Work and Pensions Committee Inquiry into Collective Defined Contribution Pension Schemes Response from The Pensions Management Institute
- 2 - Response from the Pensions Management Institute to Work and Pensions Committee Inquiry into Collective Defined Contribution Schemes Introduction PMI is the professional body which supports and develops those who work in the pensions industry. PMI offers a range of qualifications designed to meet the requirements of those who manage workplace pension schemes or who provide professional services to them. Our members (currently some 6,000) include pensions managers, lawyers, actuaries, consultants, administrators and others. Their experience is therefore wide ranging and has contributed to the thinking expressed in this response. Due to the wide range of professional disciplines represented, our members represent a cross-section of the pensions industry as a whole. PMI is focused on supporting its members to enable them to perform their jobs to the highest professional standards, and thereby benefit members of retirement benefit arrangements for which they are responsible. In preparing our response to this Inquiry, we decided to consult our members. As noted above, our membership represents a cross-section of the pensions industry as a whole, and we believe that their collective insight would provide a particularly effective insight into the views of all professions working within the occupational pensions sector. With this in mind, we prepared a survey for our members. Given time constraints, we were only able to run this between 27 November 2017 and 19 December 2017, but during this period, we received 98 responses. These have formed the basis of our response as set out below.
- 3 - Benefits to savers and the wider economy Would CDC deliver tangible benefits to savers compared with other models? The view of our members (see survey results below) was that overall CDC schemes would be a beneficial introduction in the UK. We note that in other countries most notably the Netherlands the provision of benefits in the form of a scheme pension results in greater consistency in the value of retirement benefits as members are less vulnerable to the influence of market conditions at the point of decumulation. Crucially, we are aware of research conducted by Aon which suggests that retirement benefits from Dutch CDC schemes are higher than those enjoyed by British retirees from conventional DC arrangements. CDC is able to take a long-term investment strategy that avoids completely the rigid accumulation / de-risking / decumulation cycle of conventional DC. Another attractive characteristic is that CDC achieves a more equitable degree of risk-sharing between the scheme sponsor and membership; something that has never been possible either with conventional DC or Defined Benefit (DB) arrangements. CDC also offers the possibility of a seamless auto-enrolment vehicle. A series of defaults would apply to each phase of membership: enrolment, investment strategy and ultimate decumulation could all be managed effectively without requiring any form of active intervention by the member. However, our members also expressed concerns about CDC. The strongest criticism stemmed from the inter-generational cross-subsidies associated with this type of scheme design. Members were concerned that the contributions of younger members are used to provide benefits for retirees rather than secure deferred benefits for younger members. This in turn leads to another concern: that this type of scheme is susceptible to funding strains in a manner comparable with DB arrangements. Some have even compared the funding characteristics of CDC schemes with With Profits funds. Our survey asked: To what extent would the introduction of CDC schemes improve the standard of workplace pension provision? Responses were as follows: Count percentage A significant improvement 15 16% A moderate improvement 37 38% No change 28 29% Mildly detrimental 11 11% Extremely detrimental 6 6%
- 4 - It should be noted that over half believed that the introduction of CDC schemes would see an improvement in the standard of workplace pension provision. Comments from respondents included the following: Individual members bear less of the investment risk, employer not exposed to the open-ended risk of DB - feels like a happy middle ground. For those employers who want to sit between DB and DC it offers another option that can only enhance the outcomes for their employees if they feel that DB is a step too far We also asked: What do you see as the major advantages of CDC schemes? Responses were as follows: Count percentage Higher pensioner incomes 35 36% Members free of investment decisions 42 43% Members largely unaffected by costs and charges 30 31% Trustees not constrained by having to use unitised funds 19 19% Other 9 9% 28 respondents (29%) saw no specific advantages arising from CDC schemes. We also asked: What do you see as the major disadvantages of CDC schemes? Responses were as follows: Count percentage Intergenerational cross-subsidies 46 47% Loss of member choice over investment strategy 32 33% Schemes vulnerable to funding problems in the manner of DB 52 53% schemes CDC schemes have to be very large 43 44% Members may not understand them 64 65% Benefits are not guaranteed 48 49% Other 11 11%
- 5 - One respondent was concerned by perceived similarities between CDC schemes and With Profits funds. 7 (7%) respondents saw no major disadvantages associated with CDC schemes.
