Govt should boost CDC pensions to rebalance consumer risk

The ‘great risk transfer’ is the name given to the trend of transferring risk away from institutions — employers, the state, financial services providers — to individuals, as represented by, among other things, the steady move away from defined benefit schemes towards DC models.

In terms of harm to individuals and damage to public trust in institutions, we believe risk transfer represents an even wider systemic failure than well-known examples such as the widespread mis-selling of payment protection insurance

John Taylor, IFoA

Though acknowledging that there are benefits to this move, the IFoA is concerned that the negative consequences have not been properly examined and some element of rebalancing is required, easing the burden on consumers and returning some risk to institutions.

It ran a call for evidence between February and May 2020, gaining around 50 submissions, followed up by roundtable discussions in September with stakeholders including the Trades Union Congress, the Pensions Policy Institute, and the Association of British Insurers.

CDC, decumulation pathways, funding codes…

The IFoA’s final list comprises 10 recommendations split between two categories: rebalancing risk and helping consumers with financial decision-making. 

The first recommendation is for the government to be proactive in encouraging the take-up of CDC schemes where appropriate, emphasising their positive qualities vis-à-vis traditional DC schemes.

CDC schemes “are expected to offer better outcomes for individual savers than [DC] schemes”, the IFoA’s Great Risk Transfer report notes. 

“Because members pool their retirement savings into a single fund, they also pool and share the risks associated with uncertainty about the performance of their investments and about how long they will live. This risk sharing allows the scheme to invest in assets with higher expected returns.”

Though CDC schemes are not without their share of challenges, the report argues that the pooling of risk between members mitigates potential upsets in a way traditional DC schemes do not.

The report also argues for the government to consider introducing decumulation pathways, available to all but designed specifically “as a safety net for savers who cannot or will not engage with the decumulation process when entering retirement”. 

“Ideally, this would cover not only contract-based pension schemes, but also trust-based schemes, since the latter may increasingly provide decumulation solutions.”

Other recommendations in the first category include determining a minimum required level of insurance cover, learning from “re” schemes like the levy and pool system Flood Re, and examining the ways it could be expanded to other areas of insurance; and using the Solvency II review post-Brexit to introduce regulations “that will enable and encourage insurance companies to offer affordable guarantees, thereby accepting a transfer of some investment risk from customers”.

It also calls for the “bespoke” route in the Pensions Regulator’s new DB funding code to be genuinely bespoke, and for the code in general to place as great an emphasis on avoiding scheme closures as it does prioritising member security.

Where individuals are concerned, the IFoA report recommends that the Financial Conduct Authority sets more ambitious targets for individual take-up of Pension Wise appointments, and to put in place regulation or guidance that strengthens consumer protection in risk transfer incentive exercises.

The government should also “reinvigorate” its public messaging around minimum pension saving levels and auto-enrolment, the report states.

John Taylor, immediate past president of the IFoA, said: “Transfer of risk to individuals has been driven by governments and companies seeking to reduce their risks. While this may be a rational strategy for these institutions, it has had damaging impacts for consumers and society as a whole.

“In terms of harm to individuals and damage to public trust in institutions, we believe risk transfer represents an even wider systemic failure than well-known examples such as the widespread mis-selling of payment protection insurance.”

Though acknowledging that it would be inappropriate if not impossible to try to reverse the trend entirely, Taylor argued that greater choice and access to pensions and insurance products is possible and desirable. “We believe there are opportunities to rebalance risk away from consumers back to institutions in a way that is likely to benefit society as a whole in the long run,” he said.

Promoting CDC would be ‘controversial’

Though welcoming many of the proposals and supportive of efforts to get the government working with the industry to tackle the problems identified in the report, Aegon pensions director Steven Cameron told Pensions Expert that the government promoting CDC take-up could prove controversial.

“The recommendation likely to prompt most controversy is for the government to effectively promote CDC schemes with the recommendation being to “show employers that CDC schemes are an attractive alternative to DC schemes”, he said. 

“While CDC does seek to transfer certain risks back from the individual, there are many complexities, which again the report highlights. Many of these will be very difficult for members to appreciate, particularly if being auto-enrolled.

“The actuarial profession has a role to play in working through all the complexities, including additional risks where employers are paying at or little more than the minimum, and to put in place mechanisms to reduce the real risk to intergenerational fairness.”

Cameron added that the report’s recommendation around decumulation pathways “warrants further investigation”.

“Current investment pathways for non-advised individuals can help them choose a broadly appropriate fund, but they don’t help determine a sustainable level of income,” he explained.

The proposal to extend these to include an income guide could address this, although as the paper highlights, there are many factors to consider including health, longevity and investment approach.

John Breedon, head of strategic, asset and risk solutions at Buck, and John Yates, principal and DC proposition leader at the same company, told Pensions Expert that the report was right to highlight the “systemic shift” in the provision of retirement income.

“We must do more to deliver better outcomes and protection for individuals. It’s widely accepted that auto-enrolment contributions will be inadequate for many, so suggested contribution levels would help,” they said.

Though investment pathways “seem logical”, they cautioned that the “additional protection of the new DB funding code” should not go “too far and [lead] to closures that would otherwise not have happened”.

“Furthermore with transfers from DB to DC having become extremely popular, more protection is needed. Even where multiples are high, a transfer or capital lump sum within other incentive exercises aren’t for everyone,” they continued.

“The consequence of failure on all of this will be the circle completing and the state needing to again provide for individuals leading to an increase in general taxation at a time when taxpayers can ill afford it.”