Collective individual defined contribution schemes may be the only viable form of collective pension scheme in the short run, according to David Blake, director at the Pensions Institute, Cass Business School.
In a somewhat unexpected move, the Work and Pensions Committee launched an inquiry into collective defined contribution pension schemes in November 2017.
In his submission to the inquiry, Blake outlined three key features of CIDC schemes.
How do you calculate a contribution rate that is deemed to be appropriate to the individual?
Phil Farrell, Quantum Advisory
CIDC schemes keep individual accounts for all members in the accumulation phase, making it easier to value each saver’s pension pot, according to the academic.
The contribution rate would be set to be actuarially fair to each member.
A third advantage of CIDC, according to Blake, would be the unique derisking investment strategy afforded to every individual in the run-up to retirement.
CIDC facilitates freedom of choice
Under a CDC arrangement, employer and employee contribution rates are set in the same manner as conventional DC schemes. However, assets are pooled, and members are without individual pension pots. Schemes outline a notional target, or ambition, for pension payments, but these are not guaranteed.
In contrast, a CIDC arrangement would draw boundaries between member benefits with their separate pots.
The WPC continues its work on pension freedoms, alongside its CDC investigation. According to Blake, conventional CDC schemes are incompatible with freedom and choice, but CIDC could offer the solution.
The CDC model is “designed to have the members sharing, but it’s not designed to have any flexibility whatsoever”, Blake said. This comes down to the absence of an identifiable pension pot for each member, he added.
CDC schemes have also raised concerns over intergenerational fairness. “There is a danger of redistribution… the earlier cohort take out money that should really be more appropriately given to the later cohort. It can turn into a Ponzi-type scheme,” Blake said.
Advantages of CIDC include low transaction costs and economies of scale achieved through pooled risk, according to Blake.
Arrangement could put schemes up against insurers
The regime under which a CIDC scheme would operate would hold importance, according to Paul Sweeting, professor of actuarial science at the University of Kent.
“If it was an insurance regime then you’d be quite limited on the investments that you’d be able to hold for those retirement payments,” he said.
“If you were in a pensions regime, then you might be able to argue that you could take more investment risk, but you’d be setting yourselves up as direct competitors to insurance companies with perhaps an unfair advantage in terms of the level of capital you’d need to hold,” he added.
Sweeting disagreed with Blake’s view that CDC schemes and pension freedoms are incompatible.
“It’s not necessarily inconsistent with freedom of choice, because you can always work out some sort of transfer value to give to people so they can take it somewhere else and take the level of investment risk they wanted to take, but it’s not designed with freedom of choice in mind,” he said.
The difficulty of linking members to income
In his submission to the select committee, Blake highlighted the ability to set contribution rates for each member with CIDC, creating a direct link between payments into the scheme and the benefits received.
Phil Farrell, partner at consultancy Quantum Advisory, queried the ability to set individual contribution rates in a CIDC arrangement.
“How do you calculate a contribution rate that is deemed to be appropriate to the individual, because it’s inextricably linked to the ambition income level for that person. It might not be what they’re after, it might not be what they require,” he said.
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Pension freedoms have been a popular way of giving savers control over their retirement planning. The identifiable nature of savings afforded by CIDC goes some way to meet this demand, but has left Farrell unconvinced.
Although individual pots might address some of the concern of people wanting to know where they are putting their money away, “ultimately, all the kind of factors around that which are going to generate... this adequate income, are going to be out of their hands”, Farrell said.
