By Carl Giannotta
In the Netherlands, CDC schemes act as a kind of half-way house between the traditional DB and DC models espoused in the UK.
The CDC structure attempts to eliminate the negative features of both; a scheme without the potential to wreak havoc on a sponsor’s balance sheet whilst simultaneously benefitting from the collectivism and economies of scale of a DB scheme for members. A CDC can also exist as an industry-wide scheme, completely autonomously of a sponsoring company (all hairdressers in the Netherlands, for example, have a sponsor-free collective pension scheme).
Sounds too good to be true? There are of course drawbacks – members’ benefits can be cut in nominal terms or indeed simply remain non-index linked, resulting in a real-term cut to pension income.
The Collective vs Individual Freedom
With pensions in the UK press since the Budget 2014, on a superficial level, now would seem a perfect time for Steve Webb to speak about further innovation. That being said, CDC stands as somewhat of an incongruity with the Conservative Chancellor’s changes. The Budget transformed pensions into a leading individualist free-market Tory policy in which the populace could finally take charge of their own destiny when it came to retirement income. Perfect for the clued-in member wanting to run their workplace pension pot like a SIPP (cue applause from retail platform and fund providers). The collectivism advocated by the Liberal Webb would, to an extent, remove individual choice from such members, just as auto-enrolment and the Budget have the British public engaging with pensions and savings.
CDC schemes throw a new spanner in the works of pension-based risk, namely that of the intergenerational mismatch. This was a pet subject of Keith P. Ambachtsheer in his Pension Revolution and relates to the fact that within any collective scheme, today’s guarantees for retirees are tomorrow’s risks for successive generations, due to cross-subsidisation.
Dr Ros Altmann has also alluded to this, stating that due to a reticence among schemes to cut pension benefits, younger members could end up with less than if they had their pot individually earmarked as with a traditional DC arrangement.
As an aside, there are currently legal barriers to CDC structures entering the UK market. Under current UK case law, any target or ambition of a DC scheme regarding benefits is likely to be interpreted as a liability, creating a deficit and a debt payable from the sponsor, turning into a DB with the potential for tapping the sponsor for deficit funding. In this respect the legal position needs to change through new legislation provisions to accommodate flexibility in terms of benefit targets for members.
Utilitarian CDC
Despite the plausible claim that CDC takes away some of the freedoms instilled by the Budget, it does so no more than would a traditional DB scheme; few would argue that DB is an inherently weaker model than DC, so why apply such flawed logic to the individual vs collective debate? While recognising its weaknesses, it is my contention that CDC would create more utility in the market than it would destroy, for numerous reasons: the economies of scale brought about by CDC, in particular, CDC schemes without a sponsor, will negate the negative impact of market fragmentation; the fact that there are so few payers in the AE space. Furthermore, implementation of CDC post-auto enrolment staging will be difficult.
If you think that CDC sounds too good to be true then you are probably right. CDC is not a risk-free cure-all for today’s pension problems. To understand CDC is to acknowledge the risks associated with the structure from both the sponsor’s and the member’s point of view and how in turn they compare with DB and DC structures.
Carl Giannotta is head of institutional sales and business development at Kas Bank
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