Confirmation in the Queen’s Speech earlier this week that Dutch-style collective defined contribution schemes (CDCs) will be launched in the UK suggests this government really does have it in for the annuities market.
On reflection that might not be such a bad thing, but the decision to launch CDC schemes in the UK – and to do so now – is an interesting one. The schemes, which will launch in 2016, could see millions of workers change the way they save for retirement. Instead of contributing into individual pension pots, employees would pool their investments with thousands of other members into huge group funds. At retirement, members would take their income directly from the fund, negating the need to purchase an annuity.
There are several benefits to this type of structure: unlike traditional DC schemes, CDC gives members a clear picture of likely pension amounts as they move through their career. Furthermore, their biggest selling point has always been the ability to remain invested in growth assets at retirement. Traditionally, someone retiring at age 65 was forced to invest in assets such as government bonds for 30 years or more through the purchase of an annuity policy. It is from this key difference that claims of CDC schemes being able to increase member outcomes by as much as 30% originate.
These calculations may well be accurate, but since the government announcement less than three months ago that compulsory annuitisation will be scrapped from next year, it does make you wonder how much of a unique selling point this extended growth asset phase really is. With or without CDC, people can now invest in ‘riskier’ assets for as long as they like.
One only has to look at the Dutch experience to see that there are risks for both employees and employers alike. The major concern over CDC is the smoothing of investment returns, since the design of the pool is aimed at evening out the peaks and troughs of performance. In fact, the Dutch collective system faced this exact problem when in April last year, under orders from the Dutch central bank, 66 of the country’s more than 400 pension funds started cutting their monthly payouts by an average of 2% to make up the funding shortfalls. At the time, the payout reductions sent shockwaves through the country and as a result, young people are increasingly losing faith in the pension system.
As a result of these shortfalls, employers have found themselves paying in extra money rather than face the industrial relations impact of benefits being reduced. Unsurprisingly, the reaction from UK employers to CDC has been muted, based in part on the Netherlands’ experience.
It’s not all bad news however – providing CDC schemes can eventually operate at scale, sharing risk means lower operating costs and access to different types of assets. Infrastructure and other previously out-of-reach investments can boost diversification, lower risk and provide more stable returns.
CDC could also answer one of the critical concerns of the new flexible pension arrangements unveiled in the Budget: what happens to members who live longer than expected but without the insurance of an annuity?
After being forced down the annuitisation route for so long, having several different options may be be the best thing for savers. Ultimately, the future of defined ambition may be determined by how well its collective approach can be squared with the new individual freedom granted by the Chancellor’s Budget.
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