LCP tell us that after modelling two and a half thousand scenarios they have found that pound for pound, CDC delivers up to 50% more than standard DC when used on a “whole of life” basis.
The finding is an indictment on the current system of providing workplace pensions. We are spending £70bn a year incentivising a way of paying people in retirement that could be 50% more efficient. Even the worst of our utilities would blanche at providing a delivery mechanism that poor. Look to the pipes!
We have known that CDC can produce radically better outcomes for decades, Derek Benstead explained how in his Stakeholder Pension submission in the last century. GAD dismissed CDC a few years later and the idea lay dormant as various DC panaceas were tried. Stakeholder Pensions gave way to workplace pensions, charge caps came and partially went. There has been a lot of noise around investment pathways , default decumulators but in practice CDC has not happened.
Now the large actuarial consultancies are lining up to promote it and I expect that a new Labour Government will give CDC a puff in the Kings Speech. But fundamental questions remain unanswered (see title)
I’m a fan of the CDC concept but a word of caution, nobody can join a CDC scheme without first becoming an employee of Royal Mail and even then , you will only be looking at a whole of life CDC plan if you’ve worked for the company for a year and work there all your life.
The whole of life model is one that few people starting their first job would expect. Though those few do include most postal workers who – once they’ve done a year – tend to stick at it. CDC works for Royal Mail and for a few other job for life occupations (Church of England vicars). What are these people doing in a DC plan? Why are such people not in a DB plan? Can the huge amount of fees racked up to launch the RMCP be justified as VFM?
The question is only worth answering if we are prepared to accept
- That DC is irreversibly flawed?
- That DB has been damaged beyond repair
- That ordinary people are going to be sufficiently impressed by CDC schemes to make them wanted.
I am not convinced that DC’s flaws cannot be pinned , that DB cannot be returned to guarantee retirement income and that anyone outside the magic circle of senior pension actuaries believe that those 50% better pensions are going to become a part of day to day retirement.
As mentioned at this week’s Pension PlayPen , the question we should be asking is what value we put on guarantees. The two principle rivals to CDC are annuities and DB scheme pensions, both of which are guaranteed and give up much of their potential upside to deliver to an exact expectation.
If we are to have unguaranteed pensions , then the public are going to have to be convinced that what they are getting isn’t just drawdown without the freedoms.
So far, the arguments around CDC have been top down. They have come from actuaries arguing whether CDC is 70%, 50% or 40% better than DC or DB.
When Scottish Widows asked 1500 of their workplace savers what they were expecting from their workplace savings , 80% of them said they wanted a consistent income that paid for life – whether they’d be happy to accept that the consistency would be subject to market forces wasn’t asked but that conversation is not being had.
As Calum Cooper wisely said at yesterday’s Pension PlayPen meeting, we have lost sight of what we are trying to do with pensions to the point that there is no common purpose. I see no reason why any employer would want to spend the millions in fees to set up a CDC scheme of their own if there were no business case. There is zero recognition that CDC is 50% better by staff and therefore it is not seen as a cost effective upgrade in DC.
Likewise there is such as strong lobby among those who oversee DB pensions that the guarantees are integral to the value of the pension, that there is no way that DB benefits can be re-established on a CDC basis. This despite all the reports from actuaries that CDC produces considerably better outcomes than DB (30% better according to WTW).
CDC has no target. There is no focus on by whom, no focus on through whom and no proper understanding of to whom. It is currently an actuarial and legal concept on which millions of words and pounds has been spent to negligible effect.
CDC is good , it works and it should be implicit in many DC plans as a means to turn pots to pensions. It isn’t and it won’t be until people start properly focussing on the purpose of what we are doing with our retirement savings.
The important point that I draw from this LCP publication is not only that CDC will be up to 50% better than DC in the workplace, agreeing with other eminent actuaries, but that the reality is that most employers will access workplace CDC through joining multi-employer CDC schemes rather than having their own individual scheme.
