By Kathryn Fleming, Partner at Hymans Robertson
The higher incomes come from paying lower death benefits from longevity pooling, and assuming higher risk asset strategies for longer offering higher returns.
In practice, an employer and the scheme member pay in fixed contribution rates and these are invested in pooled assets. Each scheme member accrues a target - but not guaranteed - pension. Pensions are then paid from those pooled assets.
Behind the scenes, the assets and liabilities are valued on an annual basis, using best estimate actuarial assumptions, from which a determination is then made around the pension increase (or decrease) to be applied equally to all pensions. For a member, this helps planning for retirement and removes some difficult decisions. For an employer there will be no surprises when it comes to costs.
From our analysis, a whole of life CDC scheme would likely deliver in excess of 10% higher incomes in retirement from the longevity pooling element alone, when compared to traditional DC schemes (based on Hymans Robertson’s view of best in class investment strategies).
Perspectives of different stakeholders
CDC’s are designed to improve member outcomes whilst sharing risk, but they may be a little bit difficult to get off the ground, with the Royal Mail scheme being the only one established at the time of writing. Let’s consider the perspective of different potentially interested parties.
An employer with employees saving into a DC Master Trust or a GPP; they are likely to stay on their current path as investment and member engagement strategies are always evolving, but CDC might appeal if it could be used as a recruitment or retention tool.
An employer supporting a DC trust. If they are thinking of making a move away from a DC trust, with the move to Master Trust being a tried and tested cost-effective path to follow, they may need a significant trigger to consider CDC instead - unless CDC is offered within a Master Trust.
What about trustees in a single trust DC arrangement? They are already living and breathing scheme rule complexities, so no barriers there but they are unlikely to have the decision-making powers to move to CDC for whole of life. They may, however, consider a CDC provider for decumulation.
What about employers with open DB schemes? CDC offers a more affordable option, with the potential for similarly styled benefits. CDC could be a lower risk option for future accrual. However, they are in the minority and the set-up costs of CDC schemes may be a factor to consider.
What about the trustees and sponsors of a Master Trust? They are arguably the closest to the innovation in the decumulation space that is already taking place and CDC is an option, but it is currently not the only option on the table (see recent research on risk sharing).
The Government has shied away from making CDC compulsory and we are still on a legislative journey. I wonder what more will be needed for CDC to keep gaining momentum?
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