This is Con Keating’s second blog covering the consultation on TPR’s proposed Code of practice for CDC.
In the period since writing the first blog, I have managed to resolve one of the major uncertainties I expressed there concerning ‘lump sums’. Under the legislation, a CDC scheme must offer a pension, albeit one which may be adjusted to reflect the adequacy of the scheme funding. Briefly, a CDC scheme/section of a CDC scheme can only provide “qualifying benefits”, which must satisfy the following:
- include the payment of a pension,
- be subject to the book balancing rules,
- the book balancing rules are, in summary, uniform in their application to all members and
- the benefits are not excluded benefits as specified in the CDC Regulations.
Tax-free cash commutation is an element of a pension. Confirmation of this understanding can be found in the amendments made by the Finance Act 2021 to the Finance Act 2004 to cover CDC schemes, which very much envisage CDC schemes/sections providing tax free commutation lump sums just like DB pensions.
I have not as yet resolved my questions over the applicability of the charge cap to CDC schemes.
Several of my respondents during the Pension Playpen ‘Coffee Morning’ on CDC made the point that this proposed Code looked very much like the Master Trust authorisation Code and that the CALP (Costs, Assets, Liquidity Plan) feature appeared there first. As I had never had reason to read the Master Trust Code, I was unaware of this – but it does, no less than 37 times. Since that webinar I have been told that the team within TPR which produced the Master Trust Code did indeed produce the proposed CDC Code.
When discussing the CALP, the Master Trust Code states:
“The objective of master trust authorisation is to protect members’ benefits, and this is partly achieved by introducing a framework which gives the trusts the financial support needed to discharge benefits without cost to the members, even if support from a scheme funder has been removed.” [Emphasis added].
In other words, it envisages a funded reserve separate from and in addition to the assets held to meet pension obligations. However, with CDC no such distinction is possible. All of the assets ‘belong’ to scheme members and to set aside some part of those assets as a reserve is to impose a cost on scheme members, immediately.
Parsimony through re-use is in general to be encouraged as it enhances efficiency, but that requires a fundamental similarity of situation to be effective. An illustration may help here: the apparatus used to measure the alignment of car headlights in MOT tests can accommodate many different marques of car but would be useless if applied to the landing lights of light aircraft. With CDC there is only one class of claimant to the assets; the members of the scheme, while with Master Trusts there are two; the promoter and members. CDC and Master Trusts are therefore fundamentally different, and this difference is not trivial.
It is necessary for the full costs of the adverse events resulting from scheme failure to be provided for. Depending on the scheme size, and the specific type of event, these may be of the order of 1% – 5% of the gross value of fund assets. However, the risk is far lower than this; simulations indicate that the likelihood of these events occurring is less than 0.5% which means that the risk is between 0.005% and 0.025%. Such high consequence low probability events are natural candidates for insurance solutions, not internal provision through reserving, as this is an inefficient use of capital both at a micro and macro level.
From the standpoint of both equity and incentives, the costs of a scheme failure should be borne by the members of the scheme at the time of failure, not even in part by previous generations of member. This means that the pensioner member should see their pension based on the full gross value of scheme assets not some net of reserve provisions value.
With these reserves, the proposed Code actually imposes costs which exceed the inherent risks. Far too much of the Code is concerned with a very small fraction of possible outcomes – it needs fundamental revision. These costs fly in the face of the efforts made in recent times to lower the costs of pension provision, notably the charge cap.
There is a further bizarre element to the reserve provision concept – that the assets making up this reserve should be subject to ‘haircuts’, and we are treated to an elaborate table of these. It is reasonable and sound risk management practice to apply haircuts to the assets held to support liabilities to others. However, when we are considering liabilities to ourselves, it becomes nonsensical. In risk management parlance, this haircutting is a classic case of ‘pig on pork’.
The Code has much to say on member communication, though as noted earlier this is seen predominantly as an IT issue, it does state:
“where ad hoc feedback is received from members it must be considered and, where appropriate, acted on.”
It also requires the production of yet more reports
– “A report must be provided to members on how their feedback on communications has been taken into account.” [Emphasis added]
Why just communications is the obvious question? In addition:
“A report must be provided to the trustees on how feedback from members has been taken into account. This report should be provided quarterly.” [Emphasis added]
This is a report from trustees to trustees about the decisions, actions, and inactions that they have taken in the past three months. Quite how the expense of the compilation and publication of these reports could be justified is beyond me nor what their actual purpose is.
One of the lessons we might learn from the ongoing USS saga, where many members are completely exasperated with the trustee and confidence in and engagement with the scheme is now at rock bottom, is that trustee accountability to members needs to be clear, evident and enforceable. The ability of a member to ‘do’ something is a most important element of ongoing engagement. In the case of USS, the level of member disenfranchisement is clear, especially for most staff who are not in UCU.
Ordinarily, engagement may be achieved by member mutual arrangements where votes of the membership in general or extraordinary meetings may appoint or remove trustees or modify scheme rules. Unfortunately, this appears to run foul of the fit and proper persons requirements of section 11 of PSA 2021.
