This blog is my take on a presentation by Catherine Donnelly which was delivered to a webinar , the IFOA generally allowed me to attend. Catherine is a Professor of Actuarial Maths at Herriot Watt University. I found her presentation grounded. It answered many questions and was a fusion of two good things, academic rigour and common sense.
Since publishing, Catherine has sent me the youtube of her talk – it’s a credit to the IFOA that they are putting this in the public domain – thanks
The main question this blog asks, which is the question I asked to the webinar, is
“what is stopping a pooled annuity fund being set up with a pension trust or indeed by any commercial pension provider looking to provide a variable annuity product”
So let’s follow the logic of Catherine’s presentation through ideas she presented
There’s a lot of money in the system and while it’s easy to get money in, it’s not so easy to get the money back again – at least not as a “pension”.
What Catherine is proposing, is what I spent an hour with the DWP on Tuesday- proposing.
We need something to meet the demand of people promised a pension from their workplace pension which is neither annuity or drawdown, but something in the middle.
that is precisely it – that is on the money Catherine Donnelly!
And all that is needed, for accounting purposes is a ledger recording money in (contributions), investment returns and longevity credits which are created when someone in the pool passes away. This looks remarkably like what you account for when running any pension arrangement that pools mortality.
I’ve included the badge of the IFOA here, as this slide is a little beyond my maths, but what’s here has been around for getting on a decade and represents the formula you’d use to make sure that everyone benefited equally from someone dying.
And this seems to me the most sensible way yet presented to show that there need be no intergenerational unfairness so long as we have people coming to retirement who need a pension and people ending retirement by dying.
But back to Catherine’s presentation.
Above is a simple model which we can all follow.
This is how an actuary sees the model stochastically
And people make their £100 work in different ways according to different investment experiences.
and this is why such a fund does not work for a single cohort, any more than it works for a single person.
This collective approach is a tontine and is clearly not what is needed. Distribution of returns is crazy! Catherine only talked of tontines when prompted to do in questions, she is right, it is a toxic word. A tontine is not legal under current law and so long as tontines are considered possible within a pooled annuity fund, I sense people will doubt their legality. This issue needs clearing up.
And just because you’ve got more people in your cohort, doesn’t make things a whole lot better. I was quite surprised by how little better increasing scheme numbers made things – suggesting smaller pools may be viable.
But what really makes a difference is keeping the pool open. You need is a cohort a year , from an open fund (think Nest or similar with tens of thousands of new entrants each year).
Look at the distribution of potential outcomes now, compared to what we saw with the single cohort.
And where you get both regular cohorts and larger numbers in each cohort things get better again.
Catherine’s presentation so far had addressed the question of whether an open fund improves the certainty of outcomes. I think it did so. There are further questions…
Catherine has proved to herself that an open fund improves the pooling of annuity risk, but does the distribution of income vary from one cohort to another?
The answer is yes, if cohort 31 is the last cohort – because it has no cohort 32 and others coming belong behind. This is the big screw up for DB schemes and if we think we can make CDC work by saying, “we can wrap this thing up anytime“, we lie!
What Royal Mail appear to have said to themselves (and perhaps tPR) is “let’s hedge our bets”. They will reduce the allocation to equities in the fund, as people move towards extreme old age , meaning that were the fund to close , the fund would eventually become a bond only fund (ripe for buy-out). So the fund has self-sufficiency written into it. Maybe the operation will be a success only for the patient to die.
This obsession with scheme closure is one of the reasons I’m so against TPR’s CDC code – it assumes happy endings for CDC through extinction. Instead it should look to find ways to keep itself relevant! Just as we need to work, we need to retire, there is no scenario I can see where there will be no need for something akin to the pooled annuity fund. There will always be another cohort!
Moving on ….
I think we must accept that a closed pooled annuity fund creates undesirable dispersion of income to those in later cohorts entering the fund. But how much can income fall within the lifetime of being invested in such a fund.
This brutal slide tells me that Catherine’s fund – or indeed CDC, will fail – if it is considered as close ended – ever!
Actually, though there may be times when the initial promise (in this case a variable annuity rate of 6.37%) will be breached, the model suggests it won’t get breached by much.
This of course is just looking at the impact of variations in mortality, it doesn’t look at variations in the returns on investment.
But Catherine’s analysis suggests that people’s expectations of likely changes in income as time goes by can be managed.
Yes – there will be variability of income in this approach, but the variability reduces with numbers within the cohort and expectations can be managed by getting people to buy into different levels of variability.
In short, the trade off is around the variable annuity rate and people’s desire for certainty. This is one that I think most people could understand.
But this assume an invariable in investment returns, I think we need to look further into how this can be achieved.
I haven’t got Catherine’s ordered mind, her patience or her analytical skill. But I have got onto her wavelength in agreeing her four questions are the ones that matter
These are the key questions anyone would need to ask if setting up a pooled annuity fund.
If you can find satisfactory answers to these questions and can convince yourself and others that your fund is truly open (e.g. has no reason to close), then I see such a fund improving member outcomes.
Catherine’s four questions are the ones that we need to focus on. I suspect that we are closer to running such a fund , than we suppose. Which is what I discussed with the DWP.
My initial question remains unanswered; ” can we run a pooled annuity fund within current regulations?”. I hope we can.
There is much merit to this concept, but why struggle to try and shoehorn your glass slipper onto the current rules and regulations? My understanding is that DWP are keen to find two or three models of CDC that secure widespread industry support and to pass new regulations so that they are clearly allowed, and give consumers both confidence and protection. This is a form of CDC and should be included in that debate.
My pushback on the DWP is
1. That there is nothing much here to regulate, if you are prepared to accept it sits within the Master Trust Assurance Framework
2. That if they collar this as CDC , it will have to wait till stage 3 of the CDC roll-out , which will be too late for lots of people who need innovation now – not in 3-5 years time!
3. The legislative and regulatory timetable for the DWP is already clogged up with all kinds of things – it would be kinder to civil servants, to avoid a further burden.
So can we have these funds today – without having to pay £77k to apply for each pooled annuity fund and without having to set each up with the rest of the CDC Code’s paraphernalia?
I would say we could, though whether they could pass permitted links guidance and sit on insured platforms is another question.
Adrian, the TPR’s CDC Code risks strangling CDC at birth. I would rather put my trust in the FCA’s permitted links than in a hope that master and single employer trusts will offer me something in years to come. Much as I liked what was said at the Dunstan Thomas event yesterday, there was a worrying lack of urgency about delivery that smacked of other projects (dashboard, DB code, GMP equalisation, McCloud etc.) There are 700,000 consumers accessing pension pots each year, they make for a very long queue!
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Hmmm. “How many people are needed to join every year?” This begs the question as what happens if they are needed but don’t join?
Such problems don’t apply when the pooled annuity fund is structured as a closed Tontine Trust.
Catherine admits she doesn’t know the full history of Tontines, perhaps Henry you could share a link to the following which has a number of historical papers explaining why tontines were always so successful: https://tontine.com/research
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