What’s the point of ‘retail CDC’? You have to start by defining what problems you’re trying to solve. Do you mainly want to pool longevity risk or do you want to share real-return risks? If latter, but not between generations, it just needs better technical support for drawdown.
— Stuart Fowler (@fowlerdrew) April 29, 2022
The snag with Stuart Fowler’s argument is in the phrase “it just needs better technical support for drawdown“. A lot of people talk about educating British people to better manage their money and a lot of people want to encourage those same people to kick start their financial empowerment with a midlife MOT, a visit to Pension Wise , an engagement season with their pension statements , a chat down the pub…the list could go on.
The trouble is that much as those on the sell-side of the financial services industry want people to read the instruction manual and manage their journey, most people just want a consistent amount of money in their accounts.
Yesterday I got paid for April, my pay went down, like most people’s (I earn £30,000 pa). It hurts but I knew it was coming and I understand why it went down. I am still pleased to get my payslip and know that the money is in the bank. Of course , the pay you get from a pension is not subject to national insurance, that’s worth remembering.
A “retail CDC pension” is better marketed as a “wage for life paid by your pension pot“, that wage can be flexible enough to pay bonuses in good time but may require pay-cuts from time to time, both in inflationary and in real terms. It is a wage paid to you which is taxable but does not attract national insurance. It means you get paid – without going to work.
Getting paid, whether its from your employer, a private pension , the state pension or for other state benefits is something that stops happening when you stop working, the idea of saving for your retirement is that you save enough to stop working. Your savings take over from your pay.
There is a tremendous disillusionment with pensions when this doesn’t happen. Nobody tells you when you take out a pension plan that one day you are going to have to learn how to pay yourself a pension that lasts as long as you do.
As for “technical support”, what does that actually mean? If I employed Stuart as my IFA, and I wish I could afford to), then I would expect a cash flow plan that ensured my bills were paid and that my monthly income was paid to me as if it was pay. I would want to be able to award myself a bonus from time to time to pay for exceptional items and I’d expect there to be months or even years when I would have to tighten my belt (as I am doing now).
But doing all this and keeping an eye out on the distant horizon, on the rate of “depletion” of my capital reservoir, that would be something that I think would be beyond even Stuart, for no-one know when another person is going to die, or how long someone’s love one might survive him. Nor can we know the future impact of inflation and whether investments will mean that our pensionable pay keeps pace with the demands on our wallet – even Stuart.
Most people want to look forward to a wage in retirement that means they never have to go back to work!
So what’s the point of a (retail)CDC pension?
Well in one sense, it has Stuart inside. IT ensures that the investment of my money is given the best chance to capture market opportunities available. That’s not something I can do on my own. I can’t spread my money around the listed markets, get access to private markets and find my money into lucrative illiquid investments that pay me well and are productive in their own right. Nor can I make sure that my investments are environmentally sound, socially responsible and furthering good governance. In short I can’t do this myself but I can if my money is pooled in a fund with thousands, potentially millions of others. If I was in a billion pound fund, I would be more confident than if my fund was worth a few thousand pounds. And if the point of the fund I was invested in was to stick around for as long as there were new people retiring , then I would be happy for my money to be deemed “patient capital”, because I knew that the pool never needed to be depleted.
Investment pooling over an infinite horizon is part of the point of investing into a retail CDC fund, it makes for better returns than can be achieved by a fund with a finite horizon and today such a fund can be managed, because of relaxation of permitted link rules, with the same scope of investment as a grand DB plan or a sovereign wealth fund.
No restrictions on investment , no need to put money aside
By running a CDC fund with no time horizon (with the prospect of new people entering it as regularly as people start drawing the state pension, the time horizons of a CDC fund give it the opportunity to harvest the longest term returns – like laying good wine down for drinking in 30- 40 – 50 years to come.
But because the CDC pension is paid without the certainty of income always going up in a certain way (indeed with the possibility that it produces a pay cut from time to time, the fund is not having to adopt a cautious approach and the fund manager is not having to put aside capital to meet guarantees if the fund doesn’t). This makes the fund very cheap to run and means that a much higher income can be drawn from it than from an annuity. Typically experts predict that the pay from a CDC pension would be 30% higher than from an annuity. Most of this is down to better investment returns, some down to lower reserving.
The final “point” to CDC, is that it takes away the big worry for people in drawdown, that their pension income expires before they do. This worry is of course not a worry to the very wealthy for whom a private pension is just one of their sources of retirement income. It is a very real worry for people who have only their pension pot and a state pension. For these people, whose affairs normally don’t warrant the attention of Stuart or other advisers, the peace of mind that comes from having a “wage in retirement that lasts as long as they do” is of great value, it is another point of a retail CDC fund.
Finally, let’s look again at what Stuart is saying. His tweet is asking what CDC is doing. My answer to his questions is that it should be aiming to
- Better share “real-return risks” than can be done using an annuity or drawdown
- Pool longevity risk – as an annuity does, with all the sophistication of modern annuity underwriting
- Manage a consistent income for all in the pool through mechanistic or discretionary pooling mechanisms.
Stuart should point out that there is nothing new in what I am arguing for and point to funds such as Prufund as doing much of this already. This is true, there is little in retail CDC which is radically new. But this approach , reinvents what has been possible before for today’s market where the need for this approach is so much more urgent
- We now have around 650,000 people each year reaching the point when they can ask to get paid by their pot – who know longer do this by purchasing an annuity
- We now have 10m new savers due to auto-enrolment who will continue to want help turning pots into pensions well into the next century
- We have a static and possibly diminishing advisory workforce and a not very successful guidance service – none of which appear capable of providing mass market technical support for drawdown.
What is new is the market need for pensions not pots. What is also new is the relaxation of the permitted links regime, the Government’s desire for long-term investment in private markets and the reduction of the numbers for whom pensions are paid from defined benefit pension schemes.
Even the best IFAs can be blindsided by these larger demographic, fiscal and economic changes. But Stuart need not be worried, retail CDC does not pose a threat to his livelihood nor the livelihoods of other IFAs and financial advisors. There will always be a minority of the population who will prefer to pay for the technical support that an IFA can give and would prefer the flexibility and individual care that comes with it.
There is much to be said for collaboration. I hope that those working towards non advised solutions will recognise the value of advice and vice-versa.