“The Pensions Regulator must assess whether each of the following is a fit and proper person to act in relation to a scheme in the capacity mentioned –
(c) a person who (alone or with others) has power to appoint or remove a trustee;
(d) a person who (alone or with others) has power to vary the provisions of the scheme”
Some guidance on interpretation of these requirements would have been helpful.
The prescriptive, formulaic approach to communications, along with the references to member engagement are indicative of confused thinking on the part of the Pensions Regulator. Member engagement is not an end objective in and of itself. The objective should be that members are justifiably confident in and relaxed about their pensions, and that aspirations should be achieved. In that situation, members may find no need at all to ‘engage’.
There is one simple measure, seemingly unknown to the Regulator, which will go far in achieving these ends. The scheme should publish the level of funding achieved to date relative to the promises originally made at time of award(s). To be able to assure members that “We are on track to meet the promises originally made.” Is far more powerful in building confidence than the viability-based statement that “We expect future investment returns to be high enough to meet our obligations”. When combined, they are even more powerful.
” With CDC there is only one class of claimant to the assets; the members of the scheme, while with Master Trusts there are two; the promoter and members”
I agree with regards Royal Mail, but with regards future CDC solutions? If a master trust extended its remit to include CDC – either whole of life or decumulation only, wouldn’t CDC simply be part of its existing CALP?
I can only think the DWP were looking way off into the distance to where member only schemes are set up with no sponsor (decumulation only mostly).TPR are petrified of non-recovery of fees for DC schemes that have gone wrong – where members are being hammered. But CDC looks a different order of scheme. So I think the CALP is disproportionate even there.
But the bigger point is that what is needed to provide collective decumulation for ordinary savers is not CDC as envisaged in the CDC code. It’s clear that most of what is needed can be done within the master trust assurance framework without the extra costs of applying for and maintaining what amounts to a CDC licence. the Code risks becoming a white elephant.
Certainly I agree that this Code looks likely to make both PSA 2021 and the Regulations obsolete – we would have Royal Mail and nothing else.
The concern with costs and fees of wind-up strikes me as completely unbalanced. If we introduce a simple rule that we will wind-up if the scheme assets fall below 110% of accumulated member contributions, we have left both the liquidation and shift to a DC scheme (new or pre-existing) open.
Were DWP looking ahead – I don’t think they were. It is not evident anywhere else other than the explicit ability to consider new forms beyond the single employer arrangement.
So sorry but I think that experience has taught many of us in the pensions industry that the best assumptions can prove wrong and, particularly with respect to long-term pension funding, well-intentioned reassurances of safety cannot be relied on by members over a many decade time horizon. It is, in my view, essential to have reserves set aside to meet possible costs of wind-up or scheme failure. for example, discovery of a major IT error that has left member records in disarray can cost huge sums to put right. Even if the risk is small, the cost could be enormous and, in the worst case scenario, could significantly reduce member resources for their future retirements.
And I believe that members who transfer out should take a ‘haircut’ on their transfer values, to bolster long-term scheme resources for other members who decide to stay and rely on the scheme for decades to come, when markets could collapse or other failures could impact them. Leaving a CDC scheme is rather like selecting against the remaining members, taking short-term resources away from a long-term liability stream. If members cash out after a strong market run, the probability of them causing detriment to future members is clear. In CDC, each member does not own their own ‘pot’, the money belongs to the scheme for distribution to others when they reach pension age. That seems to me to be fundamentally different from DC from a members’ perspective. It is indeed possible that members (especially younger members) may receive far less pension than they might see others receiving (of course there is also a chance they will receive more!) and that risk needs to be clearly explained to them. Risk warnings that there is no guaranteed pension and that their future income could be seriuosly damaged by a number of factors within a CDC scheme are really important. Otherwise, there will be a false sense of security created and I have seen the damage that caused in the DB space, when ‘minimum funding’ requirements were described as offering guaranteed full pensions, but ended up causing many members to lose their entire entitlement after the scheme collapsed. The design was only ever intended to provide a 50/50 chance of members receiving their full pensions, but that was never explained – and even after the first schemes began to fail, many in the pensions industry insisted this was a one-off aberration and would not be a widespread risk. Allowing people in those schemes, who knew the true risks of lower pensions, to transfer out with their full pensions protected, created far greater losses for remaining non-retired members. Building up surpluses in pension schemes seems to me to be a prudent risk management strategy, giving buffers against bad markets in future and other changes that have not yet been foreseen, including administrative failings that prove costly to remedy.
Sorry but I believe members need to be better protected than this blog would suggest.
I agree with Baroness Altman. Risk equals probability multiplied by severity. There may be a small probability, but the severity would be fine.
Reserves of 1% to 5% of funds should be constituted, most likely paid by the employer.
As a minimum the reserves should cover what a commercial enterprise would charge to take on the scheme, akin to the Risk Margin in Bulk Annuity business