AON says well designed CDC would have weathered 2021/22 markets

[RobertT]

https://www.actuarialpost.co.uk/article ... -21578.htm

Aon has said that a well-designed UK Collective Defined Contribution (CDC) scheme would have weathered the market disruption of 2021 and 2022 without the need to cut members’ benefits.

This conclusion was reached after updating ‘Collective DC in adverse markets’, Aon’s analysis from 2020 which assessed how CDC schemes would have fared over the last 90 years of economic rise and fall.

Chintan Gandhi, partner and head of Collective DC at Aon, said: “Our updated analysis and expanded chart, below, revealed that a well-designed CDC scheme would have continued to withstand the market turbulence of the last two years without cuts to members’ benefits.

“Based on the experience of 2022, a CDC scheme was expected to provide an increase of over 9 percent to members’ target pensions. That’s not quite matching the prevailing rate of inflation, but not far off.”

Chintan Gandhi continued: “The nature of a CDC scheme means that members’ target pension increases can be adjusted to reflect positive and negative experience over a period of years. This means that the impact of market movements – in either direction – are shared between members and then smoothed over time.

“By contrast, defined benefit (DB) pension schemes generally provide guaranteed increases to members’ benefits - although many apply a cap to increases. For example, this can be of 2.5 percent or 5 percent each year depending on the scheme’s rules and/or when members accrued their service.

“Given CDC schemes are expected to hold a significant proportion of growth assets, it’s likely that CDC schemes would not have been invested in a way that led to the liquidity pressure seen in many closed DB schemes during 2022 - the result of rising gilt yields.”

Madalena Cain, associate partner and Collective DC specialist at Aon, said: “Our analysis also shows that DC pension pots would have struggled to see returns matching the level of inflation this year. For DC savers invested in bond-based strategies approaching retirement, rising yields have led to a fall in their DC pot. For the 10 percent of these savers who typically buy an annuity at retirement, they may still be able to secure broadly the same level of retirement income as before, given annuity pricing moves in the opposite direction to rising yields.

“However, the majority of those retiring exclusively with a DC pension pot would be likely to face the very real challenge of retiring on less than they expected or having to work longer.

Madalena Cain continued: “While much has been said about annuities becoming more attractive, it is all relative, as our recently published The Power of Pooling analysis and our 2013 whitepaper, The Case for Collective DC, revealed. CDC is expected to provide on average over 30% higher outcomes than DC where annuities are used to secure a lifetime income.

“Also, for the 10 percent of DC savers who buy an annuity at retirement, the majority buy the single-life, non-increasing - flat - type.

Against the backdrop of high inflation, flat annuities may not be a particularly good fit for retirees’ needs, while single-life products provide no contingent benefit for those survived by the member. By contrast, CDC schemes are required at the outset to target increases at the least in line with inflation - and we expect them to offer dependants benefits on death.”

[cockneyrebel]

Rhetorich abounds !!
1 What if its not well designed ?? whatever Well Designed means !!!!
2 Why have so few businesses taken on a CDC scheme ?
3 Expect they will Look after dependents re death of holder Expect ????
All people really want to know is how much they getting each month so they budget accordingly in line with other part time job/state pension they may get

[renrag40]

........ and that is exactly what is lacking from the CDC pension........ CERTAINTY........ even an annuity will not be reduced once it has started to be paid out but a CDC pension can be......... the worse of all worlds.
It would be more accurate to describe CDC pensions as an inferior version of career average pensions without any certainty of what you will get from 1 year to the next when you are drawing the pension.

[RobertT]

1 What if its not well designed ?? whatever Well Designed means !!!!

It ultimately comes down to the choice of investments.
But if you read the 'Collective DC in adverse markets' link in the original post, you'll see that a drop in markets doesn't automatically mean a drop in pensions.

2 Why have so few businesses taken on a CDC scheme ?

Because they want to see how the RM scheme works out first. We are the guinea pigs.
Although I think the future of CDC lies more in the expected future ability to convert DC into CDC at retirement, rather than 100's of standalone CDC schemes.

3 Expect they will Look after dependents re death of holder Expect ????

The RM scheme does include dependants benefits on death.

All people really want to know is how much they getting each month so they budget accordingly in line with other part time job/state pension they may get.

We've known for 5 years that we're going the CDC route and we've known all that time that CDC pensions can go down as well as up.
Many people will be in the scheme for a few years before they take their benefits, so they'll be able to see how the benefits increase or decrease over that time.

We know what the baseline amount is – the accrual rate is a pension of 1/80th and a lump sum of 3/80ths of pensionable pay per year of membership.

What we don't know is if the investments will allow an inflationary increase each year, a rate below inflation, or whether there may actually be reductions in pensions.

The modelling Aon did, went back 90 years to see what would have happened had CDC been in existence during that time. They came to the conclusion that CDC pensions would only have reduced in 2 of those years.

Personally, I'd be surprised if the modelling works out that well going forward, but I sincerely hope it does.

[RobertT]

even an annuity will not be reduced once it has started to be paid out but a CDC pension can be......... the worse of all worlds.

But only 10% of DC pension holders buy an annuity. The rest use drawdown or cash out completely, which doesn't necessarily offer an income for life or any certainty.

It would be more accurate to describe CDC pensions as an inferior version of career average pensions without any certainty of what you will get from 1 year to the next when you are drawing the pension.

