How do we create a CDC the general public can trust?

CDC needs clearly valued property rights for it to be trusted

Too much of the debate on CDC has focussed on theoretical constructs where the scheme looks and feels like a replacement for an employer sponsored DC or DB scheme. These abstractions await another employer to sponsor like Royal Mail will do.

Meanwhile, there are others looking to how the principles of CDC can be applied at a individual’s  level. This is from Claire Altman on Linked in – she’s MD of individual retirement business at Phoenix

CDC is on the march – and a big question for those of us thinking about this beyond single employer CDC schemes is whether (and how) an element of benefit should be guaranteed, particularly so that in later life, there is a floor beyond which reductions can’t go. But if the benefits of CDC increase by reference to age, taking longevity out of returns has the effect of diluting the usefulness of CDC overall. Much to debate and explore…and looking forward to continuing the discussion.

Phoenix has responsibility for the payment of retirement benefits for millions of policyholders and members with DC pots. If CDC is on the march, it is because commercial organisations are waking up to it solving the difficult problems we have around not knowing how long we are going to live.

A Dutch friend wrote to me overnight having watched me struggle to articulate my frustration with the current CDC consultations

An aha moment (for many) in the Dutch debate was the insight that the Royal Mail type of CDC is a bundled package consisting of many components. The solution for CDC 2.0 is to unbundle longevity risks from financial market risks. With that insight it is possible to move ahead and design a good suite of products that are easy to explain. The main difference between drawdown and lifelong income products is the longevity pooling, the rest is more or less the same.

My Dutch friend goes on to say

With these principles in mind, we can easily construct a transparent and fair CDC 2.0 product meeting the design objectives of DB- CDC. This is not rocket science…and hopefully we can convince DWP that this is the way forward.

Unpacking CDC from its black box

CDC need not sit in a black-box. It can be unpacked and explained to ordinary people. CDC can be explained by giving people access to valuations of their rights within the scheme

This is more relevant and effective than projections based on abstract assumptions. It is better than scholarly charts trying to show the likelihood of future financial calamities and how the scheme will be resilient to them. That conversation can be had with the Regulators.

People want to know first up,  what they’re getting as a monthly payment right now and what they can expect in future years.

If we have to explain the role of the actuary, I’d use Derek Benstead’s aspiration “to be wrong 100% of the time, but to be fair to everyone over time”.  Where discretion is needed (in fixing the rate of future increases/decreases in pensions)  we shouldn’t claim actuarial infallibility – but we need to make a promise of utmost transparency.

Utmost transparency

And to prove that CDC isn’t a “black box”, there needs to be transparency on the value of giving up this pension. That means  giving people clear numbers on what they could transfer away from a CDC scheme and any entitlement they might still have to tax-free cash.

Where people cannot take the normal transfer value (e.g. when the scheme is needing to protect itself in bad times) , any value adjustment must be clearly stated and explained.

People will need to know how their CDC counts towards their lifetime allowance and whether part of their pension might be paid without a tax – through UFPLS.

What we don’t need are page after page of risk-warnings explaining how things can go wrong (and why the people issuing the warnings have no liability if they do). Instead we need clear information about how CDCs work and what impacts pay-outs (to use my friend’s word – we need CDC to be unbundled and stripped of its actuarial mystique.

How we create CDC for the general public

CDC is for me, the alternative to investment pathways that we have been waiting for (and sadly have a bit of waiting still to do).

I’ve been puzzling over this week’s consultation on the Pension Regulator’s Code of Practice for CDC (I made a right hash of blogging about it earlier in the week). It needs to be read in the light of the DWP’s consultation on CDC and the Master Trust Assurance Framework, a working knowledge of which is essential (something I didn’t have).

Creating member specific valuations of CDC property rights is vital – not least to calculate tax-free cash.

Both the DWP and TPR’s consultation’s  say nothing  about how CDC schemes will calculate tax-free cash entitlements. This is one of the reasons I agree with Guy Opperman that the consultations only look at part of what CDC will become

There are  two ways of calculating tax-free cash  this under current pension law.

