Back in 2019, CDC was trumpeted as the great leap forward for pensions
There were many who thought Royal Mail would never launch its Collective Pension Plan, they were wrong and it is a testament to Jon Millidge, Terry Pullinger, Hilary Salt , Simon Eagle , Angela Gough and many others that the concept was seen through. Back in the day management consultants would have called Royal Mail “starter-finishers”.
Praise too to Government for bringing a new regulatory regime into play.
The Government clearly delayed the launch of its latest consultation on CDC – this time on multi-employer schemes – so as to ride the bow-wave created by Royal Mail.
What the consultation is about, is a series of amendments to the original legislation to allow smaller employers to join a single scheme owned by a “proprietor” and fund their section at a defined contribution determined by an actuary.
Most of the consultation is about ensuring that when things go wrong, they either get put right quickly, or that the scheme is closed in an orderly fashion or that assets are moved to a master trust of another CDC scheme so members are protected. There is no mention of the PPF.
The multi-employer CDC scheme gets no concessions from the charge cap. The costs of set up will have to be recovered from the member through a 0.75% charge and/or from participating employers. There is no means for the Proprietor to extract capital from the fund other than by reducing spend on member services, fund management, administration and the various tests that will need to be applied to the fund to ensure that the target level of pensions is achieved.
If multi-employer CDC was a windfarm or an electric car, it would hope for more hope to get it off the ground. There is no such help, so what incentive is there on employers to adopt CDC?
Why would employers do it?
The easy answer is that CDC could and should be a vital employee benefit that would attract and retain good staff. Try this on the Church of England and you quickly see that rectors don’t give their life to the Church for a decent pension. Giving a good pension is something that the COE has always done, not just to its core staff to those working with aligned employers.
The not so easy answer is that the cost of paying guaranteed DB benefits is too high and too variable to enable organisations like the COE to plan ahead. Switching to CDC means they can lock into a contribution rate which is defined and float the pensions to their core staff and those who depend on the COE DB scheme. It’s not so easy as this means a risk transfer from employer to staff and the staff will need convincing of the upside of giving up a guarantee.
The answer we are not hearing is that employers currently paying into a DC scheme, might want to pay a defined contribution to give staff a better benefit. They might want to do this because of staff pressure (some unions are reporting discontent at DC arrangements) or to get competitive advantage. Some will simply see CDC as right for their remuneration policy but we are hearing precious little from DC schemes (including master trusts) about CDC as an alternative to DC.
The key to the success of multi-employer CDC will be its adoption by one of the key master trusts. The most likely candidate seems to be the consultancy owned master trusts (now down to four – NOW, Mercer, LifeSight and Aon. But whereas the economics of DC master trusts are easy, the economics of CDC most definitely aren’t.
One Master Trust that has openly stated its ambition to adopt CDC is what was known as The Pensions Trust and is now TPT Retirement Solutions. It will be interesting to see its reaction to the consultation and I hope to speak candidly with them at the PLSA Conference in Liverpool next week.
Who is this for?
So far the Government has been on solid ground with CDC. With Royal Mail it had a firm partner who had committed itself from the start to the project and had the deep pockets to fund much of the development work which others will benefit from.
The model being proposed for multi-employer CDC looks very much like the Royal Mail model and it will appeal to groups of employers with a lifelong service ambition from their staff. The Church of England is an example and , at the moment, the example that we know is interested. Postal Workers and Church people may be different , but they have similar career “trajectories”.
The model mentioned in the consultation but not yet pursued is one that is not whole of life but targeted at the spending phase of a whole of life pension – “decumulation only”. CDC people are split between those who say that CDC only works properly on a whole of life basis (till death do us part) and those who see DC as working adequately till retirement and only deficient in not paying a pension.
We still await the game changer
My personal view is that most people want a pension from their saving and a CDC decumulation scheme might be the popular scheme that the multi-employer whole of life scheme is yet to show itself. However, the economics of decumulation only CDC are difficult for Proprietors and I see little appetite from DC master trusts for a product that is still some way from even being consulted on.
That said, DC schemes are now maturing at a fast rate, 700,000 people a year are getting to the end of their DC saving careers and finding nothing satisfactory but a tax-free cash sum (even that is under threat). The real need is for innovation for those reaching retirement and this consultation does nothing for such people. The CDC consultation does not deal with transfers in to multi-employer CDC schemes, this is not a means to turn pots to pensions but a means to build pensions from the first contribution (Whole of Life).
The multi-employer CDC scheme is a niche product that will be helpful to a small number of employers, but it is not the “landmark moment” that Emma Reynolds calls the arrival of Royal Mail’s Collective Pension. It is another small step and the issue Reynolds has is whether there is enough momentum left in the project for small steps. Perhaps she needs a great leap forward, but perhaps that is a little too radical a thought for now.
CDC provides a target level of pension not a guarantee
In my experience there has been considerable interest in CDC by employers. But it is a subset of employers – those who previously provided DB pensions and who are still paying contributions into DC arrangements above auto-enrolment minimum contributions.
The contributions into the Royal Mail CDC scheme are 13.6% from employer plus 6% from employee – that scheme is targeting an inflation protected 1/80th of average salary pension plus a 3/80th guaranteed minimum lump sum at NRD of 67 (no reference to tax here!) with a 50% survivor “spouse’s” pension. Employees can also boost their lump sum benefit by paying an additional 1% contributions which is matched by the employer.
Looking at a DB scheme with similar benefit structures and allowing for 0.75% for administration costs, I estimate the required investment return to be less than assumed long-term inflation (RPI/CPIH) + 1%. (I refuse to think about target investment returns in terms of historic gilt yields – see Henry’s next blog). This doesn’t appear to be an overdemanding target.
The 2010 Auto-enrolment Regulations for DB Schemes set a minimum accrual rate for average salary schemes with discretionary benefits of 1/120th with Minimum Rate inflation protection to be funded. There is an implicit assumption that this would require contributions in excess of but not dissimilar to the 8% auto-enrolment minimum requirement. Remember to add the administration costs – so bloated by legislation and TPR. However LCP analysis would suggest that similar contributions paid into a DC scheme would provide only 2/3rds of those benefits.
When thinking about pension adequacy Is a 1/180th pension with lump sum by commutation an “adequate” pension and would CDC provide better “value for savers”?
A younger generation of actuaries are learning that interests rates of 0.5-1.0% are not normal or sustainable. Hopefully the older generation will rediscover their principles they so easily abandoned on the false alter of QE boosted LDI.
Back to the future, with cost of debt normalising at somewhere in the range of 6-8%, and corporate ROIs at 10-12% minimum. And 1/80 + 3/80 DB accrual once again costing combined conts in the range 9-12%.
Given the Regulatory scarring inflicted on corporates from the last 2 decades of ill-informed overbearing regulation (that has as intended destroyed DB, and left our economy in an under invested mess), corporates will be very resistant to return to the collective. I hate to say it but the only way to get transaction on the collectives is to give them a cost advantage over the DIY AE DCs. Mandate AE DC to 6+6, but allow CDC (or DB) at current 3+5%. I know which I’d prefer. The CDC will deliver 50% more pension with less risk.
Oh, but most importantly, get rid of the disaster that has been TPR. Pension inadequacy has never been worse after their 20 years at the helm. At a minimum get them to retrain their brains, around a mandate that requires them to support investments + actually increase pension outcomes, please.