Industry experts are calling for ‘collective’ defined contribution schemes to be the default option for DC members, following the radical overhaul of the pensions system announced in the Budget last year.
CDCs pensions, which were legislated in June last year, have been widely touted as a potential saviour of more secure income at a time when final salary pensions are in decline.
Under the CDC model, contributions are not retained in an individual fund for each member but are pooled.
When a member retires the income is paid from the asset pool rather than through the selection of an individual retirement income product.
Ministers believe that pooling money in this way will help increase the retirement incomes of some workers up to 30 per cent.
Speaking to FTAdviser, Henry Tapper, founder of auto-enrolment service Pensions PlayPen, said he thinks that default CDCs as a product in its own right is an idea which is “waiting to happen”, due the fact that “no-one has really worked it out yet”.
He commented that both the Pensions Management Institute and the National Association of Pension Funds are both looking at CDC not as something which employers pay into, but as a way in which people get paid their pension pots collectively.
This would mean people would transfer the pots which they had accumulated, bringing them together in order to get a “pensions promise” for the value of the pension.
Mr Tapper explained that the promise would not be as strong as a guarantee, but something closer to a retirement income target, adding that it would probably be higher than what could be achieved from an annuity, but not as high as if an individual chose drawdown.
He referred to the CDC schemes as a “halfway house, a mid-market type product.”
Mr Tapper added that he thought this year would see more talk of CDC, as there is “all this frustration that’s been building up among the squeezed middle”.
Tim Middleton, technical consultant at the PMI, broadly agreed with Mr Tapper’s direction of travel on CDC schemes, pointing out that auto-enrolment is dependent on effective defaults to operate effectively.
He also noted that the decumulation phase was not currently addressed by the industry to the same extent that the accumulation phase is.
“Whilst enrolling members into schemes and selecting a investment strategy are currently addressed effectively by defaults, the same cannot be said of members’ decumulation options,” stated Mr Middleton.
“This is because members are required to make an active decision with regard to converting a fund into retirement benefits. An effective default solution could however apply were members enrolled into CDC schemes as by default the fund could be converted into a scheme pension.”
Mr Middleton argued that this would help resolve some of the problems associated with the de-risking phase over the years leading to retirement, as there would be no need to make changes to the range of assets held.
“Members would of course retain the option of anuuitisation, drawdown or uncrystallised funds pension lump sums, but that would require active intervention on their part. CDC has been successful in other countries and offers the possibility of implementing automatic enrolment with effective end-to-end defaults.”
However, pension experts have not been so positive on these scheme types, with Ros Altmann warning that the schemes rely on “inter-generational risk-sharing” and reliability of actuarial forecasts.
Jim Boyd, director of corporate affairs at Partnership, previously said: “ “From one perspective CDC can be seen as a with-profits fund, however young people might be forgiven for viewing CDC as an inter-generational ‘Ponzi’ scheme.”
This was a view that Tom McPhail, head of pensions research at Hargreaves Lansdown, previously agreed with.
“The nature of ‘with profits’, the issue around ‘cross-subsidy’... if you have a conveyor belt of new members you can achieve stability potentially.
“But there is a risk, as we have seen in Holland, that if the actuaries get their sums wrong, there is a potential situation where we are running at a deficit and the problem is that new members may have to fill the deficit that exists.
ruth.gillbe@ft.com
