The man who reformed the church

The title of this blog might seem ambitious.

Britain currently has no CDC pensions, only an application for a CDC pension scheme, sitting with TPR – from Royal Mail. While that scheme will provide a very ambitious, very expensive and hard to replicate solution to Royal Mail’s problems, it is not the CDC we can expect to see in future, it is the door to more, but it is a one-off. Every CDC scheme will need to be individually approved at some cost and every scheme will be designed for the purposes of a single sponsor or a handful of sponsors in a CDC mastertrust. This is not mass-market stuff and it is a market we might call DB-lite – where DB schemes wish to shed their guarantees and move to a system of conditional indexation where nominal values of pensions fall once in a blue moon, because of the conservative design insisted on by the DWP Regulations and the Pension Regulator’s CDC Code.

But the potential for CDC to become a default means of turning DC pots to pensions is massive and I believe the UK is likely to do this better than any other pension system (including those of the Dutch, the Australians and the Canadians).

I argue this on four grounds

1. There is a longstanding private pensions culture in the UK – people are used to paying for pensions through the workplace.
2. There is a residual annuity culture despite the pension freedoms – generations before the current one expected to see personal pensions be turned to annuities.
3. We retain an annuity infrastructure both through bulk buy out/in and through the remaining infrastructure of retail annuities, we have a well developed market that knows how to price and administer income for life arrangements.
4. Our pension incentive system (EET) is based on income replacement – the cashing out of pension pots is counter to tax and welfare policies built up over generations

No other country in Europe , the Commonwealth or elsewhere has the unique history of UK pensions. The pension freedoms did for our pension system what Henry VIII did for the monasteries, it brutally tore down a system that didn’t work while allowing those aspects of the Roman church to develop as a Church of England.

While many will see Osborne’s 2014 rabbit as an act of fiscal vandalism, it proved immensely popular as annuities were as much loved among the populace as the Papacy was in the early 16th century. Pensions will survive and rebuild as did the Church and to coin the phrase “it will build back better”

Creating CDC funds, valued in billions and invested with no anticipation of closure through “de-risking”, also allows investment strategies that ensure that government, tax-payer and pensioner interests are well-served through the investment into  productive capital.

As I have argued in recent blogs, CDC is a product for the people and not for actuaries, lawyers and a few large corporates anxious to de-risk the balance sheet and protect the P/L (no offence to Royal Mail and the CWU whose circumstances are unique).

CDC has the capacity to meet core needs

• people’s desire to have pensions “done for them”
• people’s need for more income than from guaranteed annuities
• the comfort of knowing their income will last as long as they do.

CDC can deliver a pension with features that might include

• An underwritten rate – as with annuities, CDC pensions can be underwritten on individual life-expectancy
• A pension that has built in inflation protection as standard or as an option
• A pension to protect the family – as with annuities, CDC could be established on a last survivor benefit
• A pension with the certainty of getting your money back – a simple insurance has been built into Australian CDC which ensure the money transferred into a CDC pension is paid back to the estate on early death
• A fair-value transfer; a transfer-out facility can be established that’s fair to those remaining but gives the option to cash-out where a cash sum is needed.

All of these features come at a cost, a cost to the income today and tomorrow. The more flexibility and personalisation you build into a collective, the less the mutual benefits cut in. For those who do not believe in collectives, there are other options.

The final advantage we have as a nation – nudge.

Unlike the USA and some other advanced economies, we have a culture of compliance with defaults that has made auto-enrolment a success. Rather than opting out of workplace pensions , more than 9 in 10 of us “stayed in” and of those well over 9 in 10 stayed in the default investment option.

This compliance with rules , stretches to trust in fiduciaries, whether it’s insurance governance or trust governance, most of us are happy to have things done for us, provided we have the option to get out. The key difference to the way we do things than the Americans do things is that in the USA, personal decision making is more prevalent and more encouraged. The key difference between ourselves and the Australians is that we do not compel people to take certain actions with their money, we nudge them. Nudge works great in the UK , better than anywhere else in the world.

CDC is a natural default, it should not be compulsory (as annuities were) nor part of “choice architecture” as options under investment pathways are. It can be competitive, but it must compete on the right things – not a simple evaluation of rate. There can be an open market option for retail CDCs which people can choose to use, but a well regulated market – as happens with workplace pensions (GPPs and mastertrusts) can mean that any CDC option offered as a default could meet a  standard that provided its user with assurance that they were getting value for money.

In summary, CDC is the natural extension of auto-enrolment into retirement. It is a product that has similarities to the pensions people enjoyed in the workplace before a defined benefit became a guaranteed benefit. CDC reverts to the system of best endeavors on which our private pension system was built but includes the commercial players on whose infrastructure its operations and investments will depend.

Above all, CDC sees not the rebirth but the revitalisation of a pensions culture that fell into disrepute, was ripped apart and is now ready for reformation.

Martin Luther