Yet it is difficult to see how such trust can be built when neither a guarantee nor individual ownership is being offered. Hopkins says: “The challenge is to get people to comprehend why this type of scheme is going to deliver better outcomes than those which currently exist.”
Even if the employees can be persuaded to embrace a CDC scheme, they may well become disillusioned with it in the future. The retirement income target will be met, if the investments perform as the actuary expects. “But if those targets prove to be inaccurate then either the pensions will cease to increase or they could be reduced,” Hopkins says.
Both those scenarios have happened in the Netherlands, where a version of this system has existed since just after the millennium. Rather than improving member outcomes, CDC has undermined faith in the pension system.
Cardano head of DC Ralph Frank says: “There has been constant debate and multiple regulatory changes since its inception more than 15 years ago.”
Cardano recently examined what increases the five largest CDC schemes had granted to their members over the last decade, as these schemes account for more than half of the assets in the Dutch pension system. Frank says: “Not only have the increases granted by these Dutch pension schemes fallen short of price inflation over the period but three of the five also cut pensions in payment at different times.”
In other words, some scheme members have not only experienced a real-term loss in income but also in nominal terms. “Members who thought their pension payments were guaranteed have discovered this is not the case,” Frank says.
The key cause of this disappointment has been a lack of interest-rate hedging during a period when the cost of borrowing fell sharply.
“It was a risk management issue,” Frank explains. In theory, the UK system could avoid this pitfall by learning from the mistakes of the Dutch pension companies and having the necessary risk management systems in place.
Models from the PPI and Aon paint an optimistic picture. But those models should be thoroughly tested.
Tim Gosling, policy lead in DC at the PLSA, says: “We are keen to see how sensitive these better outcomes are to different asset allocations.”
In particular, the PLSA would like to see what these models would predict for an asset allocation that more closely resembles the Dutch system of 60% bonds and 40% equities – they want to know if this model would have predicted the reality.
Gosling says: “Our central question is what type of investment strategy is being proposed to achieve a better outcome than that achieved by the Dutch pension schemes and how sensitive the model is to different asset allocations.”
The PLSA would also like to know where the benefits of the CDC system accrue. Gosling says: “Is it during the accumulation phase or are they more likely to happen later on when members start taking a retirement income?”
It appears most of the benefits of CDC happen later on. Gosling says: “If money keeps coming into the fund while money is flowing out then the benefits of compounding the whole pooled fund are greater than in individualised draw-down.”
This focus on retirement income has become even more important after the introduction of freedom and choice legislation, which has created a system that is paternalistic and personalised.
Auto-enrolment created a paternalistic system for saving into a pension pot which requires virtually no engagement from the scheme member: there is no need to worry about investment decisions. But that changes as the member approaches retirement. Then the member has to decide how they are going to use their pension pot so it lasts the rest of their life.
