Another day, another plan to ‘reform’ the UK pensions market. At this rate, it is going to be a very long 15 months to the 2015 General Election.
The latest idea to excite the papers is pensions minister Steve Webb’s promotion of Dutch-style ‘collective defined contribution’ pension schemes – or ‘CDC’ to the pensions and think-tank world to whom it has hitherto been almost exclusively known.
After supportive write-ups in the Daily Mirror and Daily Mail yesterday, CDC – or at least its alleged benefits – is now a bit more familiar. With shadow pensions minister Gregg McClymont a fan and Ed Miliband’s favourite think-tank the IPPR also coming in out favour of ‘going Dutch’ it is time for those of us a little more sceptical about CDC to speak up.
Here are 10 points everyone should understand about CDC:
1. CDC does not guarantee higher retirement income
CDC’s fan club repeatedly state that it could deliver higher pension income than workplace GPP schemes. But CDC schemes are no more immune to lower than expected investment returns than other pension schemes. The Dutch system has recently seen unilateral cuts in the level of benefits paid. By April 2013, two million active members, a million pensioners and more than two million deferred members in The Netherlands had faced a reduction in benefits.
2. CDC can hit the young
CDC schemes work by sharing risks between all members, pooling the investment in one fund. This brings down overheads but involves transferring risks from old to young, with younger scheme members bearing the risk of reduced future payouts to ensure the benefits of older members are preserved. That is why the youth wings of three major Dutch political parties recently agreed a cross-party campaign to ditch the Dutch model and move to a UK-style system of individual pension plans.
3. CDC would require UK pension savers to give up their current rights
Under CDC there are very limited options for a saver to choose the contribution level, risk profile or investment strategy. Everyone is treated the same as a ‘collective entity’ not as a group of individuals. This is similar to the ‘with-profits’ model which is disliked by UK regulators for the lack of transparency it affords the individual.
4. CDC requires a collective labour market
Unless the Daily Mail has had a Damascene conversion to collectivised labour markets, it may want to look more closely at CDC. CDCs in The Netherlands are built on the collective model of employers, unions and employees agreeing all major labour market decisions together. CDCs are heavily unionised with senior union officials having more say over how an individual’s contributions are invested than the employee.
5. CDCs are regressive. It is puzzling that so many on the centre-left of British politics are fans of such an obviously regressive system. In CDC schemes, low-earners, who tend to have below-average life expectancy, subsidise the high earners who tend to live longer. Unlike in the UK, there is no scope for those with low life expectancy (often the poorest) to receive higher retirement income through enhanced or impaired annuities.
6. CDC schemes are less transparent and more complicated than UK workplace schemes
The UK pension debate in recent years has – rightly – focused on the need for greater transparency and simplicity, especially in workplace schemes used for auto-enrolment. Yet CDC schemes are notoriously opaque and complicated, with members unable to be certain how the total pot will be distributed and its risks managed, a key concern for UK regulators in recent years.
7. CDCs increase the risks of market concentration
For CDC schemes to work economically, they need scale; to be as big as possible. Yet for pensioners, very large pension schemes carry risks as well as cost savings; a strategic mistake by the trustees, actuaries or investment managers would have an impact on a much bigger number of savers than those saving through a UK-style Group Pension Plan. If CDCs begin but do not grow significantly as Steve Webb has alluded to, it will be difficult for them to achieve economies of scale to deliver their promises of lower costs and better investment returns.
8. CDCs place much greater burdens on employers
With CDCs employers not only need a collectivised bargaining structure (see above) they also have to take a much greater role in explaining to employees the choices they face, including the fact that future project retirement incomes may not be delivered. At the moment, employers need only facilitate their workers joining a GPP and even that has been a monumental struggle in some places.
9. CDCs will need someone to guarantee outcomes
As John Ralfe has pointed out, CDCs rely on a higher proportion of equity holding than normal DC schemes to deliver the returns its advocates promise. Yet the cost of insuring against underperformance will rise over the option period, meaning a guarantee will typically be needed from an investment bank, insurance company or government to reassure savers that they are not entirely in the hands of the long-term equity markets.
10. CDC would take a generation to introduce
Deciding the future shape of the UK pensions system is not like playing Lego – it can’t be taken down and rebuilt every day to suit the whim of the moment. Pension systems tend to reflect the long-standing cultural preferences of the society they operate in which is why the UK now has a largely individualistic system (replacing the more collectivist post-war DB model) while our Dutch neighbours have traditionally had CDC reflecting its highly collectivised labour market and employment model. If we understand this, it should make us even more wary of assuming that any transition to such a radically different model would be anything other than hugely time-consuming, counter-cultural, opposed by regulators and potentially oversold by politicians needing to demonstrate ‘vision’ or another ‘silver bullet’.
There is still much to be done to build confidence in the UK pension system and UK workers need to continue to be encouraged and incentivised to save more and save longer for their retirement. We in the pensions industry have more to do too.
But raising false hopes that if we all go Dutch, the Land of Milk and Honey awaits is as misleading as it is irresponsible. It is certainly not what many people in The Netherlands think about their system.
Let’s concentrate instead on making the current reforms work effectively for employees and employers to deliver good retirement outcomes from low-charging workplace schemes.
Huw Evans is director of policy at the Association of British Insurers