- 6 - How would a continental-style collective approach work alongside individual freedom and choice? By default, CDC schemes pay benefits in the form of a scheme pension. Existing statutory provisions would require this benefit to comply with certain requirements, such as: Limited Price Indexation increases in payment Provision of a dependant s pension The option of commuting part of the starting rate of pension to a lump sum We understand that the Pensions Act 2015 would permit benefits in payment from a CDC scheme to be reduced, although given the various proposed scheme design options for CDC arrangements greater legal clarity would be beneficial. There would also have to be a credible mechanism for calculating a member s notional share of fund. This would be necessary for calculating compliance with the Lifetime Allowance (LTA), calculating retirement benefits and calculating transfer values. One CDC design achieves this by awarding points to members based on the monetary value of contributions received. These points allow for investment returns achieved between the date of contribution and the ultimate date of calculation. The system can be seen as being broadly comparable to a Nectar card. It is of course possible that some members will opt not for the guarantees provided by a scheme pension and will prefer to exercise the options made possible by the Freedom and Choice reforms introduced in 2015. Our view is that if CDC schemes were to pay transfer values in the manner currently required of registered schemes, this would be perfectly possible. Our survey asked: The inquiry seeks to know if CDC schemes are compatible with the existing Freedom & Choice agenda. Assuming the CDC schemes are able to pay transfer values, do you believe this would be a problem? Responses were as follows: Count percentage It would not be a problem 48 50% It would be a minor problem 38 39% It would be a major problem 11 11% Comments from respondents included the following:
- 7 - Few schemes currently provide full freedom and choice options themselves, requiring members to transfer out to access them. So CDC schemes would be no different. partial transfers should also be allowed Any perceived problems at the scheme could generate a run, and given the popularity of "Pension Freedom" many will want to cash in their savings at retirement. This doesn't support long term investment and could create issues similar to those which affected With Profits, and I can't see the Government permitting any form of Market Value Adjustment to protect remaining members.
- 8 - Does this risk creating extra complexity and confusion? Would savers understand and trust the income ambition offered by CDC? Historically, the pensions industry has been unrealistic about the extent to which members can become engaged with pension saving. Arguably, during an era when DB provision was dominant, this was of limited significance: the value of befits was determined in advance by scheme, and members were not required to make investment decisions. The historic failure to achieve effective member engagement in the era of conventional DC has been addressed in other ways. Auto-enrolment works through harnessing inertia. Members do not have to give explicit consent in order to join a workplace pension scheme, and the design of default funds acknowledge that the vast majority of members choose not to self-select funds. It is unlikely that members of CDC schemes would understand the design of their scheme any better than do members of existing arrangements. Our third survey question indicates that 65% of respondents believed that members would not understand CDC. However, the lesson of auto-enrolment is that this need not in itself be a barrier to success. Effective governance is more important than high levels of member engagement. This would be as true of CDC as it is of any other scheme design.
- 9 - Converting DB Schemes to CDC Could seriously underfunded DB pension schemes be resolved by changing their pension contract to CDC, along Dutch lines? How would this be regulated and how would the loss of DB pension promises to scheme members be addressed? We were somewhat perplexed by this question. Most DB schemes including those with serious funding problems are closed to new entrants. As a constant flow of new entrants is important to maintain a CDC scheme s funding, converting a closed scheme to CDC would not be an obvious course of action. There would also be legal complications: a Regulated Apportionment Arrangement (RAA) compares benefits to be provided from a replacement scheme with those payable via the Pension Protection Fund (PPF). This would not be applicable in the case of a CDC scheme unless the RAA concept were to be significantly redefined to accommodate the characteristics of a CDC scheme. We asked our members: The inquiry asks if underfunded DB schemes might be converted to CDC arrangements. Were this to be permitted - by means of a modified form of Regulated Apportionment Arrangement (RAA), for example how beneficial for members of stressed schemes would this be? Responses were as follows: Count percentage Very beneficial 5 5% Quite beneficial 31 33% No impact 5 5% Potentially detrimental 32 35% Potentially very detrimental 21 22% Comments included the following: Likely to be detrimental but it would depend on the terms of the payment to the CDC scheme. Presumably, transfer values would be reduced due to underfunding and members are moving to a non-guarantee environment. If so, it does not look great for the transferring employees. How would this interact with the PPF? Would you be better falling into the PPF and getting a fixed level of benefit rather than relying on someone's best guess on investment strategy and benefit apportionment? Don't allow CDC to be used as mechanism for employers to avoid their funding obligations. I do not see this as an advantage over the PPF.
