Simon Eagle, Willis Tower’s Watson CDC ace, has published an article in Corporate Adviser that provides sceptics and enthusiasts for CDC with a way forward from the work that he has been doing for Royal Mail.
I urge you to read the article, it is thoughtful and clearly results from the experience of designing what actuaries call a “whole of life” solution for the posties.
But crucially, Simon’s thinking has turned from a model that builds up and delivers an entitled “wage for life” to one where the build up is in a standard workplace savings scheme and the wage in later age is bought, very much as you’d exchange your pot for an annuity. This is what actuaries call “decumulation only” CDC.
I’ve been saying for over a year now, that this cannot be done as a CDC scheme – because the idea of a pension scheme is based on it being organised around an employer and that’s what most of us, when we get to retirement , don’t have!
Simon and I agree that rather than setting up a CDC scheme, we need a CDC product, which operates independently of an employer and operates as a “pension fund” paying income out to us for as long as we need it (till death do us part).
Simon starts his argument by pointing out that the current options available to savers wanting to spend their pot (the investment pathways) default to drawdown and decisions that Simon reminds us we are “often ill-equipped to make”. This is perhaps a reference to the “flex and fix” proposals being put forward by LCP via Steve Webb.
Instead of a period in drawdown culminating in the purchase of an annuity in later life, Simon is proposing a “CDC decumulation product” – something that people could choose or could be the default option if you decided you wanted to start spending your pot. This is quite radical- it makes CDC something that is “plug and play” and could be offered on any pension platform – whether the money has built up in a SIPP , a master trust or a workplace personal pension.
A CDC decumulation product would allow the purchase of an income payable for retired life, at a variable rate. This would be similar to purchasing an insured annuity but with a crucial difference – there would be no guarantee, insured or otherwise, of the level of income.
This is where the “product” is radically different, it does not need insurance (though it might be administered by an insurance company”, it is a mutual fund where the man agers of the fund would would collectively share risk across members and over time, with the expectation of providing a higher income than could be provided by an annuity.
This expectation , Simon tells us, would be because the fund would invest more heavily in growth assets (because it would not be subject to the solvency rules established for annuities) and because it would be much cheaper to run than an investment strategy depending on manual interventions for each saver (and advice).
And the key thing about this approach is that those who die early, subsidise those who live long, everyone is incentivised to live happily for longer through what actuaries call “longevity pooling”. If you don’t know what I mean, you have never known the exhilaration of getting fit at 60!
Willis Towers Watson are not shy about the scale of what they mean by “higher income”
“We’ve estimated before that this greater investment freedom could lead to 50% higher expected retirement income”
Simon rightly points out that where individuals are investing their own savings, they deserve options on how and to who the investments are paid. He suggests that an income rate can be agreed based on individual circumstances with the income being planned to be paid to a spouse or partner if the CDC holder dies with one. Likewise, people could choose whether to buy into a CDC that plans to pay an increasing income or a level one (multiple sections of one CDC can be created).
These options relate to the benefits , not the investment, the fundamental advantages brought by investment and longevity pooling are not lost by people exercising different options.
One bum note – de-risking!
Simon, who I hope to see next month is 95% right but the 5% where I think he’s wrong – can be put right with some de-actuarisation! De-actuarisation is the process of replacing actuarial instincts with common sense and it is something that I am quite good at.
Simon’s actuarial background assumes that this CDC product has “trustees”. This is a legacy of his sitting in WTW offices for too long, you should get out more Simon, trustees are useless for those of us with pots, this CDC product doesn’t need trustees, it needs a management board as any fund has, and the fund should be properly regulated by the FCA and not by the Pensions Regulator. The risks – operational and funding – are risks that the FCA and its big brother the PRA know all about. This may not be an insured product, but it is an investment pathway and should be subject to the Consumer Duty.
Simon’s actuarial background assumes that this CDC product needs “de-risking”. As we have learned this year , de-risking in the traditional sense, means loading up with gilts and corporate bonds and selling equities and other growth assets. This isn’t de-risking, it’s just shifting risk around and it doesn’t make for better outcomes (just because it says “de-risking).
What WTW did with Royal Mail was to establish the asset allocation of the Royal Mail’s CDC fund based on how close each member was to their anticipated death. This means that the scheme will have more “low-risk” assets if the collective membership get older and less if there are more youngsters joining than old members hanging around. This is an actuarially precise way to run a pension scheme but it errs too much on the side of caution. The actuary is always asking “what would I have to do if I had to wind this scheme up tomorrow” and this method is all about convincing him or herself that the scheme could be shut down in an orderly way. This is what is wrong with the TPR’s CDC code and it’s all about fear that the sponsor of a CDC scheme might go bust – meaning that the scheme would get no new members, no new contributions and would need to be unwound.
But we do not have to set out with failure in mind as this chart shows. The sweet spot of a CDC product remains so long as new people join the fund and old people die.
Things only go wrong when a CDC scheme or CDC product closes and there is no reason that this should happen , people keep on having a need for an income that lasts as long as they do.
So all this de-risking is actually spurious actuarial nonsense deriving from an obsession with Defined Benefit mark to market valuations that assume that a scheme should always be “buy-out ready”. WTW has form on this, this is how they used to think about scheme specific DC defaults – it’s a systemic problem but one that can be fixed!
We need to deactuarialise Simon and his colleagues and simplify the investment strategy of the fund. The fund does not need to match liabilities as there are no guaranteed liabilities. It simply needs to be run in the best interests of all members with proper oversight.
More that unites than divides
Reading Simon’s article in Corporate Adviser , convinces me that WTW get it. They’ve got to deactuarialse a little more but they are well down the road to a common sense approach to CDC which bypasses all the rules and regulations that TPR has dreamt up for schemes and focuses on what really matter, improving the retirement outcomes of the millions of people who will never have access to a CDC scheme.
I have written yesterday that we now have a political situation which means we can move forward a lot more coherently with TPR and FCA working together, DWP and HMT working together – with CDC bridging the gap between DB and annuities on one side and drawdown and cash-out on the other.
Thanks Simon , thanks WTW! Let’s hope we can now move forwards – hot on the heels of a new ministerial team.