LCP have done some work on this question.
The link to the full report is here.
What is so different about CDC?
It’s the first question that we got from large employers their and unions and it’s the message that needs to get to smaller businesses who do not have unions but are looking for better ways to pay people. For CDC is a better way to pay people a wage for life when they are ready to or have to retire.
People are pretty straightforward about what they want. If they put money away when they are young , they want to know they will be looked after when they get to the end of their careers whether that be lowly or highly paid, people’s expectation is that the wage for life will replace the income they had when they worked.
LCP have a posh phrase for the rate that a pension replaces how much people were paid. They call it the “replacement ratio” and there latest work asks the simple question, how well would our two main pension systems , Defined Contribution and Defined Benefit have done over the last 80 years since Britain came out of war and back to normal life.
What LCP find for CDC vs DC vs DB. This is what 80 years of data tells them
Ivan, Laun and Helen use their data skills to model what would have happened if CDC had been around from WW II till today.
Across all periods considered, well-designed CDC schemes prove resilient to radically different market conditions. In our modelling, CDC outperformed individual DC with annuity purchase in every period tested. This is not because CDC eliminates risk, but because of how risk is shared and managed within the scheme.
In particular, CDC benefits from three structural features:
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Sustained exposure to growth assets, allowing members to participate in long-term equity returns without being forced to crystallise losses at retirement
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Intergenerational risk sharing, which smooths the impact of sharp changes in yields and market conditions
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Adjustable indexation, enabling the scheme to absorb short-term volatility while still capturing upside when markets recover
This what we explain to large employers and unions who are keen to listen. The reason that CDC matters is that it gives more wages in retirement than people can save for on their own.
Here is LCP’s key finding, based on data crunching. If you want to see all the assumptions that they’ve used then you can go directly to the report .
But this chart makes it clear that over the past 83 years since 1943, people would have got a better wage in retirement from CDC than they’d have got from DC or DB pension systems.
No matter what is going on with the economy and with the way the City reacts to it, CDC can deliver pensions in a way that DB couldn’t and DC does but not so well.
Where an employer is prepared to stand behind a DB plan , DB has provided a better replacement income most of the time I have been alive (since 1963 in these models). Only in the last 20 years has CDC done better. We’ll come to that in a better but I think it fair to say that for the employee, a DB pension was, is and for the lucky few – will be , the gold plated pension that they get in retirement.
This is LCP’s second headline and we can understand it by thinking of what Martin Lewis said on his show recently, if we have more than five years to invest, then investing into shares is better for you than saving. I know it sounds ludicrous since these pensions are all designed to pay out for on average 25 years but a lot of what goes on within DC and DB plans is what Martin Lewis calls savings. Only in CDC is an investment for ever.
From this , I think it is clear that for employers, unions and most of all the people these organisations look after through workplace pensions, CDC does particularly well for those who are in CDC for the whole of their life. If you join CDC at 40 you will do well but it is over the last 20 years that CDC would really have helped the younger saver. This takes some explaining but it’s vital for all those I’ve mentioned to understand what LCP is saying so I’ll quote them
In all time-periods the younger member accrues a significantly higher pension than the older member. This is primarily due to accrual being cheaper for younger members because they have a longer horizon.
This is not as simple as it sounds. There is much you can read if you go into the report and I urge you to. But take it from LCP who have no skin in the CDC game (they are not providing a CDC scheme as “proprietor”).
Finally, CDC does something that is remarkable – paying inflation linked pensions
If you take the level black dotted line as the inflation linked pension, the one that you and me would call our expectation for wage increases, you can see that apart from the period when growth didn’t keep up with inflation (it’s called stagflation), CDC has beaten inflation giving ordinary people a pension that goes up in real terms (beating inflation).
We’ve only just done that in the past 20 years but as the first chart (at the top) shows, DC has done particularly badly in providing income recently.
LCP’s message is one that I was brought up with, that collectively we do better than if we try to do it ourselves. Of course there are clever people who make more from money than most of us can ever dream of and LCP acknowledge that some firms will not want to offer a collective solution, but I suspect that there are very few large firms that would pay more in retirement using CDC than through DC. Since most large employers have given up on DB it seems the best they can do.
LCP speaks to us as actuaries do but if you’ve got this far you will probably understand them
Relative to individual DC with annuity purchase, CDC avoids locking in poor outcomes at a single point in time and allows members to continue participating in long-term growth during retirement. Compared with purely individual arrangements, it spreads the impact of adverse market conditions across members and over time, reducing the severity of poor timing for any one cohort.
Of course they hedge their bets as I did , by offering employers an argument to continue in DC
These features come with trade-offs. Outcomes within CDC vary by age and market experience, and pensions in payment may fluctuate in real terms. Whether this is viewed as desirable depends on how fairness is defined: as individual ownership of outcomes, or as collective sharing of risk.
I spend a lot of time with Terry Pullinger who teaches me plain speaking. In plain speaking LC are saying that if you want people to own their own pot and take their chances, DC may be better, but if you want people to share the bad times and the good but generally to get more, then CDC is the type of workplace pension for you. That goes for whether you are reading as an employer, a member’s representative or potential member of a CDC.
