Collective defined contribution schemes are back on the table. And this time, it looks like for real. At last, there is demand, albeit from just one employer, Royal Mail.
The work and pensions select committee is running an inquiry and the government also appears to be taking it seriously.
Unfortunately, a lot of the old hype remains. Claims, for example, that CDC delivers 33 per cent more benefit than DC is both untrue and misleading.
Defined benefit, DC and CDC pensions are free to invest in what they like, so none have an advantage in terms of accessing special asset classes.
The other claim is that CDC can run at a lower cost than DC. Again, this is nonsense. If we examine the retail Sipp market, administration can be had for 0.25 per cent and a choice of passive funds from 0.05 per cent: 0.3 per cent all in.
If the member wants help with investment management, they can choose a multi-asset fund built from passive components for just over 0.2 per cent. All in, they will still be paying less than 0.5 per cent.
This is about the same price a member of an average DC scheme will pay. In other words, the retail investor has access to the same “institutional” price as a large employer for admin and fund management.
So, what does CDC do that DC does not? Firstly, it pools investment risk between members. Secondly, it pools longevity risk between members. And that is about it.
For those thinking it looks a bit like with profits, you would not be far wrong. However, CDC aims to avoid the same solvency rules that apply to insurers. Those rules require capital to be set aside so that guarantees can still be met, even if the future does not pan out as projected.
Instead of guarantees, CDC offers the looser promise of a benefit at retirement. The benefit, once in payment, can change (for example, by not applying promised inflation rises) or, in more extreme circumstances, be cut.
Exiting the scheme to choose drawdown, an annuity or cash also presents a problem. If the promised benefit has a higher capital value than the underlying assets of the scheme, do you allow the member to leave with the higher value? Or do you give them only their fair share of the scheme assets?
Nobody is saying CDC is not doable. But those of us who have been around a long time worry that history may be about to repeat itself.
Take the claims in the 1990s that double-digit investment returns would continue for the entire 25-year life of an endowment. We also discovered customers did not understand the difference between a promise and a guarantee.
Claiming this “new” invention is the greatest thing since sliced bread is delusional. Much worse,it is unfair to the potential members of these schemes being set up for disappointment.
CDC schemes are not special, they are just different. They have their own unique set of advantages and flaws. Let’s hope our regulators insist equal weighting is given to both and that clients now understand the difference between a promise and a guarantee.
John Lawson is head of financial research at Aviva