The move to CDC looks happily inevitable.
I hope that by 2030 most people in workplace pensions will have access to a pension and the amount of certainty from their pension will be dependent on fiduciaries (trustees and personal pension IGCs) offering pensions as well as annuities to people looking for income as they stop working to retire.
CDC is the alternative to paying yourself by way of drawdown or by swapping your DC pot for a pension. It is a very deficient way of paying income and will – because it is so light on guarantees, the means that will over time pay most income.
However, there is a way to buy into a pension that offers a base level of income that is certain and only floats a proportion of the income. Nest have been exploring offering this type of pension that is commonly called “a shared ambition” pension. UKAS is a DB pension scheme that some time ago converted to “shared outcome”. I have been working for some time on the Pension SuperHaven, which also works on “shared ambition”.
To want to be a part of a shared outcome pension, you have to have a lot of trust that it will operate in your interests and so a lot of work goes on at regulators and legislators to ensure that the limited guarantees in shared outcome schemes are backed by proper sponsors. In the case of Nest it looks as if the strength of the scheme and its backers (the DWP) will enable it to offer a basic pension which we can have certainty in, only the increases in pension ,year after year, will be determined by the performance of the Nest fund. UKAS is a super-well funded pension that is providing a basic pension under defined benefit rules and a large part of the return to members is floating on the returns of the investments. Pension SuperHaven (PSH) is backed by capital from banks keen to get a shared return in the upside and providing certainty when times are not so good.
More on how Shared Ambition pensions work – looking at PSH.
We are working with TPR and DWP on how we promote this DB scheme to the market and I am happy to spend as long as these organisation want to so that we can get it right.
We are pleased that the testing we have done over the past two years suggest that compared to an annuity, PSH can offer a higher certain income by 10-15% but the comparison is important. We do our testing against the best annuity rates for individuals from Retirement Line. So we are offering a defined benefit that will be backed by the Pension Protection Fund (this is not an insurance like an annuity).
Most importantly, it is an investment with an upside which we intend to pay as a Christmas Bonus each year. This promotional slide was set before a group of experts last year as we introduced the concept
The critical comparison at outset is with the annuity that can be purchased and we intend this to be a proper comparison taking into account those with reduced life expectancy.
This second slide shows how members who are comfortable with the base pension and the possibility of further “Christmas bonuses” will get “shared outcomes”. We intend to take transfers to Pension SuperHaven and to sit “inside existing” DC trusts. This is not an asset grab, the money made by the bankers who sit behind PSH are rewarded by returns over time and not by annual management charges. We want shared ambition to reward both the people who run Pension SuperHaven and take risk as well as members.
Behind the concept is a way of making defined benefit pensions work in a world where the money has already been committed to “pensions” but cannot access “pensions”.
In short, we want shared outcomes for DC pensions so that master trusts and large sole-employer pensions to be paying pensions. Not all DC trusts will be able to do this themselves and we want to work with those who want or need to offer retirement income on a lifelong basis to their members at retirement.
Value for money?
My organisation, AgeWage, has been involved in providing VFM comparisons using IRRs from member’s actual data for some time. We think that history is a guide to the future and we think that in time , a historical basis for VFM will be developed for the pensions people get (“decumulation”). Right now we can use proxies for performance based on the SMPI system but we have much more to do to make it easy for people to compare pure CDC, shared outcomes (with more certainty) and annuities. We are very interested in the factors used by LGPS which offers members pension rights if they transfer DC pots “in” , in their first year of LGPS membership.
I am sure that the hardy readers who have followed me this far will understand just how ambitious PSH is. We can understand how hard the DWP and TPR find the concept of a capital backed pension scheme as a commercial scheme. But we are optimistic that in the new world where CDC is seen positively and organisations such as Nest are looking at shared ambition, we will not be considered quite the freaks we have felt in times past!
While I entirely agree with much of your blog and the prospective value of the PSH offering, I would respectfully point out that the UKAS scheme characterises itself as “shared ambition” and not “shared outcome”.
Firstly, pensions in payment are guaranteed inflation related annual increases not an investment performance related “Christmas Bonus” nor the possibility of a pension decrease as apparently was the case in the old style Dutch CDC arrangement.
Secondly, the “shared ambition” element is restricted to the pre-retirement phase where the annual revaluation of the accrued members’ retirement pension right is not based on a link to past inflation, as in other DB schemes including those adopting conditional indexation, but on an assessment of the future investment performance of the current assets of the scheme plus future contributions, If the assessment is that those assets may prove insufficient to pay the pensions already promised then the annual revaluation can be reduced, and even in extremis set to zero, but the previous year’s revaluations remained guaranteed by both the employer/sponsor and also in the PPF.
Thirdly, as in all DB schemes, the predictability of the pension income increases as the member approaches retirement but in the shared ambition scheme that predictability includes the discretionary elements. The member is not required to make any “investment” or product purchase decisions which could significant change the pension outcome and there are no artificially shortened investment time horizons.
Fourthly, the pre-retirement adjustable revaluations of both the active and deferred members, helps protect the position of the younger members against those closer to retirement as the younger members receive more annual revaluations with the possibility of an above inflation pension outcome for their own contributions based on the efficiencies of a pooled collective DB Scheme.
Fifthly, as the employer/sponsor’s contributions are determined on a balance of cost basis, it is the employer not the member that ultimately bears the investment risk. That risk of additional contributions being required is reduced by the build of surplus assets over the assessment of those required to generate the income required to pay the benefits already guaranteed. At the same time, the surplus assets will continue to generate further investment returns to meet the shared ambition of increasing the prospective members’ benefits whilst reducing the employer’s funding cost. The surplus also minimises the significance of the employer covenant.
I would emphasise that a shared ambition scheme operates under existing legislation and regulations. The only restrictions are set by the “Minimum Rate” funding requirements in the Auto-enrolment Regulations but even they fall away as the surplus builds.
Finally two questions:
1. Would it not be in the interest of employers with a surplus in a closed DB pension scheme to use that surplus to reduce their future employment costs by using that surplus to fund an open shared ambition section, rather than transferring it to individual DC accounts with the tyranny of employer DC contribution rates that will be near impossible to reduce in future but which provide a high risk and uncertain pension outcome for their employees? The employer can set the minimum pension guarantees at a level which utilises the efficiencies of an open and cash flow positive collective DB pension scheme to provide a guaranteed and increasingly predictable pension outcome for their employees which exceeds that which the DC contributions could purchase.
2. Is a reduction in future employment costs more likely to lead to economic growth than a one-off distribution of assets used in whole or part to provide dividends to largely institutional and non-UK investors or by share buy-backs that reduce the prospective yields of current investments?
Thanks Peter, I think we will shortly having a discussion amongst a group of similar thinking people to you. These questions are very helpful and we’ll try to get consensus.