CDC started out as such an uncomplicated idea – a “wage for life that lasted as long as you do”. But that was before the pensions industry got to work on it. What we have now is a mess which has little chance of ever being implemented, other than at Royal Mail. The PPI has given us the current state of thinking on what is called “decumulation CDC” – a concept which has become as arcane as its title.
It is not the fault of the PPI that things of got to this pretty pass, they are doing no more than setting down what is being spoken about in the actuarial consultancies and law firms and the Royal Society of the Arts, which have captured the concept.
Too ambitious to succeed
The original conception of CDC was of a plan where money flowed in as people chose to spend their savings and flowed out as pensions. If people lived longer than expected, they became a drain, if shorter they added to the resilience of the scheme. The first big idea was to have an approximate balance by spreading risk of mortality over a large pool – hence the word “collective” – the first C.
This idea of scale is articulated in the report
The minimum economically viable size will depend upon both upon the number of members and the total assets under management. The necessary scale may be equivalent to that required for a master trust to have an adequate charging base to cover its costs.
Of course most master trusts – including Nest, started with a single member and grew. There is nothing particularly speculative about starting a CDC scheme on the same basis, but there needs to be a clear marketing plan. The PPI document does not suggest that there is a clear route to scale.
But it does suggest that it would take approximately 30 years for a CDC scheme’s membership to reach a stable age profile. The inference is clear, CDC is presenting its membership with instability in the meantime. With such time horizons and no clear plan as to how to achieve scale, CDC as a decumulator is consigned to failure.
Investments designed for an endgame
The second big idea was that CDC offered a limitless time horizon. However, such has been its timid development , that most of the CDC legislation and regulative Code is preoccupied with how to wind it up. Royal Mail are still in discussion with HMRC as to how a wind up will be treated for tax-purposes. It has not opened for accrual or to pay pensions and is unlikely to do so till April 2024 at the earliest.
The current state of thinking on the investment of CDC seems to assume that it will close fairly soon after opening.
This is completely against the concept of CDC as a scheme that operates in perpetuity. It establishes the scheme as something that could be wound up at any point and be bought out as a bulk annuity. In practice , the gains that were envisaged for CDC would – under this vision be exchanged for a replica of DB with hedging reducing the capacity of the scheme to invest into the future – the modelled asset liability structure.
This portfolio is more return seeking than portfolios typically designed to back annuities or DB schemes and so offers a higher lifetime income than other guaranteed-for-life products or schemes.
Ultimately, it was determined that a portfolio mix of 40:40:15:5 between equities, gilts, bonds and cash would result in a marginal improvement on the current annuity rate
One might well ask – what is the point?
A concept caught in the weeds of advice and guidance
The third attraction of CDC was that it was a product that was done for us, one that was simple to understand and required no investment knowledge and very little by way of decision making. This idea like the issues of scale and investment – has recently become very complicated
A personalised blend of products would enable an individual’s particular needs regarding income levels, need
for predictability and risk appetite to be accommodated. It is a complex balance to define the most appropriate
combination for an individual and advice may play a role in enabling this.
I would like to join a CDC plan and get paid a wage for life with a rate of return well in excess of what I could get from an annuity. Until recently , I thought that this could be achieved reasonably easily, but I was wrong. What a CDC decumulation scheme now requires is beyond the imagination and risk appetite of our pension system. I will need to look elsewhere for a means to turn pot to pension.
What is the PPI’s vision for CDC?
I had expected the PPI to focus on the actual opportunity to provide better pensions to ordinary people than could be achieved by operating a drawdown or buying an annuity.
Instead I got a lot of preamble about the history of CDC including this.
CDC pension schemes become (sic) a reality in the UK when the Pensions Schemes Act 2021 became law, and regulations governing CDC schemes were set out
CDC became legal in 2021 but they do not become a reality till they open their doors to members. No CDC scheme is open in the UK today.
Rather than focus on the key issue, that people don’t buy annuities , struggle with drawdown and expect a pension from their workplace pension , the report focusses almost entirely on how CDC can be managed to replicate a DB scheme.
The report suggests that CDC will be a success if it can clearly articulate itself to members. But the report finds it hard to explain the simple idea that the scheme will do its best but doesn’t guarantee always to hit its targets. Instead it explains
The potential scheme offers an income level which offers a high opening benefit level, which broadly increases in line
with the Consumer Prices Index (CPI) [Figure E.1], though the actual year on year increases vary [Figure E.2]. This
is achieved with a significant proportion of growth assets which offers a higher benefit level at the cost of reduced
benefit predictability. (my bold)
How high is high?
We are not given much information about the benefits arising from the model but are told that all members are expected to join at 68. We aren’t told if the rates quoted offer any kind of residual pension for those with dependents.
The asset mix used in the decumulation CDC scheme offers a higher return and therefore a higher opening benefit level. With the proposed assets profile of 40% equities, a member who bought in with a £100,000 pot could expect an opening benefit of £6,077, anticipated to rise with inflation.
Modelling the same CDC scheme, but with the 10% equity investment more comparable to an annuity, this same member would see an opening benefit of £4,890, which
is 19.6% lower and does not include a margin for risk premium or the cost of capital associated with an annuity.
I am sorry, but a 6% CPI escalating pension paid from 68 does not get my heart pumping. If this is the basis of the offer, and the report makes it very hard to work out what the offer is, then it is simply not worth bothering with, either to supply or to buy.
We have to remember, that this is not being guaranteed like an annuity, the CD pension is volatile and – we are told – communicating this is key to the success of CDC.
The report makes two attempts to demonstrate the likelihood of members getting what they are promised. I have studied these charts for some time and can’t work out what they are actually telling me. These charts aren’t in the weeds of the report, they are in the executive summary, this is supposed to make things clear to the general reader. They are the E1 and E2 mentioned above.
CDC has – in these examples, become the plaything of actuarial models which are quite beyond my comprehension. What is being said? How can this kind of analysis do anything other than set CDC in the “wet cement of institutional rigidity”?
CDC has been captured
CDC has been captured by the actuaries and lawyers. This report was part sponsored by an insurance company.
The capture characterises CDC as uncommercial, unproductive and hard to sell. The model envisioned by the PPI is the worst of all worlds, offering little more than an annuity for a whole lot of risk to its sponsors.
If there is a way of stopping CDC developing , this is it.
There are other ways to provide people with a means to turn pots to pension and if the CDC capture means we can no longer use CDC to describe them , so be it.
I have yet to read the report, but Henry if your reading of the paper and your initial reaction is correct, then we have arrived a a dreadful state of affairs. Clearly proponents of CDC need to regroup, particularly as recently as last week TPR publically came out in support of CDC as a vehicle for delivering pensions.
An excellent assessment, Henry. As you know, I have vehemently opposed CDC since its inception. In 2018 the FT published this letter of mine:
Sir,
A small cabal of consultants to the pensions industry has been banging the Collective Defined Contribution (CDC) pensions scheme drum for some time. Without a client cause, success has eluded them: there is next to no demand for CDC from corporate sponsors of pension schemes. Having transitioned from providing Defined Benefit (DB) to pure DC pensions, employers have no intention of entering what would be a very complex, untested, arena.
But the opportunity to play a role in settling the Royal Mail’s pensions travails has been gleefully leapt upon. The consultants’ have attached their CDC cause to settling what is ultimately a labour dispute. This renders the CDC debate primarily political, rather than being driven by any performance merits. This is not a sound basis for the formation of pensions policy.
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In addition, CDC is fundamentally incompatible with pension freedoms. Furthermore, why reinvent the wheel when one could simply wrap a With Profits fund in a workplace scheme governance framework?