CDC Pensions – a complex solution that provides simplicity for employees.
Complexity is bugbear to make people save for their retirement. The need to save is easily explained, but the simplified solutions from the past, at least to the pensioner, of defined benefit pensions and state pensions are either no longer profitable (DB systems) or are under great pressure from changing demographics (state pensions). The new methods used to solve the level of savings in the pension market are much more demanding of financial expertise.
Take, for example, Britain's auto-redemption strategy. This has been, by some measure, an outstanding success. Over 13 million people have been auto-enrolled, and the 9% payout rate has been much lower than predicted. However, there is one drawback ̵
The standard fund is generally a cautious fund and may not be appropriate, especially for younger savers wanting to increase their pension savings over a full working life. Nevertheless, the largest championship NEST has claimed that nearly 99% of its savers, representing over half of the United Kingdom, are invested in their standard fund and do not play an active role in managing their own investments.
Similarly, the introduction of pension freedom has eliminated one of the factors that contravened pension savings – the fear that people would catch in annuity with poor interest rates if interest rates were poor at the date of retirement. This has led to a decline in sales of annuities and a large influx of new pensioners into drawdown products. However, managing a fund's income is a very complex matter, and that means that the entire life expectancy and investment risk are borne by the individual pensioner.
Among the approaches that try to solve these problems for workers is the idea of collective defined contribution pensions – "CDC". CDCs work by collecting all contributions from the member to a single, professionally managed fund and releasing the member from the responsibility of growing the fund. The fund then undergoes an actuarial valuation every year and adjustments are made both to promises to the active members and the payments to pensioners who pay. This ensures that the system's debts and assets stay in sync.
These types of pensions already exist in other countries, especially the Netherlands, and are a smart balance between collecting long life and investment risk while at the same time requiring little financial knowledge from the individual employee. It also makes it possible for employers to facilitate and encourage pension savings without taking on board the undeniable debts that are linked to the old defined benefit schemes.
CDCs would require changes to law allowed in the UK. Pensions Minister Guy Opperman is now committed to introducing this legislation in response to an innovative system proposal from Royal Mail Group and Communication Workers Union (CWU). This proposal concerns a CDC system that covers all employees and which will be based on a collective collective fund. This has many benefits for employees, which means that they do not need to actively manage their investments during the accumulation period and guarantee them a payment from the system for the rest of their lives, even if the actual payment amount is not guaranteed as it may rise or fall each year based on on the annual actuarial valuation of the system.
Although many are calling into question the lack of government initiative at this time, given that the Brexit process takes most of the legislative bandwidth, the Minister congratulates on embracing this system and rapidly proceeding with the legislation required to follow it. The fact that much of the legislation will be secondary legislation, which is relatively easy to change, rather than primary, confirms Oppenheim's stated purpose of carefully monitoring the development of the Royal Mail Group system and making further changes based on how the system works in practicing one welcome flexible approach from the minister based on an appetite to try new approaches and learn from the experience.
This is a welcome development in the pension market and will provide a much-needed alternative in the future that overcomes some of the disadvantages of pure fee-based systems.