Let us imagine a conversion rate from pot to pension for everyone at a certain time of their lives – let’s call that the date of the state pension to simplify decision making on what we measure decumulation decisions by.

Let’s suppose that everyone gets a conversion rate based on what everyone wanted – let’s say it was today 7% – being the return of capital and interest/return on your pot, managed collectively.

That means that if I have £100,000 in my pot to buy a pension , I get £7,000 in the first year as extra pension (to my state pension) from every provider I approach.

Your master trust or the manager of your GPP or you if its a self-invested personal pension would be expected to keep enough money in the pot to pay the 7% of your pension every year and if there was enough pot then the manager (including you) would be deemed a failure and you’d have to reset that 7% to something lower and take less risk. Your management might have to be given up and a certain return purchased (you’d de-risk yourself a failure!)

Of course some smart people will think me crazy but I don’t think I am. There are level annuities payable to savers at 7% – especially to those who are 67 today and so 7% is a good number which DC, CDC and DB pensions could pay to all 67 year olds as a pension.

What would the question be if that was what DC pots paid as pensions?

Growth in income a measure of VFM?

My friend John Mather makes a telling point with regards what we consider value for money

If only VFM were expressed in a return over inflation! It seems only the scheme member wants to see .

If we take the example of everyone getting a pension paid as a percentage of the pot (7%) then what might happen if people were defaulted into

1. An annuity
2. A DB plan
3. A collective DC plan
4. A pure DC plan (like Nest)

Allow me to explain in simple terms

1. An annuity would pay a  pension today, a guarantee on the income and some formula for the future growth (inflation or fixed amount or level)
2. A DB plan would pay an income increasing by inflation (let’s say indexed by CPI- capped at 5%). It could pay more than a promise if in surplus.
3. A collective DC plan (CDC) would pay pay increases when it could afford to and unlike DB and CDC wouldn’t guarantee the 7%. It wouldn’t allow you to be flexible but it looks to have plenty of upside and you’d be insuring with others in the collective
4. The DC plan would do what the CDC plan would but would give even less certainty than CDC in exchange for personal ownership (retail not collective). Although you’re in one fund, you are not collectively so you’d probably revert to a certain annuity if you outlived the average.

I think that most people will assume the 7% as certain in all four cases. It is of course not the case, annuities can go bust, DB plans can go into the PPF and see income restricted, CDC and DC pensions have no protection on capital. There are big differences in security if you are risk-based in your thinking,

Certainly with the DC plan you can move your money to another plan so it will be sold as flexible. The other options are not likely to be very flexible, you are stuck with the deal you were defaulted in,

All these things will be very important to those who are choosing providers of pensions by default decumulation. This kind of choice will be at participating employer level, choice for members will be to opt-out of the decumulation chosen for them so I am now coming back to John Mather’s point…

If only VFM were expressed in a return over inflation. It seems only the scheme member wants to see that.

Nest is going to provide a DC pension. It wants to pay increases (subject to having the money to do so) at inflation, it might pay more if it has a surplus or less if it doesn’t look able to sustain the (let’s say 7%) increasing pension. The VFM is what Nest actually pays and inflation is VFM. More than inflation on those increases is good value and less is bad value. That seems to be simple so long as we see the 7% as certain (it isn’t but we think it is).

The argument from those DC schemes that convert to CDC at retirement (or earlier for those not at retirement) is that the 7% is pretty certain too, but like Nest it isn’t. That won’t be the issue, CDC is going to be judged by the increases it delivers which those like Lifesight or TPT who want to be decumulating CDC but looking to be judged by its extra return on increases compared to inflation. To many pension folk , security will be the most important thing – especially on the ability to pay the 7% (my number it could be more or less).

But if John’s right, then ordinary people will be interested in increases in pensions (return over inflation) as the upside of value for their money and return under inflation as failure.

If we can see all types of pension as safe then people will be looking at the upside, and will be unhappy if  finding they are getting downside (lower returns than inflation). I think a measure for employers is likely to be risk-based first while staff will assume certainty and be looking at upside – at how the pension is doing against inflation.

Value for money is a fascinating subject because at such an important time for deciding on what to offer as accumulation, we have to guess how it will be measured (judged).

We will

How do we make sure we know what we are getting?

My guess is that what those who are choosing their workplace pension going forward will use as VFM  a combination of upside (employers will want to back winners) with protection from downside (they will want to know that the 7% is there to stay).

If we can discount the possibility of the 7% being under threat (as Nest say we can) then the money is with the retail DC and collective DC options – because we want all the upside of the approach to growth a DC fund can adopt.

If we can’t discount that possibility then we will see much heavier use of annuities and DB style decumulation (as I have argued for). But these will not offer the upside of DC and CDC , and the flexibility of DC (where you can walk away from the pension).

If we start considering “walk-away” as a value for money measurement, then we are into a much murkier world of decision making.

My guess is that people know more about risk v return than pension experts give themselves credit for. People know when betting on a horse that the more that can be won, the less likely it is to win and there are thousands of risk/value decisions we take which add up to a “not worth it v worth it” outcome. The better the information that is available, the more balanced the approach, the less information, the higher the probability people will take a safe decision.