Warning This is not an expert article, it is a blog written by someone who lies awake at night thinking how pensions can be made better. I don’t have the answers and I don’t necessarily have the right questions so if you read this, please feel free to explain where I’m wrong. Thank you
Whatever happens to CDC , happens in the future, it is a new product. What has happened in the past – to DC and DB pensions, informs the future but is only partially relevant,
We must start with a conviction that there is a “rate of return” that is achievable over time – around which the pricing of CDC is made, This “rate of return” is what is deliverable from people’s investments and is the fundamental driver of what a CDC pays by way of income.
I take as my inspiration in thinking of this , Con Keating’s idea of a “contractual accrual rate” or CAR, this is the expected rate of return on all an arrangement’s assets to keep the promises in payment in kilter with the means to pay them. In a pension scheme there is a sponsor who can top up if the CAR is consistently not achieved, there is no sponsor for the kind of CDC we have been discussing. All that a scheme can rely on is the voluntary decisions of savers to transfer money into such an arrangement. If people stop joining and investing, then the CDC is dependent on its investments and if the investments can’t keep in kilter with its promises, the promises will have to be cut.
So the CAR is really important. Set it too high and confidence in a CDC is lost and people don’t join it. Set it too low, and people will prefer other pathways – annuity or drawdown and CDC will get into trouble another way.
And CDC will always be vulnerable to competition. When gilt rates soar, annuities will prove popular, when equity and bonds soar – (as still happens”), then the CDC income may be scoffed at. When everything goes down, people will wish they were in cash.
People must have confidence that the CDC income they get promised upfront is achievable over time, even if it might not be achieved every year. I wrote yesterday that a CDC has levers to smooth matters if it has the confidence to manage itself around future contributions. To do that, it will need to have a business plan that satisfies regulators, advisers and the providers who manage the DC assets in various schemes. And finally, and most crucially, it must have the confidence of those whose money is at risk if a CDC goes wrong.
Because a CDC does not have an employer to call on (as defined benefit pensions do) and it doesn’t have a backstop of an insurance company guarantee (as an investment annuity does). It only has the constituency of those who invest in it, it really is a people’s pension.
How high should the CDC rate be?
I am being provocative asking this question as I think it the wrong question. The CAR shouldn’t be set at a rate that makes CDC attractive but at the rate those who are running the CDC believe is achievable over time. If the pricing of CDC – e.g. the lifetime income offered per pound invested is insufficient to encourage mass take up, then the CDC has no future and indeed will fail to start. We have seen many start-ups fail for lack of initial momentum.
But if the CAR is set above the expectations of those who are running the scheme , then it is no more than a marketing ploy and a lie, the lie that sunk with-profits. You may attract funds but you won’t continue to do so if you cannot meet your promises and quite rightly a CDC that can’t meet its over-inflated promise, should be put under new management. In practice, the regulation of CDCs involves an assessment of business plans, this is what the master trust assurance framework boils down to. That assessment is appropriate for CDCs as Superfunds and whether it is carried out by TPR or FCA (or both) it will need to be done with rigour. We are actually very good at rigour (ask Edi Truell).
Once you have a CAR and a business plan that makes sense, then you can start thinking about how much flexibility a scheme can offer. What I have been hearing from those I listen to in Canada and Australia is that you are not going to offer much comfort to savers beyond a better managed drawdown
For instance, the Canadian model for this “Dynamic Pension Pools“, offers very little smoothing of income and is principally selling long term investment return and longevity protection – it looks like a product for people who don’t rely on their pension pot and are happy to take their chances from year to year. John Ralfe has criticised this as being a massive waste of time and money but it seems to be getting traction not just in Canada but in Australia with Q-Super and others beginning to offer self-annuitizing funds.
Nor is there much demand , it seems, for the pension rate offered to investors to be complicated by underwriting. It seems that overseas models don’t pay you more or less depending on your state of health or lifestyle. Critics will point to CDC as unsophisticated and look at underwritten annuities for better value. Whether to offer underwriting, second life pensions and indeed any future promise of income, are all business plan decisions.
Again there is a trade off between maximising individual incomes against the demand for a mass-market product that could act as a default and from which the more sophisticated could choose to opt-out.
Next steps for CDC
The time has come for those who have the capacity to model solutions (the actuaries and fund managers) to meet with those who market them (the commercial master trusts, SIPPs and the insurers who run GPPS and non-workplace legacy). As I have said before, there is no point in making a thousand products for a thousand schemes, one product needs to be pluggable into multiple schemes and capable of taking the bulk of at retirement pots by default. Without scale this will not work and there is no big pot of money to seed a CDC, a CDC is going to need co-operation, it is also going to need public acceptance and it’s going to need Government endorsement (more than regulatory approval). I am struck by Bonnie’s six point plan to get things going. These are good next steps for the Jo Gibson and the DWP’s retirement income group to consider.
In the states, some have proposed a government (taxpayer) backed guarantee.
Fifteen years ago, Professor Theresa Ghilarducci, proposed “a rescue plan” for Americans, including a new type of personal retirement savings account called a Guaranteed Retirement Account (GRA). The GRA would use the funds of the federal employees Thrift Savings Plan – while funds are pooled and professionally managed, workers would be able to track the dollar value of their accumulations, as with 401k and IRAs today. Unlike today’s individual retirement accounts, workers would not be responsible for investment decisions. Regardless of actual investment results, participants would have a guarantee of no less than a fixed 3% real rate of return – guaranteed by the federal government (taxpayers). If the trustees determine that actual investment returns have been consistently higher than 3% over a number of years, the surplus will be distributed to participants.
Updated for 2022, maybe this “guarantee” concept borrows from other American investments, such as a Fixed Indexed Annuity, a “Buffer” Exchange Traded Fund, Guaranteed Minimum Accumulation Benefit, or Guaranteed Minimum Withdrawal Benefit – where the “floor” or “guarantee” isn’t from an insurance company, but taxpayers. Of course, a 3% real rate of return guarantee given 2022 market performance …
Fifteen years ago, I criticized this GRA concept because it shifts risk from older Americans to younger generations – that’s inappropriate, at least in America, because seniors (age 65+) already have the lowest rates of poverty (when compared to working age folks or children under age 18). In fact, since the 1950’s, official poverty rates for those age 65+ in America have declined from 30+% to < 10%.
Remember, in America, poverty is measured by income, not by accumulated wealth.