It is aiming to be similar to section B of the CARE scheme – a lump sum upfront and income for life, with similar accrual rates and inflationary increases.
If it does what it's supposed to do, then it should do that.

[renrag40]

If draw down was used sensibly it would provide an "income for life"....... using the 3% rule would see the vast majority of pensioners through.
The CDC will never provide the benefits of Section B of the CARE scheme for the simple reason that it guarantees nothing but the tax free lump sum....... that is of course if the CDC scheme ever gets off the ground....... after all why would RM want the expense of providing half decent pension provision when they claim they cannot afford the present pay and T & Cs of the OPGs?
Please do not say because they will look ridiculuous if they didn't start the CDC scheme.............. Thompson et al have proved numerous time during the present dispute that they could not give a fig for theirs or RMs public image....... all they are interested in is the money.

[RobertT]

If draw down was used sensibly it would provide an "income for life"....... using the 3% rule would see the vast majority of pensioners through.

Factor in the cost of living and the unknown of how long you're going to live and many people will run out of cash. Even those who are sensible!
Why do you think so many retirees who left employment are now returning to work?

The CDC will never provide the benefits of Section B of the CARE scheme for the simple reason that it guarantees nothing but the tax free lump sum

If CDC does what it aims to do, it should provide similar benefits!
DB pensions don't guarantee anything either. If the sponsoring employer goes bust, the PPF will only pay out 90%.

that is of course if the CDC scheme ever gets off the ground....... after all why would RM want the expense of providing half decent pension provision when they claim they cannot afford the present pay and T & Cs of the OPGs?

If they were going to scrap CDC, don't you think they would have done it by now?

There are reports of an expected £650 Million loss this year, but not once have they said pension provision will have to be looked at, or reduced.

The cost of the current schemes to RM is about £400 million per year. CDC will be a little higher at £430 million.
If they were to just offer the legal minimum contribution rate, that would reduce to less than £100 Million.

But they are still ploughing ahead with CDC!

A board of trustees have been appointed and they've applied to the Pensions Regulator to start the scheme.

Please do not say because they will look ridiculuous if they didn't start the CDC scheme.............. Thompson et al have proved numerous time during the present dispute that they could not give a fig for theirs or RMs public image....... all they are interested in is the money.

But yet there's still no signs of CDC being shelved! In fact, the opposite is true!

[heapsy]

I think people would have a bit more confidence in the CDC scheme if a: there was a guaranteed, if not slightly lower rate of increase to the current up to 5% index linking, say 3.5%. And b: if there wasn't the fear of a reduction during payment. Surely this would have been win win for RM. Those that don't get many years in the scheme, maybe 5 or 6 say, wouldn't actually accrue much pension, so the increases for RM wouldn't be that great. Secondly, those who do manage to get 15, 20 or more years in would not be guaranteed such a big increase, this would of course still be better than no guarantee, coupled with longer service, would still be better than a DC scheme.

[RobertT]

I think people would have a bit more confidence in the CDC scheme if a: there was a guaranteed, if not slightly lower rate of increase to the current up to 5% index linking, say 3.5%. And b: if there wasn't the fear of a reduction during payment. Surely this would have been win win for RM. Those that don't get many years in the scheme, maybe 5 or 6 say, wouldn't actually accrue much pension, so the increases for RM wouldn't be that great. Secondly, those who do manage to get 15, 20 or more years in would not be guaranteed such a big increase, this would of course still be better than no guarantee, coupled with longer service, would still be better than a DC scheme.

As soon as you introduce guarantees to CDC it would become a DB scheme!
RM don't want to offer a pension with guarantees because there will always be the potential for deficits, which will fall on the company to fund.

They just want to pay in their agreed percentage of pay.
The risk is with the membership!

The lump sum element of the CDC scheme, the DBLSS, is guaranteed in the same way as the DBCBS is. But they both represent one off lump sum payments, which can be planned for well in advance.
Whereas the long term liabilities of a DB pension are unknown to some degree. Due to not knowing the rate of inflation in the future or life expectancy levels, etc.

The people responsible for the modelling of CDC, suggest it could actually be better than DB, and that would have been the case in 2022 going by the original article I posted.
It would have seen a 9% increase in benefits, compared to a max of 5% with NRA60/65 benefits.

Obviously one swallow doesn't make a summer, and only time will tell whether CDC turns out as is hoped, or whether it becomes a dead duck.

[heapsy]

Did I imagine it, or did I read somewhere that there would be a smoothing out mechanism in the scheme? Whereby higher returns would be rolled over for future years?

[RobertT]

Did I imagine it, or did I read somewhere that there would be a smoothing out mechanism in the scheme? Whereby higher returns would be rolled over for future years?

There will be a smoothing mechanism, but probably not in the way you're thinking.

A common 'with profits' fund will have a smoothing system in place that averages out the returns over a certain period of time. So if you have investment returns of +20%, +16% and -6% over a 3 year period for example, the average return on your money over those 3 years would be 10%.

But RM's CDC scheme will use an inter-generational smoothing technique, whereby the risk will be transferred from the older members to the younger ones.

This explains it better than I can: https://blog.actuaries.org.uk/how-does- ... -pensions/

Aon's 'CDC in adverse markets' is also worth a read: https://www.aon.com/getmedia/7e8cec1d-c ... rkets.aspx