"Collective DC (CDC) has recently been highlighted by the UK government as a potential route to lower charges and higher pensions. Pensions minister Steve Webb has suggested that it will ‘feature prominently' in his upcoming defined ambition paper. We argue that such arrangements are at best a mechanism to transfer the pension shortfall to our grandchildren, and at worst a badly-designed pyramid scheme.
"CDC employs smoothing of investment returns, in the belief that sharing of the investment risk will allow greater flexibility, in turn generating better results. This requires inter-generational subsidies and by definition there will be winners and losers in such an arrangement. The apparent alchemy will only last for a relatively short period, due to the knife-edge balance of equitable smoothing and the inevitable constraints of reserving requirements.
"Another advantage of CDC is the benefit of economies of scale from pooling assets and bulk-buying administration and investment services. This is clearly very important for DC members where high costs erode the value of a member's future pension. However, these savings are not exclusive to CDC. Most other forms of industry-wide arrangements give this benefit without the associated need to raid our grandchildren's piggy-banks.
"Finally comes the issue of sharing mortality risk, or rather longevity risk. Paying pensions directly from the CDC assets will result in funding requirements similar to those of a DB plan or life insurer - as the UK's shrinking working population takes on the growing burden of longer-living pensioners, we'll probably soon be reading about grossly-underfunded CDC plans. DB plans failed when employers removed their guarantee; with CDC, there is no guarantor, other than the plan itself. Joining an underfunded CDC plan would therefore be a great act of charity by a young new member, but not a great act of retirement saving."
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