For the few, not the many

23 Jan 2019

For Con Keating the DWP’s CDC consultation lacks depth in some areas, details in others and has a dog that does not bark.

The long-awaited consultation on collective defined contribution (CDC) pensions has been published and there have been several well-attended meetings to discuss the paper and possible designs of schemes.

The paper is disappointing in that it greatly limits the scope of the proposed legislation: “The initial framework is intended to facilitate provision by single or associated private sector employers…” and “… our initial approach is intended to facilitate CDC provision by schemes established by employers with a sufficiently large workforce to pool longevity risk and sufficient resources to develop an appropriate design, and which have a history of pension provision and an established governance structure in place alongside experienced advisors.”

This works well for Royal Mail, whose proposed scheme has clearly served as a template for the consultation, but there are fewer than 20 other companies which might satisfy these conditions. It feels as if we might almost be back in the world of the nineteenth century private railway acts. These conditions also exclude some of the largest schemes in the country, namely the multi-employer, industry-wide schemes, such as USS and Railpen.

The Work and Pensions Select Committee had a much broader vision: “…more diverse and ambitious provision of collective pensions across industries and professions, and to self-employed and gig economy workers.”

The paper is much concerned with “sustainability” but leaves the term undefined and unexplained. The concept is more than a little elusive, given that pensions can and must be cut to maintain balance between the targeted pensions and the assets available.

Scheme governance is touched upon but not investigated in depth. This is regrettable as these are effectively member mutual organisations, whose members bear the risks of the scheme; they are best positioned to decide what does and doesn’t constitute sustainability for them. It is appropriate for the scheme trustees and indeed The Pensions Regulator to recommend winding-up when circumstances, in their opinion, justify this, but the decision should be left to a vote of the membership. The generic criticism of the consultation paper is that it envisages many areas in which regulation may be introduced, but where these concerns are best dealt with by scheme rules.

The classic example is one of subsidy by new member awards of the entitlements of older members. A simple scheme rule to the effect that awards should be made on the basis of the trustees’ best estimate of available investment returns will resolve this. It is also worth noting that the risk management rules of a scheme will serve to temper rapidly any over-generous awards.

It is important to eliminate as many of the potential discretions as possible, and this is best done through scheme rules. This will serve to build member trust and confidence, and enhance scheme sustainability. It would also add considerable substance to the proposed authorisation process to be implemented by The Pensions Regulator.

It would be wrong to paint a completely negative picture of the consultation paper. Its proposals will allow the creation of some CDC schemes; some of the proposals might even be considered adventurous, such as the proposal not to introduce any buffer requirements, which is unconventional but correct. The requirement to require similar treatment of all members when adjusting pensions is also sound. Indeed, it is a key element of inter-member and inter-generational fairness.

There are a few bizarre ideas, such as the requirement for schemes: “to undertake a peer review of their underlying actuarial assumptions prior to seeking authorisation” and its companion: “This peer review would be undertaken by actuaries independent of the scheme actuary.”

The spectre of a conventionally wrong herd comes to mind, along with an absence of redress. The consultation proposals may not quite be a full-employment charter for actuaries, but they do get assigned a number of responsibilities which could be discharged equally well by a “suitably qualified or experienced person”.

The consultation is thin on taxes, lacking detail of the precise treatment.

There is a dog which doesn’t bark at all in the consultation. It is very surprising, given the prominence of the Communication Workers Union in the Royal Mail case, that unions get only a single mention. It is doubly surprising, given the emphasis in the consultation on member communication, a field in which unions are active and have considerable experience and expertise, and that only occupational schemes are permitted.

There is a rambling discussion of a particular asset allocation strategy – the movement of return-seeking assets to low risk securities as members and the scheme age. This appears to have been lifted from the Royal Mail design. It may be appropriate there but it is not in general. The investment of a fund and its implementation are already the subject of a statement of investment principles (SIP), which requires disclosure to and approval by members.

The incidental effect of risk sharing among members is to add an extra degree of freedom to the investment management mandate.

The terms of award define a target return for the fund to equal or exceed, which risksharing among members may modify. This is the heart of sustainability. The incidental effect of risk sharing among members is to add an extra degree of freedom to the investment management mandate.

The target return now needs to be achieved on average over a term arising from the amount of un-utilised risk-sharing capacity. Accordingly, the proposal for the charge cap to apply annually at overall fund level should perhaps be applied to these mandates on average over their term.

This consultation is important; it will shape the future regulatory environment for CDC and all of its permitted variants. It deserves attention and response.

What we should seek in the CDC legislation is flexibility, to permit variation in scheme design and in the range of potential sponsors.

Con Keating is head of research at BrightonRock Group

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