The best thing about work

The concept of the “employer covenant” is different for member and trustee

The concept of collectivism in pensions is restricted to the workplace. The key instruments of collective pensions are payroll that collects contributions, the corporate treasury team that provides the corporate funding and the workforce that participates, albeit mostly passively. The strengths of collective pensions (they work) are their weaknesses (so long as the employer is in place).

CDC schemes can close if an employer decides to stop contributing, is forced to stop contributing or if the scheme is deemed unfit by the Pension Regulator. The scheme can be run on as a closed scheme or wound up and transferred to another CDC scheme, an occupational scheme or to individual SIPPs for drawdown or individual annuities.  In all these cases there will be a serious loss in the expectations of members but no more serious as were the member to leave employment.

In short, from a member’s point of view, a CDC scheme is as fragile as his or her view of their employment prospects. The employer covenant is not to the scheme, it is to the individual member. Trustees and their advisers tend to forget this, probably because they lack empathy with the fragility of most people’s confidence in their career prospects.

This may seem obvious but it becomes more important, the weaker the relationship between the member of staff and the employer. One of the factors that makes Royal Mail an incubator of CDC is the strong sense of identity between the staff and the employer. It may not always be a happy relationship, but it is a recognizable relationship and many postal workers consider no other employer relationship.

This is most definitely not the case with the majority of the population who find they can move through a number of employments doing what they do, their skillsets are rented to whoever can hire them, most of us are guns for hire.

The trustee/scheme covenant is what concerns members.

Since most of us are “guns for hire” and do not consider our current employer much more than the organization that pays for our skills, we prefer to have a fixed amount paid into our pension than be reliant on a defined benefit paid by our current employer in years to come. This is why pension transfers are so popular, this is why DB is so out of favor. If we valued DB pensions as much as the money pumped into them by sponsors, we would not have a transfer crisis.

Frankly we do not value the trustee/scheme covenant of a DB scheme because it is linked to an employer we don’t trust to pay us our wages in five years time, let alone a pension for the rest of our lives.

My worry about the CDC scheme covenant is that it is unlikely to be any more valuable than the DB covenant. Whoever said we wanted our employer paying us a pension anyway?

The employer covenant is a legacy issue – trustees and actuaries get over it.

People misunderstand the actuaries and trustee’s dilemma. They think that actuaries and trustees cling to the right to determine their member’s futures and find value

Reading a recent presentation by a firm of actuaries on their and trustee roles in CDC I discover that the Trustee’s CDC role is

• Similar to DB

  • make investment decisions
  • communicate with members
  • ensure good governance
    • but they don’t have to negotiate contributions with the sponsor

The actuaries CDC role is

• advise on assumptions

• certify viability including

  • actuarial tests of value

  • that the scheme meets the legal requirements

  • that member communications accurately represent estimates and projections

And there is a key point that the actuaries would like to make to trustees

It’s crucial to both roles to recognize that the decision made will affect member’s benefits – Aon

Actuaries and trustees can remain relevant in CDC in a way that they can’t in DC because they need to exercise discretion. This human element is asserted without a counter-factual.

But there are two counter-factuals.

Firstly, could you run a CDC scheme without actuaries and trustees?

I am quite sure that the rules established for all aspects of scheme management, including the loss of the employer, could be set down in smart contracts and assigned to a distributive ledger which would need no more oversight than the occasional test from a risk officer.

Secondly, could you run a CDC scheme without an employer?

What other source of funding might a CDC scheme have than the employer’s covenant to pay defined contributions through payroll?  Well speak to the shareholders of Pension Bee and you’ll find that it does not receive any contributions from employers, it is entirely funded from transfers into it from DC savings schemes, typically employer funded. Pension Bee is not a CDC scheme but it is conceivable it might be – if it chose to offer scheme pensions rather than investment pathways (or even as well as).

Pension Bee doesn’t have trustees or actuaries, but it seems to be providing good savings outcomes. Might it provide better retirement outcomes using technology rather than trustees and actuaries?  It is conceivable.

Actuaries, trustees  and employers are not essential  to after-workplace pensions – even to CDC!

The member’s voice

In the debate on CDC, the member is being used as a pawn. Those movers and shakers who inhabit the back row of the chess boards are the aforesaid pension professionals who have done minimal research on what savers actually want.

A “not so recent” Aon DC survey

“showed that around 60% of members want a retirement income for life from their DC savings”

This is about the same proportion who said they’d be prepared to be auto-enrolled into a workplace pension in DWP studies in 2010-12. In practice opt-out rates were less than 10%. It may well be that 90% + of savers who were offered a scheme pension as the default investment pathway, would not opt-out for pension freedom. That is speculative but has some evidence base, most people are consistently underwhelmed by pension choice!

The member’s voice is faintly heard until it is denied its expectation. When people find they are losing an entitlement , people can get noisy. Look at Waspi or to a lesser extent the noise around losing protected pension retirement ages.

We are coming to a point where people’s expectations of their workplace pensions will be tested. This comment is from Aviva’s Alistair McQueen

“A record nine million people will reach the age of the pension freedoms in the coming decade. That’s more in ten years than we’ve ever seen before, and probably more than we’ll ever see again. This is the retirement of the children of the post-war baby boom. This is the decade of the pension freedoms. Our industry will be tested, and will be rightly judged. In ten years’ time we must be judged to have passed our test.”

For me, the test will be against the PLSA’s Retirement Living Standards. How many of those nine million will be able to say they are retiring on even the minimum of those standards?

The member’s voice will be heard louder when those middle earners who historically have received the fruits of their employer’s covenant on defined benefit, no longer have the prospect of a retirement income to supplement their state pension.  What they saw happen for their parents, won’t happen for them. They will have a workplace “pension pot” but no “workplace pension”.

And crucially, when they come to the point where they need to replace their workplace income with a workplace pension, there will be no trustee to turn to , no actuary to turn to, no employer to turn to. Unless that is, they are in a CDC scheme.

We all need to move on

The employer covenant in providing pensions is shrinking and very fast. Other than in the public sector, there is massively reduced future accrual in DB and no alternative pension – only pension freedoms – for staff.

Employers will continue to fund and process contributions to DC savings for retirement but they will not be involved in paying pensions (other than in rare cases such as Royal Mail where special circumstances apply).

To fill this gap in provision, the Government expects to see commercial providers offer CDC schemes . To date , the assumption has been that these will be the commercial master trusts, mainly because they are “occupational pension schemes” and are typically run for employers by trustees and actuaries. This is the continuity plan being put in place.

But continuity plans assume that the old conditions apply. Many people think that they don’t and that we are now in a world where it is the member who has to take decisions on how they organise their pension, not the employer. The member takes those decisions without the help of trustees and actuaries.

For trustees and actuaries to remain relevant , they will need to have to justify their existence not just to employers (who may at  best signpost CDC), but to the savers in the workplace pensions, whose money is at risk.

These savers have currently little or no relationship with trustees and actuaries and have little regard for their employer’s covenant. They have been taught that in the brave new world of pension freedoms, they are in charge. But they have little capability to manage their pensions and they know it.

The task for pension professionals, whether working as employers, trustees or insurers , is to find a way to help the savers with a pot, but no workplace pension. CDC might do that, but it looks like happening outside the workplace!

The skills for managing the payment of pensions are increasingly with insurers who pay annuities to individuals and manage other investment pathways. They are responsible for the after work pensions of millions. Phoenix alone has 14m policies! I expect to see the large insurers who have traditionally helped ordinary people manage their affairs stepping up to the challenge of “after-workplace pensions” and offering trustees , actuaries and employers an alternative to the pension covenant that has persisted these past 7o years.