Yesterday I was inspired by reading a great article by Eversheds’ partner, Michael Jones in which he called on government to recognise CDC as a retail product available to anyone with savings in a qualifying DC pot.
By shifting the mindset from scheme to fund , from TPR to FCA regulations and by considering the commercial application of the CDC concept to retail decision making, Jones and Eversheds are proposing the “break-out” of CDC from the constraints necessarily imposed on the regulation of large schemes such as Royal Mail. I did not read anything that suggests that the regulation of CDC in the retail space would be less rigorous, it could however be more suitable if the purchasing customer was considered the saver rather than a trustee.
The commercial advantage to master trusts of “to and through”
I wrote two further blogs talking about the application of a retail CDC fund to two mastertrusts at different stages of development. People’s Pension is a well developed master trust with 6 million members whose problem is finding a way to look after these members as pensioners. HSBC’s mastertrust has yet to build scale and is looking for a value proposition (beyond its wellbeing platform) to make it compelling to employers and their staff.
The commercial advantage of offering a CDC fund as a way of turning pot to pension is that so long as the assets stay within the trust, the funder has a right to participate in the fund management charges of the CDC fund. Provided that the fund can operate for all members of the trust, it could – if auto-enrolment was considered to extend beyond accumulation, be considered the default fund for those spending their savings. Indeed it could be integrated into existing lifestyle structures so that an accumulation fund fed the CDC fund on a “to and through” basis.
The aspects of CDC pensions that lend themselves to becoming defaults are
- That they offer a “done for you” solution to pension management – unlike drawdown
- They offer an income that lasts as long as the fund owner(s) need it
- They offer an income that is more affordable than through annuity purchase.
- They do not compel usage, other pathways are available
The commercial advantages of CDC to non-workplace pensions
While master trusts are generally considered as providing value for money to workplace savers, the same cannot be said for much of the legacy books of personal and stakeholder pensions sold through advisors and directly to the public roughly from 1970 to 2012 (broadly the start of unit-linking to the onset of the RDR). The cost of distribution, inefficiency of life companies and the use of clunky active management made many policies poor value – especially when abandoned early by savers whose circumstances changed.
SIPPs are generally advised on by firms such as SJP or run on a non-advised but highly supported basis (Hargreaves Lansdown, Pension Bee, AJ Bell). They tend to have higher charges than mastertrusts (see recent HSBC research)but they are attracting large amounts of money from savers who value their service and innovation.
For different reasons, legacy pensions and SIPPs have something to prove to their customers .
For legacy pensions, the opportunity of being maintained beyond retirement is currently held out through investment pathways, for which legacy is effectively a feeder. CDC is an opportunity for section 226 retirement annuities, personal and stakeholder pensions to convert and be maintained by the insurer (though not as an insured product). There are obvious red flags to this, many of these legacy plans have guarantees attaching to them – either of preferential annuities or other insured features, the majority of these plan are however unit-linked and since the abolition of penal exit penalties (for policyholders over 55) they can be transferred to a CDC pot with a maximum 1% exit charge.
For SIPPs , there is equally a limited opportunity. While advised SIPPs will continue to benefit from the sophisticated financial planning of advisers who manage tax, cash-flows and investment strategies, non-advised SIPPs split between those managed by SIPP-holders who are “hands-on” and those who aren’t. For those who want their pension managed for them – CDC as the pension pathway, could become a default. The FCA are currently consulting on requiring non-workplace pensions to offer defaults in accumulation, following the recommendation of Eversheds (above), they could extend defaults into “decumulation” on a “to and through” basis.
The commercial value of CDC to the pensions system
The current attrition of pension pots is immense. Here’s how its’ described by the author of HSBC Tomorrow’s paper “converting pots into incomes”
In total, UK citizens are losing around
£1.7bn a year during their transition
into retirement, according to data
from Hymans Robertson.
This loss can arise when members
withdraw amounts above the 25%
tax-free threshold, because they are
buying advised products that might
not be the optimal solution, or paying
transfer fees that come with moving
assets from one provider to another.
At the same time, the overwhelming
majority of single employer schemes,
as well as a sub-set of contract
schemes and master trusts, won’t
or can’t offer in-scheme retirement
solutions, forcing members to
seek out products from third-party
providers when they want to convert
their pension pot into an income.
With members left to their own
devices at a crucial moment in their
lives, this often takes place without
suitable guidance or advice.
As is seen by the FCA’s Retirement Income Study, a huge proportion of the money built up over people’s savings careers is simply cashed out. While this gives a short-term boost the exchequer , this is not what tax-relief was granted for. Cashing out pension pots is not value for money for the British tax-payer and it is bad news for pension providers whose member pots are lost at the point when they have become most profitable to them.
Of course many pots will never be profitable and Eversheds are probably right in suggesting a minimum pot size for conversion to CDC, but that size can be quite low if the mechanism in place is efficient and operating at scale. There is scope for a limited amount of cross subsidy from bigger to smaller pots.
So whether the provider is a major AE provider with small pots (Nest , NOW, Cushon, Smart and People’s) or a well funded master trust consolidator (WTW, Mercer, Nations, Aon and the insurance company trusts), there is an easy business case for CDC. It keeps assets, it attracts assets and assets in CDC funds look very sticky.
For legacy and non-workplace SIPPs the same arguments pertain, the commercial dynamics persist but may be weighted differently. The one area where CDC is unlikely to make commercial sense is where advice is bundled into the drawdown service as often happens in the advisory market. Here I see CDC drawdown as a competitor product and it may well draw invidious comparisons under the new Consumer Duty. In short CDC could do for poor value SIPPs what RU64 did for pre-stakeholder personal pensions.
But this is part of the commercial shake-up that a retail CDC product will almost certainly bring to the mature pension savings market. It’s a challenge that this part of the market badly needs. Member and commercial value is being destroyed by the mass cashing-out of mature pots, CDC could put an end to that – to the general benefit of the pension system.