Proposals for Collective Defined Contribution Schemes in the UK

[Sarenco]

Hi Colm

Are you familiar with the proposals to establish Collective Defined Contribution (CDC) schemes in the UK?

Essentially investment and longevity risk is pooled amongst CDC scheme members to provide a targeted (but not guaranteed) income in retirement.

Aon has produced some interesting papers on the CDC concept -

Collective Defined Contribution & CDC Pension Schemes | Aon

Aon Hewitt has conducted research into the CDC which demonstrates that CDC plans can offer advantages of cost certainty to employers.

www.aon.com

It strikes me that the CDC concept might be a logical extension of what your proposal is trying to achieve but I would be interested to hear your thoughts.

 

[Duke of Marmalade]

Hi Colm

Are you familiar with the proposals to establish Collective Defined Contribution (CDC) schemes in the UK?

Essentially investment and longevity risk is pooled amongst CDC scheme members to provide a targeted (but not guaranteed) income in retirement.

Aon has produced some interesting papers on the CDC concept -

Collective Defined Contribution & CDC Pension Schemes | Aon

Aon Hewitt has conducted research into the CDC which demonstrates that CDC plans can offer advantages of cost certainty to employers.

www.aon.com

It strikes me that the CDC concept might be a logical extension of what your proposal is trying to achieve but I would be interested to hear your thoughts.

Yes, this is an interesting development, The Royal Mail are the first to avail of the new legislative framework. Watsons are the Actuaries. They say the fund will invest in "growth" assets until age 67 and then wind down to "safe" assets at age 90. This compares with a conventional I(ndividual)DC plan which they say is in growth assets until age 57 and then winds down to safe assets (annuity) at age 67. They claim in the attached note that CDC will produce 70% more return than IDC. Colm is proposing 100% growth assets throughout and claims an uplift of more than 100% which seems consistent with the Watson figures.
I think CDC is the future for large group schemes. IDC is so unsatisfactory with its individualisation of investment timing and longevity risk. I think Colm's proposals may be more suitable for large CDC than for AE. With a CDC the sponsoring company can set the rules just as with DB because it is paying the piper. This removes one of the difficulties of Colm's proposals in an open AE environment as they will always be in competition with alternative conventional pension plans.

 

[Colm Fagan]

Hi @Sarenco
I only became aware of CDC schemes recently, and haven't yet had the time to study them in any detail.
From what I've seen, they deliver a higher and more dependable income for life than DC + annuity or DC + drawdown. However, my initial impression (which the Duke seems to have confirmed) is that the overall return still falls short of the meitheal approach (That is how a recent article in The Currency described the smoothed approach, borrowing from a comparison I made in the paper. Here is the link to the article in The Currency).
One nice aspect of the meitheal approach from a contributor's perspective is being able to see it as a high-interest deposit account, which is theirs until the day they die. They see the account building up each quarter as contributions are paid (employee, employer and state) and as 'interest' (c3% to 4% a year over deposit rates) is credited. Then, on retirement, they take the gratuity and have considerable flexibility in how they draw down the balance. I suggest that withdrawals could be between 3% and 8% of account balance each year (more over 80). That is a massive improvement on what I see as a CDC straitjacket. Also, the beneficiary can opt for longevity protection for some or all of their account. Most importantly, the remaining balance is there for their dependents/ estate on premature death (even when they have opted for longevity protection). We all think we die prematurely! For most people I know with DC pensions, that is a valuable benefit. We all hate writing off money, even if we're not around when it's written off. I don't think CDC schemes offer that benefit: I gather that the pension dies with you (presumably after the guaranteed period).

It strikes me that the CDC concept might be a logical extension of what your proposal is trying to achieve

Actually, I think it's the opposite. CDC schemes still need actuaries to decide how much you can take as income, etc. I say that the individual contributor can make that decision. It only goes part of the way towards investing in growth assets and so loses out some of the growth potential. Most importantly, it doesn't seem to give contributors the nice warm feeling you get from having your own personal deposit account, which you can see growing year by year, and then declining as you withdraw your savings.

I think Colm's proposals may be more suitable for large CDC than for AE. With a CDC the sponsoring company can set the rules just as with DB because it is paying the piper. This removes one of the difficulties of Colm's proposals in an open AE environment as they will always be in competition with alternative conventional pension plans.

Duke. I'm not sure what the message is here. Can you explain please?

 

[Duke of Marmalade]

Hi @Sarenco
Duke. I'm not sure what the message is here. Can you explain please?

One of the scenarios you discuss in your paper is when smoothed values are materially in excess of market values. On the face of it, it looks like "throwing good money after bad". But you point out that the member would be giving up €233 for every €100 they contribute so smoothed values would need to be impossibly higher than market values for that to make sense. But it could make sense for the employer and employee combined to give AE a miss for the while and contribute to an alternative conventional plan with as good as if not better than AE tax breaks. In a Group DC situation there is no such incentive for the employer to facilitate a move away from the CDC.
But I see the other drawbacks of CDC as you describe in your reply to @Sarenco.

 

[Colm Fagan]

Thanks @Duke of Marmalade
I agree that what you say is possible in theory. I'm not too concerned about it for a at least three reasons:
1. Most employers signing on to AE will be smaller ones who do not already have pension schemes for their employees - the local garage, wine shop, restaurant, etc. This is because any company that already has a scheme where the employer pays more than 3% (the suggested employer contribution rate for AE) will probably continue with that scheme. I would think the vast majority of existing DC schemes fall into that category. Small employers will not be tracking movements in the SV/MV ratio and looking for opportunities to switch.
2. Extreme ratios of smoothed to market value are extremely unlikely for the first 20 or 30 years of the scheme's existence. This is because new contributions tend to pull the ratio back towards 100%. By that stage, employers and employees will be very comfortable with the smoothed approach, particularly as, at a time such as you're talking about, they will be looking at quite acceptable past returns, while more conventional DC schemes will be going through the horrors. See the example of 7.16 of the paper where the smoothed value is 145.6% of market value. The smoothed return over the previous two years was 5.4%. The return for a conventional scheme over the same period was -39.2%. I can't see a rush of employers and employees heading for the alternative scheme in those circumstance - or the even worse ones that would apply if the ratio were even higher than 145.6%.
3. Even if they were so inclined, the picture might have changed dramatically by the time they had finally made the change. See the other example in paragraph 7.19 of the paper (a repeat of February 2009) when the ratio of smoothed to market value was over 140%. It was back below 100% within 9 months.