Defending collective defined contribution pensions
In a recent post I welcomed what the government is planning on collective defined contribution pension schemes – a pension scheme that shares risk among members, smooths outcomes and provides a higher though not guaranteed pension income than traditional DC.
But CDC has its opponents and critics. The ABI has attacked it – even though I’m not sure they represent their members on this. And now a report by Cass Business School professor Anthony Neuberger, published by the British Academy, says that it is “unclear” how CDC system will reduce costs for members.
We asked our guest blogger Con Keating to have a look at the Neuberger paper for us. He is not impressed.
The shifting face of workplace pensions: A review
It takes resolute determination to read beyond the stilted and archaic language of the introduction to Anthony Neuberger’s paper. Whether that effort of willpower is warranted remains an open question. The paper’s aim is clear, to inform the pensions debate and influence policy. But this seems over-ambitious when the paper proves to be rather less a rehearsal of the old and familiar and rather more a disinterment of the dead and decaying. There are no new insights here. There is nothing new in this paper, at all.
It is also lacking in any quantitative analysis. This is a serious omission in a paper concerned with policy alternatives that are largely questions of relative efficiency.
Beneath the surface, there is the ideology of self-sufficiency, of the individual, of ‘efficient’ markets and the financialisation of everything, which serves well only an elite few.
We learn “If the problem with DC is a lack of certainty for the employee… If people…want to avoid risk, they could in invest in indexed gilts.”
Let them eat cake seems the apposite rejoinder to that. Quite apart from the sheer impracticality of such a solution, it seems likely that this is a misinterpretation of the revealed preference studies. A better interpretation may be that the preference is for some variant of: “The certainty and confidence that insurance provision brings to all our daily lives, whether business or personal, enables us to breathe more easily, to find the confidence to let innovation flourish and to engage with the present and the future, chastened by the past but not allowing the fear of the possible to paralyse us in the present.”
Unfortunately, for pensions and personal savings, innovation and the insurance industry seem estranged.The paper uses the word “risk” 149 times and “pool” just twice, in the context of asset pools. It misses entirely the fact that collective DC (CDC) involves both risk pooling and risk sharing.
The collective DC scheme is using an insurance technique (risk pooling) in a mutual member risk sharing arrangement. This is a far superior governance mechanism to the conflicted managerial model of “with profits” insurance policies. There is historic precedence in the burial clubs and friendly societies of the Victorian era, when many were closely associated with the rise of trade unions. There is an unfortunate further precedence, the role of the Friendly Societies Acts in the demise of this mutual movement.
Contrary to the Neuberger’s assertion, CDC has no need to rely upon inter-generational transfers, though it would usually be the better for it. The author’s argument that a CDC scheme might suffer a lack of new members and become non-viable, if it experiences poor performance, depends entirely upon those potential members having superior alternatives available. With the cost advantage of CDC, arising from the diversified nature of the risk exposure that a collective pool has, any individual option is most unlikely to achieve this – and that makes compulsion entirely redundant.
“If one of the objectives in moving away from the first pillar and towards DC pensions is the need to reduce taxation, then collective DC does not help.”
This simply wrong, muddleheaded analysis. The move from first pillar, government provision, to private is always costly in terms of taxation. Government can provide pensions more efficiently than the private sector, with all of its costs and uncertainties. The rents being captured by the financial sector are in large part transfers, or misappropriations, of pension tax subsidies.
CDC schemes are much more efficient than individual DC. In other words to produce a given pension benefit CDC schemes cost less, both absolutely and in terms of their cost in tax relief.
There are some points of agreement; the situation is “bewildering”. Our bewilderment, though, lies in how we could have allowed regulation and good intentions to destroy the highly successful and efficient legacy DB system. Pursuit of the best at the cost of the good really was destructive.
The author’s scepticism over the prospects for defined ambition in its lightly regulated DB form seems prudent: “It is hard to believe that Governments of the future (sic) will forebear from improving the security of defined ambition schemes as those schemes get frustrated by unforeseen economic, financial and demographic forces.” Future government interventions may even lack the need for such fig leaves.
The weakest discussion of the paper centres on the motivation of corporate sponsors in providing pensions. It fails to consider the joint position of scheme and sponsor. Regulation has simply made DB provision hopelessly inefficient; offering one pound of pension benefit now costs the sponsor employer more than one pound.
Rather than indulging in a recitation of the page and a half of corrections, comments and questions the paper provoked, an optimistic ending to this blog seems appropriate.
CDC is a first step in the right direction, after two decades of misguided regulation. When we recognise that the pension problem is a problem of funding, which is costly and incomplete as a risk management solution for DB issues, then we may import the tried and tested German and Swedish solution of insured book reserve occupational DB – and all sleep well. All that is except the advisors and fund managers who currently do.