DB schemes use a formula based on pension accrued and DC pensions use the value of the investments (the pot). But CDC pensions – as being legislated for, don’t produce a pot – the only property rights people have are outlined in a section on transfer values

When a member submits a transfer request to the trustees of the CMP (CDC) scheme, the trustees will have to provide the member with an estimate of the value of the member’s share of the collective assets at that point. As with the existing transfers process, scheme rules and regulations will set out how an individual’s share of the collective assets will be calculated, taking into account any valuation of scheme assets and any adjustments that have been made. This is to ensure that the calculation is fair and takes into account the interests of both the individual member and the remaining members in the scheme.

I don’t think that the DB valuation process (involving an application and typically a wait of a few weeks while a manual calculation is created) will wash with a generation of people who have only had DC pensions. The Scheme Rules need to generate on-line answers.

In  the world we live in , we submit a valuation request by swiping our phone, we get a valuation within seconds , we can see how our valuation was created by downloading a PDF (preferably on one page). If a CDC scheme can do this, it will gain trust.

 Royal Mail’s scheme is not applicable to the general public.

Royal Mail’s scheme sidesteps questions on tax-free cash. This is  because the employer guarantees this part of the scheme’s benefits. Royal Mail’s CDC scheme will have a separate scheme to build up tax free cash (a guaranteed cash balance plan). Presumably this will be integrated in some way into the CDC scheme.

But I don’t see any other employer wanting to follow that path (and I’m not even sure how the integration will work under law – answers on a postcard please).

Put another way, members of Royal Mail’s CDC do not have their own underlying pot.

This  means that for  other employers looking to submit applications for a CDC from August this year, there will have to be a new way of calculating tax free cash and transfer values.

Either this will be based on the promised pension (as DB schemes do) or it will have to be based on  a notional pension pot (a money purchase underpin)

My personal experience of transfer values and of the taking of tax-free cash from DB schemes gives me no confidence that they are a fair way of valuing the property rights of the member. CETVs are a total lottery and commutation factors are arbitrary, they do not inspire trust.

So I am in favor of general public CDC schemes providing valuations using the valuation method used by DC, they must have a notional pot which can be crystallised for the calculation of tax-free cash and the payment of transfer values.

For people to properly trust their CDC – they should their own notional pot

For CDC schemes to wash with the general public, they will need to produce  personalised information that tells members what they can transfer away and what  entitlement they have to to tax-free cash.

While this could be achieved using the apparatus of DB valuations (as Royal Mail will do) , I think that organisations like Phoenix and the commercial master trusts will adapt. Going back to my Dutch friend, he is optimistic that a DC style system of property rights can work

This is what Qsuper in Australia and Purpose in Canada have done in their designs. The good news is that it can be implemented in the existing infrastructure such as Master Trusts and other pension vehicles without massive up-front investments.

How a notional money-purchase underpin would work

People will want to see a statement of account showing how the money they have paid into the scheme has done, what has been deducted to it (by way of costs , charges and pension payments) and what has been added to it, by way of investment growth and credits where the scheme is doing better than expected.

For the calculation of tax-free cash payable from within the CDC scheme, there will needs be a formula agreed by the DWP and tPR and I suggest that it be based on 25% of the transfer value payable at the point when the valuation is taken.

For the tax-free cash to be trustworthy, the transfer value needs be trustworthy. It cannot be driven by high level actuarial abstractions about what future pension might be payable. Instead it must be based on the statement of account, showing money in, money out and growth on the invested portion. To use pension’s jargon – a “money purchase underpin”.

Money purchase underpins are not loved by purists who see them as requiring too much investment liquidity , too much individual record keeping and giving too little discretion to those managing the scheme.

But they do make sense to us punters. I remember explaining the “nominal value” of a with profits fund as the “amount you’d have got if we hadn’t done all this smoothing”,

Calculating claims like CETVs and tax-free cash with this adage in mind, makes more sense to me than an actuarial formulation based on subjectively devised discount rates.


Con Keating and I will be picking through the bones of this on Tuesday Feb 1st

you can join us on this link


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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