightened of touching their pot for fear of money running out or restrictions on contributions, worries about known unknowns like the LTA and issues around conversion of pots to income streams when the pensioner is claiming pension or universal credit; all these things make the current system of investment pathways impossibly hard. All the noise suggests that people aren’t committing to investment pathways anymore than they are working UFPLS and the opportunities presented by pension freedoms.
In my view, the big immediate win is to offer people “in-house pensions” from pension consolidators – principally the master trusts. Once we have proved this can be done, moving to a whole of life CDC approach should be easier.
If those who run pension funds can be convinced that an accrual system can be managed without undue risk to the scheme or its sponsor and that Royal Mail’s approach can be replicated or improved within the big DC occupational schemes, then we may see more CDC whole of life schemes and that is something devoutly to be wished for.
The challenges of running a pensioner only CDC scheme are properly explained by Con’s arguments and if they can be avoided because there is appetite for CDC accrual, then I will be happy to back down.
The jury’s out
The pragmatist in me sees master trusts adopting CDC to attract and retain saver’s money to and through retirement.
The purist in me sees whole of life schemes taking over not just from DC but in time from what remains of DB accrual. If people’s experience of CDC is positive then all this can happen.
But bottom line, I don’t think that the individual DC ( IDC) workplace pension is broken as a saving vehicle and I do see investment pathways as inadequate for the needs of the mass market.
I am absolutely sure that CDC is the answer for mass market workplace pension provision and the only thing the jury should still be discussing is how best we get to that happy state.