This is an argument I am used to and it’s not one that I am comfortable to leave alone. We built a health system, a teaching system and a police and fire brigade to last and we should do the same for retirement income.
See what you think in this argument between me and Pension Oldie.
PensionsOldie says:
October 11, 2025 at 7.32 (Edit)
Fundamentally the issue is that legislation is designed to provide an occupational pension system that nobody, except those that have a vested interested in complexity and administration, wants, Employees wish the reassurance of a known income in later life, while employers wish to reduce both the current and future costs of meeting their employees’ aspirations.
Although infinitively more efficient than DC (especially accumulation and decumulation DC), CDC is a poor substitute for DB and it is vital that it does not fall into the same traps, particularly that of only considering failure. The key cornerstone will be the valuation measures adopted to assess the pooled fund against the future cash flow commitment represented in the target benefits.
In the early days of a pooled CDC fund it is likely to appear to outperform an established pension fund because it will be cash flow positive. In probably 20 plus years time the CDC fund will have matured, where its key financial objective will be to ensure that the cash inflow from new contributions and dividends and interest received exceeds the benefits paid out and the administration costs met.
In both phases the market or realisable value of the assets and especially the discount rate applied to the targeted future benefit payments are entirely irrelevant to the key success factors, these being the attractiveness of the Scheme for new contributions and the actual cash inflow generated by the existing investments.
It is only in the terminal phase of a CDC scheme when the cash inflow from new contributions has dried up that the realisable value of the assets becomes an issue. By then the current pensions in payment, probably of fairly mature pensioners, will be the key cash flow determinant.
To deal with a deficit then being projected, the obvious solution would be to merge the CDC scheme into an another cash flow positive CDC or DB pension scheme that can generate increased future returns from the combined asset pool than could be achieved by the failing CDC fund repeatedly disinvesting.
With surplus assets, the remaining mature pensioners are in for substantial unexpected windfall gains which probably could be used more efficiently for society across a wider pool. Even in the terminal phase, the discount rate applied to the liabilities is irrelevant.
Why O Why – do we not just come clean and accept that a fully open DB pension scheme is the most efficient way of meeting employees’ retirement income aspirations at lowest cost to the sponsoring employer!
henry tapper says
October 11, 2025 at 7.32
Pension Oldie; you know the diagram I publish for both DB and CDC pension plans (I publish this diagram here to counter your important contribution which I quite disagree with).
In my view you are wrong in assuming that either a CDC or DB plan needs to close. This diagram was created by Derek Benstead – you may know him.
Your assumption is that the covenant closes – the employer says “no more” and pays no more. This is less likely for both DB and CDC if there are many employers. It is less likely in CDC when the defined contribution is flexible.
I don’t think it is easy for an employer to negotiate its contribution down but I think it can be done, especially if schemes work on a money purchase basis (non guaranteed pension purchased for every contribution rather than a DB accrual replica (as with Royal Mail).
I would hate to be in a CDC scheme when the employer contribution went down but I’d rather that than being in a DB scheme closed for future accrual and then failed to meet its obligations. If an employer goes out of business, there is no contribution (not even an AE mandated amount) but that does not put at peril what has been paid into a CDC scheme, since there is no guarantee and future contributions need not be required to keep the scheme alive (hence no need for the PPF). DB schemes are vulnerable to a greater degree.
But let’s not get hung up about pension schemes closing when participating in a CDC scheme. It certainly will get less easy when a scheme is paying out as much as it is taking on but keeping a balance from income and pension payments will be part of the management of CDC schemes. A new employer will be found and if one isn’t then other options will include merger with a stronger scheme. There is always a way to maintain the promise , because the promise is not a guarantee other than best endeavours.
I know the DWP are desperately bothered about this question but if we took the assumption of failure, we would never set anything up but things we could take down; a bad state of building that would be!
I think failure is the wrong word. We need to prepare for what happens when the employer stops contributing. And I’m with Henry that I’d rather be in a CDC than DB at that point.
And to pensions oldie’s point that why don’t we accept that a DB scheme is the most efficient way of meeting e’ees’ expectations, it doesn’t solve the problem if those expectations and the associated costs being so far apart.
The kind of pessimism I’d expect from an actuary who specialises in “pensions transaction services”?
Are all actuaries trained/steeped in such pessimism, setting a low bar for expectations and a high bar for costs?
While I always defer to Derek Benstead’s actuarial expertise, and I’ve seen various versions of this chart over the years, and yet …
… I don’t actually recognise the relative positions of the blue and green lines above the horizontal from my own experiences as a DB trustee in the 1980s and 1990s.
A different investment strategy – based on listed equities with dividend growth, private equity with multiple realisations, commercial property with rental growth, and higher yielding gilts or other bonds at certain times – could result in the green line alone being sufficient to cover the red line of benefit payments for a very long time.
The blue line of contributions (at least in the 1990s before the discount rate myopia to which PensionsOldie alludes set in) also tended to be stepped, sometimes gradually upward, but at other times downward, as partial contribution holidays were implemented after triennial checks.
If I look in more detail at the first decade of Derek’s illustration, the annual contributions of 100 seem to generate a yield of maybe 2-3% after ten years? That seems to me to be a very poor cash income return on such a level of accumulating investment.
Later, after 40 years, the income seems to level off, whereas I would have expected it to keep growing for some years/decades more, possibly until the scheme closure assumption is reflected after 80 years.
Hi Henry, You appear to have misinterpreted my point. What rather clumsily I was trying to say was that we should NOT be trying to legislate for CDC schemes with a dominant background only considering failure as we have done with DB Schemes.
How many employees, It must run into millions, have lost their jobs because their employers have formed the opinion that they could not afford the DB deficit recovery contributions apparent being forced on them by a regulatory system enshrining a pricing model placing emphasis on risk premiums and profit margins?
* Has this system not unfairly penalised UK companies requiring them to give up the investment prospects of the assets in their existing DB pension scheme and also contribute assets out of arrangements that potentially provide returns to the employer as well provide benefits to members in favour of payments out of the Company into the individual pension pots of the current employees only?
* Those contributions should potentially provide better value for money in a CDC scheme than a non pooled DC arrangement but with the administration costs being borne by the members and also possibly without the advantages of mortality risk pooling.
* Who is now reaping the benefits of the blatant over valuation of risk premiums and unrealistically low projected investment returns between 2008 and 2024 and the unnecessary PPF levies paid? It is certainly not UK employers or their employees!
* Would the position have been better if we had DC all along? I think not: Whether LCP’s analysis that DB is 50% more efficient is correct or not, it is undoubtedly true that for £s of pension income in later life, employees and employers have to contribute more into a DC arrangement than in a pooled DB arrangement. If as a result, the contributions paid in have been over-generous, the sponsoring employer of an DB scheme can use the surplus to reduce its future employment costs thereby enhancing its business prospects and enhancing both the employment and pension prospects of its workforce.
We must change our legislative and regulatory mindset from one that appears to only consider risks to one that is designed to promote success. We must not let the fundamentally flawed thinking behind the DB Funding Code, with its sole emphasis on the end stage of the lifecycle emasculate the prospects for CDC.
I don’t disagree with your point except that we can’t land employers with guarantees of future payments that they object to and regulation of the guarantees that …well we know that!
CDC is more efficient as it allows for a great deal of flexibility from both employers and employees and enjoys the advantages of collective investment over many generations. We should not be planning for CDC to fail, we should promote it as the photo on the blog would have it – as there from grannies to kids.
Totally agree with Pension Oldies comments above.