Collective Defined Contribution Pension Schemes

Honour Guard 10.12.13 P D Tiley Downing Street

It emerges that the annuity market is not working for consumers in the UK.

What a surprise! Not only are pension savers losing a large proportion of their savings (and their employer’s share too) but when they ‘de-cumulate’ (or convert their fund into a pension in plain language), up to 60% are not shopping around for the best deal. The ones that do can get 25% or more in extra income, but potentially a lot more if they are in poor health and able to buy an enhanced or impaired health annuity.

It is becoming increasingly clear, however, that individual annuities are very expensive to administer. Margins are still fairly high, but barriers to entry enormous, so the likes of easyPension and Virgin Annuities are yet to surface. So even where the consumer shops around he is still losing a fair chunk in charges and costs when he retires.

The worst hit are those pensioners with small ‘pots’, and what is needed here is for National Savings to enter the market and offer a product for funds up to £10,000 or thereabouts. Otherwise those with the least will continue to be the ones that end up with the worst deal. Just as they do for utilities (token meters), high cost loans, and so on.

Collective Defined Contribution

Is there a solution? Well there is actually. The most efficient system already exists in countries like Holland. This is where pension income is paid from the fund and investment is pooled. This enables a longer term approach to saving and a more efficient use of growth assets. Schemes can also exploit the liquidity premium in such asset classes as infrastructure and property.

Back testing and various independent research studies by the likes of Aon Hewitt have confirmed that around 30% more income should be possible for the same level of contribution. Or if the Finance Director is reading – you could save 30% of your pension costs!

This is called Collective Defined Contribution (CDC) and harnesses the economies of large, not for profit, employer funded group schemes with the low risk of DC for employers. It is almost a throw back to the days of ‘best endeavours’ final salary with no guarantees or increases for inflation hard wired in to the rules.

It is those guarantees brought in with good intention in the 80s and 90s, when some employers refused to share huge surpluses with members (in terms of basic inflationary increases), that caused the demise of final salary schemes. Those guarantees ended up costing much more than anybody envisaged when inflation fell to below 5% in 1991/2 and remained there until 2009. This meant the guarantee would bite fully with no gradual reduction in value in real terms of the pension promises made.

Coupled with the other wammies of increasing longevity, taxation and short sighted investment practices influenced by accounting standards, these paved the way for a slow death for traditional final salary schemes. However, Career Average have prospered in some areas, e.g. which is a defined benefit success story if ever there was one.

So where’s the catch? Well the only catch is that in theory pensions in payment could be cut, and this has happened on occasions in Holland. However, this is rare and a modest cut is probably a price worth paying for a starting income 30% higher in the first place!

The existing annuity providers are keen to keep the status quo, and are on target to enjoy increasing levels of business as more and more DC pots begin to mature. Hopefully Steve Webb, Pensions Minister, will change the law later this year to encourage collective DC in the UK. But will employers adopt them? Perhaps it will take time to educate and persuade employers to switch from ordinary DC, but large paternalistic employers will take them up, and industry wide schemes will hopefully emerge so that smaller employers can also benefit. Who wants to miss out on a 30% pay rise?

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