- 10 - We did however consider how CDC schemes might be established in the UK. We asked: Given that CDC schemes are commonly very large in order to achieve effective economies of scale, how might schemes be established? Responses were as follows: Count percentage Converting the LGPS to CDC 23 23% Converting NEST to CDC 49 50% Converting other existing Master Trusts to CDC 46 47% Creating new industry-wide or regionally-based schemes 58 59% Stand-alone schemes for vey large employers 34 35% 18 respondents (18%) did not consider the creation of new CDC schemes a viable option. Comments included the following: There should be a wide range of possibilities for how CDC schemes could be established. CDC if introduced seems a more natural fit with Master Trust schemes, some of which were industry based anyway or larger employers. The biggest flaw in CDC is it is based on three myths. Firstly, that size of aggregate funds managed guarantees economies of scale, secondly that lower investment charges has a material effect on price, and thirdly that larger schemes charge a lower price for DC. If the lowest achievable investment charges are 0.03% for a large master trust and 0.08% for a small master trust, then on a fund of 1,000 the effect of using a large scheme is to achieve a saving of 0.50p per annum per member, yet the two schemes both might still charge the same 0.50% AMC. Economies of scale can only operate to reduce price in a market which does not have a price cap, and in particular a price cap below the cost of production. By far the greater costs of DC are incurred in third party administration charges and communication costs, which for the largest schemes will amount to at least 30 pa (NEST s are 40+) and the 0.50p saving equates to 1.6% of total costs. If NEST were transferred to a CDC who would meet the administration costs? The elephant in the room which the authorities have not yet noticed is that firstly, the regulatory pricing cap imposed on the pensions market is set below the costs to serve auto enrolment business. It means the market is not sustainable. Secondly, the administration and management costs of a traditional workplace pension are borne by the employer with only investment manger costs being borne by employees. Yet the market has been forced to follow the pre RDR insurance company Personal Pension headline AMC charge, a loss leader chasing market share offering no governance, and only covering marketing and investment costs. It should be evident that NEST s 0.50% charging basis,
- 11 - carried over to a CDC, means a loss of over 100 pa for each member pa will need to be picked up by the sponsoring employers of the CDC. Record keeping and communication costs are not lower because the fund has sizeable assets, and scale is not material. Alternatively the authorities might realise that a charge cap should only apply to investment charges, the only cost that is priced as a % of FUM and the market should determine the price and quality of ancillary services.
- 12 - Regulation, governance and industry issues How would CDCs be regulated? If CDC were to be implemented in the UK, it seems logical that existing arrangements be converted to this design of scheme. The Pensions Regulator has made no secret of the fact that it believes that there are too many Master Trusts in this sector which will never become big enough to be viable over the longer term, and that extensive consolidation is inevitable. The creation of large schemes would lend itself very naturally to the establishment of CDC schemes. We envisage that CDCs would be subject to a regulatory structure comparable to that which currently applies to Master Trust arrangements. A specific regulatory culture has evolved that applicable to Master Trusts, and we imagine that comparable approach would be developed for CDC schemes.
- 13 - Is there appetite among employers and the UK pension industry to deliver CDC? Ultimately, whether CDC would work in the UK would be subject to political will. Proponents focus on the success of the model in other countries and argue that the system combines the more desirable characteristics of traditional DB and DC arrangements. Opponents are concerned about aspects of inter-generational risk sharing in particular. Government must take care in assessing evidence and distinguish properly between genuinely informed comment and simple vested commercial interest. We asked our members Do you believe there would be a desire amongst employers to see the introduction of CDC schemes in the UK? The responses were as follows: Count percentage No there is no appetite for CDC 45 47% Yes as a long-term replacement for other scheme designs 28 30% Yes in addition to existing scheme designs 22 23% Comments included the following: Possibly, but more likely as an employer affordability decision to move away from DB and/or convert underfunded DB schemes to CDC. Could be useful as an auto-enrolment vehicle where members not interested in making investment decisions. Employers are already struggling with AE more changes would be frustrating. Potentially yes. I think immediate concerns are affordability of employer contributions and employee understanding. I don't think they are wanting further change at this point. Yes, but I'm dubious about the numbers of employers who'd take it up.
- 14 - Would CDC funds have a clearer view towards investing for the long term? As has been noted earlier, CDC schemes are not subject to the same constraints as conventional DC schemes. Unitised funds need not form the basis of scheme assets, and there is scope for investing in a wide range of assets more commonly associated with larger DB schemes. The traditional investment strategy associated with conventional DC, is which there are separate phases for accumulation, de-risking and ultimate decumulation are no longer necessary, which allows the scheme as a whole to invest more heavily in growth assets. CDC schemes are in our view are far better positioned for adopting a long-term investment strategy than is the case for a conventional DC arrangement. ***** ***** *****