Johnson: With-profits a better alternative to risky CDC

Michael Johnson, a research fellow at the Centre for Policy Studies, said defined ambition schemes create “irreversible intergenerational injustice”, among a raft of objections to the model.

In a research paper he argued that instead of introducing CDC, the use of default funds in the form of with-profits funds would deliver many of the model’s characteristics within the current legislative framework.

However, momentum is gathering for CDC. In March, the Department for Work and Pensions said that it was “tempted” to lay regulations allowing its creation after lobbying by Royal Mail and the Communication Workers Union.

And last month, a Work and Pensions Committee report suggested that CDC could help to bolster the welfare state.

The committee called for a government consultation that would include identifying means to preserve intergenerational fairness in CDC, which is a key concern among the model’s detractors.

In my opinion, CDC only works if you have some sort of compulsion

Jens van Egmond, Cardano

Johnson's suggested alternative, the with-profit fund, is a type of long-term collective investment vehicle that was first developed by life insurers as a way of distributing funds’ unplanned surpluses.

Johnson also questioned the applicability of overseas CDC examples in the UK. The model is currently available in the Netherlands, where pension flexibilities are far more restricted.

CDC needs to retain benefits and DC flexibilities

Royal Mail and the CWU are currently the sole group to have asked to set up a CDC scheme since legislation for defined ambition schemes was laid in the Pensions Act 2015.

While the primary legislation for CDC exists, in 2015 then pensions minister Ros Altmann put plans for the required secondary legislation on hold after succeeding Sir Steve Webb.

Paul Hamilton, partner and head of consultancy Barnett Waddingham’s higher education team, said that the current CDC framework focuses on sharing between savers, but sacrifices some of the flexibilities currently enjoyed in DC.

He emphasised the need to “keep those benefits and retirement flexibilities, and solve the [risk-sharing] problem at the same time”.

The paper identifies an “incompatibility with pensions freedoms”, arguing that this inflexibility “can only be overcome at the price of additional cost and complexity” with the use of individual pots in the accumulation phase, a contribution rate for each member and bespoke derisking investment strategies in the run-up to retirement.

Webb, now director of policy at pension and investment provider Royal London, argued in favour of an employer’s right to choose a CDC arrangement for its employees.

Webb, who as pensions minister oversaw the 2015 Act that brought in defined ambition and pensions freedoms, said, “If I’m running a big CDC scheme then frankly I’m not going to care about small amounts of money going in and out”.

“The main worry,” he added, “would be a big stock market movement, or something like that, and people suddenly wanted to get their money out in reaction. But that’s pretty exceptional.”

Is there a difference between CDC and with-profit funds?

The with-profit fund would “preserve individual property rights” and “extend the investment horizon and harness economies of scale through investment pooling”, according to the paper.

It would not provide guarantees, but would include “regulated consumer protections” and “be overseen by a strong, independent governance body”.

Tom McPhail, head of retirement policy at Hargreaves Lansdown, queried the difference between CDC and Johnson’s suggested alternative, arguing that they “suffer the same flaws”.

“The smoothing mechanisms applied by both CDC schemes and with-profit funds create a risk of actuarial misjudgment, something we’ve seen also clearly in the DB sector over the last 20 years,” he said.

A CDC scheme’s ability to share longevity risk and consolidate investments facilitates ‘smoothing’, which is aimed at ensuring the scheme’s sustainability.

Can we learn from overseas?

Unlike the UK, participation in occupational pension schemes is compulsory in the Netherlands.

Members of a Dutch CDC scheme may only receive their pension in the format as defined by their scheme rules. They do not have access to the same flexibilities as UK savers.

Jens van Egmond, manager DC at consultancy Cardano, said that if the UK was to learn from the Dutch, “you’d probably organise it a little bit differently”.

“In my opinion, CDC only works if you have some sort of compulsion,” he said.

The Dutch pensions regulator sets an 'ultimate forward rate', which schemes must use to discount their future pension commitments.

“In the UK, there’s no regulator to say, ‘This is the discount rate’. So, you can just change the assumptions and change how you distribute the pot of money,” he added, which would make it “really hard to gain trust” with members.