Bold and innovative thinking on Collective Defined Contribution (CDC) that leverages intergenerational risk sharing would help to solve the issue of poor retirement incomes, claims Hymans Robertson in a new paper published today Intergenerational risk sharing: it’s dynamite!. The analysis shows that risk sharing could provide an uplift in income by as much as 50% from a traditional DC plan, through the opportunity to invest in higher growth assets and the pooling of longevity risk, both of which the intergenerational risk sharing element of CDC enables.
However, there is also the potential for significant value transfer between young and old members of a CDC scheme dependent on the specific design. The analysis showed that under certain scenarios a 50 year old may receive a pension 60% higher than under DC, while a 20 year old in the same CDC scheme could receive a pension 40% lower than in DC.
Risk sharing options, such as CDC, designed well would provide members with higher value, and more secure, retirement outcomes. This could be the key to unlocking the retirement adequacy problem, claims the leading pensions and financial services consultancy.
However in order to achieve this, the intergenerational value transfer issues should be assessed, with careful plan design and communication to members, both of which are key to success, warns the firm.
Commenting on the importance of CDC as a risk sharing mechanism for savers, Paul Waters, Head of DC Market says: “There are clear benefits to CDC with income security, and higher income, a prize available for all savers enabled through the sharing of risk. There are many different ways of doing this, from the more simple form of whole of life CDC schemes we see today, to more sophisticated design versions that allow for the difference in value being accrued from different age members.
“There is a trade-off between simplicity of design, and fairness and transparency to members. It’s a design question that can be addressed, with many options available. For example, a traditional DC scheme in accumulation with longevity pooling in retirement can deliver a significant benefit uplift without value transfer from younger to older members.”
Calling on the government and the pension industry to be bolder in its CDC approach, Paul said: ”With the new government already recognising the need for greater adequacy in pension income with the Pensions Review, it’s time to move forward with CDC in its broadest form, allowing a wide range of risk sharing designs for DC members. The importance this could play must not be underestimated as it could be life-changing for members. Yet, for this to be considered a viable option, new frameworks and products must be developed. We are calling on the government to confidently back the expansion of CDC, and legislate to enable the broadest range of CDC design structures to be put in place.
“But the industry needs to play its part too, as careful design and communication is key when it comes to CDC. We must ensure stakeholders involved in the design understand the risk sharing mechanisms, and the impact on members, such that they can be addressed. At the same time communication strategy for members should be developed so members are to be able to trust their scheme and feel secure about their retirement plans, through the good times and the bad.
“Our paper outlines these intergenerational risk sharing issues. CDC design and communication should deliver the greatest good for the greatest number – while recognising the inherent trade-offs involved.”
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