By Jon Hatchett, Senior Partner at Hymans Robertson
And while a single CDC scheme might not last forever, CDC schemes as a collective might last for a very long time indeed.
This isn’t purely an academic problem to be solved in a few decades time. The intergenerational cost and risk sharing means it should be taken into account in benefit design today, even if we choose to live with certain risks in order to capture other benefits. In other words, let’s set schemes up for a sustainable future as if we may be immortal, but ensure we have an exit plan that is fair to members and sponsors. Or more simply, plan for the worst but hope for the best.
CDC schemes might reach the end of their natural life for many reasons, but some of the main ones can be broadly grouped into:
Sponsor related reasons – the entity which set up the scheme either wants it to stop, or is no longer available to fulfil its role as sponsor. For example, a corporate sponsor of a scheme might become insolvent.
Membership related reasons – the flow of new, young, active members dries up. This doesn’t have to be all or nothing. For example, in some popular scheme designs, younger active members subsidise the contributions for older active members, to keep the contribution rate simple to explain. In this example, a sharp reduction in the number of younger members will drive up the average cost everyone needs to pay. It’s easy enough to think of scenarios that could affect entire industries on generational timescales, with the current pace of progress around Artificial Intelligence and related technologies.
Regulatory reasons – while the nature of government intervention is impossible to predict in advance, anyone with much experience in pensions will know that intervention is the norm not the exception. The point to highlight here is that a future government might do something that makes CDC much less attractive than other options, leading to the closure of a scheme.
So, what are the issues when CDC schemes start entering into run off, or at least maturing significantly over time if the relative number of active members starts to materially decrease?
Covering the expenses of the scheme. These could have been capitalised (at least for a number of years) at the outset or early in the scheme’s life. But in the end, any CDC scheme needs to retain sufficient scale to outperform the alternative benefit designs net of costs.
Use, or switch to, age-related contributions/accrual. There will be age discrimination challenges to navigate, as well as complexity in communication. Any scheme that feels it could have a material shift in the age distribution of active members over a decade or two, ought to think carefully about cross-subsidies in accrual. Otherwise, the (typically) young members who are contributing to older members accrual today, might miss out if there aren’t new young members to subsidise their accrual in a few decades time.
“Full funding on entry” for accrual in multi-employer or decumulation only schemes. For each pound you pay into a CDC scheme in a decumulation or multi-employer setting, you need around a pound of benefits of value on day one. Otherwise we’ll end up with winners and losers amongst CDC schemes, and if I was approaching retirement, I would definitely not want to join a losing scheme. I would hope anyone with any sort of responsibility for my pension benefits would keep me well away from one. Again, this is a design choice, and again it risks breeding complexity.
In addition to the possible mitigation options outlined above, a “universal” and possibly Government sanctioned CDC aggregator might well support at an industry wide level. It could give providers, corporate sponsors and trustees comfort that their CDC scheme could find a CDC home should it need one in the future. It doesn’t remove all the challenges set out above, but it could certainly help if CDC blooms and is with us at scale in the coming decades.
The advertising slogans tell us a diamond is forever. We know that the same cannot be said for CDC at an individual scheme level.
However, with the right government leadership, sustaining the ecosystem is more than achievable. Having a clear plan now for what happens on exit will go a long way to helping CDC schemes become established and thrive.
We’ll need to work creatively and together to build schemes in such a way that they can deliver the benefits we want, and as an industry, we can minimise the risks for members and sponsors. With enough willpower and effort, that should be more than achievable.
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