Adrian
If pound for pound in contributions CDC is 50% more efficient in providing pensions than DC, minimum auto enrolment contributions of 8% into a CDC arrangement is projected to provide the same pension outcome as 12% into a DC pension pot. There may therefore be a political desire not to change the minimum rate contributions but instead to promote CDC.
In yesterday’s Playpen discussion the question was asked as to which provided better value for money CDC or DB. The answer appeared to be there should be little difference – except that the Scheme sponsor took the risk with DB, the Member in CDC.
The important question is therefore what outcome can the member expect for the contributions paid in.
Using 30th November 2023 market determined factors with Gilts plus 3% pre-retirement and gilts plus 0.5% post retirement discount rates and 2021 employee age and salary profiles and mortality assumptions etc, one employer received informal actuarial advice that contributions of 8% would fund an average salary with minimum rate revaluation DB benefit of 1/120th of pensionable pay. This is identical to the minimum qualifying DB scheme requirements set in s36 of the 2010 Auto-enrolment Regulations. The one important distinction is that in the DB scheme example it was assumed that the employer met the administration costs where in CDC, unless otherwise arranged it will be the member.
The questions therefore for the Pensions Review will therefore be is that level of occupational pension adequate to meet the needs of the future pensioner population and how will this be affected by employment mobility, possibly including periods of self-employment, ill health or carer responsibilities? In addition the DB pension is guaranteed, whereas in CDC should the risk to the member be factored in? We have discovered In DC the member has all the risk and is not given the tools to understand the impact of those risks, with a Pensions Dashboard giving a false sense of security.
I have mentioned this before, and it is something that i know others have researched. The spending needs in retirement are broadly RPI-2%. So anything which evidences greater value in later life when spending needs are reducing and turning this into a Present Value, needs amending. This isn’t to knock pooling, just that we firstly need to know what we are targetting before we design.
I can reconcile your RPI-2 with CPI-1 referred to in a fairly recent Institute for Fiscal Studies report in 2022.
But that report shows varying needs/requirements, broadly above average income earners spend RPI-0 on average during ages 67-75 and RPI-1 on average after that.
Lower income earners according to IFS start off at RPI-2 for ages 67-75, but again RPI-1 after that.
I also recall debates on RPI before it was delisted as an inflation index which suggested that individuals spent more with age (eg contributions to care costs), before state reliefs kicked in for some, but by no means all.
In summary, I think RPI-2 is setting the bar too low.
Just as I think (and Pensions Oldie has heard this from me before) a 1/120th DB accrual rate is poor compared with the norm (?) of 1/60th accrual we tended to see (admittedly not everywhere) in the 1980s and 1990s.
Derek, you may well be right, but whatever the consensus is on retirement inflationary needs, we shouldn’t kid ourselves that providing value is the same as providing utility value.
I agree with the questions in the blog, although know that in general to encourage change we can end up focussing on dialling up one side of the argument for change.
We can and should do a lot more with DC. The largest driver of CDC “outperformance” relative to DC tends to be in the investment strategy. But well run DC schemes at serious scale should be able to capture most of this. The second largest driver is longevity pooling which we believe is possible under current rules, but it’s not easy.
And you need to take a lot of care in any single point comparison on DC vs CDC outcomes as a lot depends on how accrual is set, especially as many structures introduce cross-subsidies. This is fine from a member outcome perspective but potentially risks misunderstanding if those funding cross subsidies aren’t clear when comparing benefit designs.
CDC should have a big role to play in future provision, at the very least in decumulation. Typical people with typical pot sizes cannot manage their own longevity risk efficiently by self-insuring, which is what traditional drawdown leads to.
As Adrian says, for most employers this is likely through multi-employer solutions of some form or other. And there’s plenty the government can do to help, not least around facilitative legislation (which might be in the pipe) on default retirements, longevity pooling, and master trust solutions.