This is a presentation given to the Cambridge UCU on Thursday 17th May 2018

1. The CDC pension
alternative
Henry Tapper

2. Why university pensions matter
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Wil Sanders (1936-2002)

3. What you should expect
• An income-for-life
• With the security of funding
• Offering sponsors value for money
• Meeting member’s needs

4. Agenda for the next 30 minutes
• The problems with defined benefit schemes
• The problems with defined contribution schemes
• The merits of an “open” collective scheme
• Collective Defined Contribution schemes

5. The problems with defined
benefit schemes
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6. The problems with DB – pre-2005
• Sponsors were vulnerable to all manner of risks;
◦ Longevity expectations increasing much faster than previously allowed
for in actuarial valuations
◦ Legislation imposing new costs on sponsors:
 Improved preservation of leavers’ benefits, with retrospective effect
 Minimum pension increases in retirement of RPI up to 5% pa
◦ The Minimum Funding Requirement meant employers had little control
of their pension costs.

7. Post 2005 – a collective failure of nerve
• “Back” covering
• Risk aversion
◦ Coupled with poor definitions of risk
• Herd mentality
• Poor modelling
• Employers fail to use their powers to gain a more satisfactory
outcome

8. Back covering
• Trustees
• Scheme actuaries
• The Pensions Regulator
◦ All protect their own backs by:
 Asking for more contributions
 Seeking to invest more in bonds
at every valuation

9. Herd mentality (the received idea)
• Close DB and use DC, “everybody else does”
• More bonds are desirable
◦ (regardless of cost)
• Pensions are bond-like
◦ (provided you are on the “flight-path to buy-out)
• Actuarial valuations use a gilt yield based discount rate*
◦ (because your balance sheet’s worth it)
* Other valuation methods are available

10. The impact of gilt based valuations
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11. Employers miss their chance
• The abolition of the Minimum Funding Requirement …
◦ replaced by the Statutory Funding Objective (SFO)
◦ gave control of funding back to employers
• Yet the introduction of the SFO …
◦ Led to a change of funding plans …
◦ Which employers misinterpreted as a lack of financial control …
◦ Triggering another round of DB scheme closures

12. The problems with Defined
Contribution Pensions
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13. Members and employers see DC as an easy
answer
)
The Pension Regulator now estimate over 100,000 people transferred in 2017

14. The products aren’t easy
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15. They can have extremely high charges
15
GAD estimate a 1% pa
Pension depletes a fund
By 27% over a lifetime
The average transfer value in Port
Talbot was £420,000 (FCA)
The typical advisory charge for
BSPS members was 2%

16. More problems with DC
• Most individuals are inexpert in managing their own investments
◦ Vulnerable to making poor decisions of their own
◦ Vulnerable to being exploited by professional advisers
• This is Hobson’s choice:
◦ High cost of non-profit annuity income-for-life
◦ Draw down has no guarantee of the pot lasting a lifetime
• Inefficiency of individual investment planning
◦ Waste of time for everyone to do individually what could be done collectively
◦ No netting off of contributions and pensions

17. The life cycle of defined contribution schemes
• While contributing:
◦ Investment time horizon limited by retirement date
◦ Want assets to be cheap
• Big risk at retirement:
◦ From sale and reinvestment of assets into an annuity
◦ Want growth assets to be expensive and bonds to be cheap
• Big risks of draw down in retirement
• Money purchase is always either accumulating or
decumulating, there is no open collective scheme sweet spot

18. The merits of an open
collective scheme
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19. The life cycle of a collective* scheme
* Whether Defined Benefit or Collective Defined Contribution
Open scheme sweet spot
Benefits paid from income
Infinite time horizon
Market value irrelevant
Scheme
closed !!
Closed scheme problem:
Selling assets to pay
benefits
Shortening time horizon
Buying assets
Low market value good
Infinite time horizon

20. Why a collective scheme should stay open
• An open collective scheme has considerable investment advantages:
◦ An infinite investment time horizon
◦ Once mature, little net cash flow in or out, little exposure to short term market value
volatility
• Closing a collective scheme increases these risks:
◦ Disinvestment risk from net negative cash flow
◦ A finite and shortening investment time horizon
• A DC scheme:
◦ Has “at retirement” risk unlike collective schemes
◦ Is either investing or disinvesting, with associated exposure to market value risk
The lack of investment constraint in an open collective scheme rewards investment

21. De-risking a DB scheme
• The big question:
• De-risking is not only an asset side activity
• If a benefit promise is onerous, substitute an easier to meet
promise
If an open collective scheme is better, what can we do to
make it more manageable?

22. De-risking DB liabilities – step one
• Suppose we decide UK equities are an attractive asset
• Offer a pension of 1/80 of pay, indexed to UK equity dividend
growth
◦ UK equities are the matching, low risk asset
◦ We have designed the benefits to match the assets
 In a reversal of the convention of matching the assets to the benefits

23. The second step
• Offer a DB pension of 1/80 of pay, with discretionary annual
increases
• This is the original Wage in Retirement Scheme (WinRS)
proposed to Royal Mail

24. The third step
• Take the WinRS design, but now allow pensions to decrease
◦ There are no defined benefit promises
◦ Communicated benefits are targets, not guarantees
• Fix the employer’s contributions
• Now we have a Collective Defined Contribution scheme
◦ Defined Contributions for the employer
◦ Collectively invested

25. How does CDC work?
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26. DB valuation CDC valuation
Actuarial
valuation
Assets
Contributions
Benefits
Actuarial
valuation
Assets
Contributions
Benefits
Mathematically the same thing

27. CDC Management process
InvestmentsContributions
Actuarial valuation
Target benefits
Member communications

28. Investments
• Unconstrained – invest for a good return wherever it may be
found
• Not compelled to invest in growth
• Not necessarily anticipating average growth returns

29. Member communications
• Best estimate target benefits
• Common concern that members should not be disappointed
• Could also communicate:
◦ Smaller benefit with 75% probability of delivery
◦ Even smaller benefit with 90% probability of delivery

30. Actuarial valuation of a CDC scheme
• Best estimate basis for inter-
generational fairness
• Discount rate for valuing target benefits
= Internal rate of return on investments
• Matches the outgo on target benefits to
income from assets and contributions
• You don’t need smoothing to get
smoothed outcomes

31. With or without employer sponsorship?
“Open access”
to general public
• Member’s contribution buys
target benefit of equal value
Single employer
sponsorship
• Exact value for members’
contributions not necessary
◦ Same target benefit for
all members regardless of
age or gender

32. Employer sponsored CDC
• Defined contributions from employee
and employer
• Career average target benefit
• Each valuation decides an annual rate
of increase which balances assets and
contributions with the value of benefits
for both past and future service
◦ planning for an even accrual rate over time
• Sometimes the accrual rate might
need to change
• Rarely pensions might need to be cut
Assets
Contributions
Future service
benefits
Past service
benefits

33. Multi-employer CDC
1. Employers can pay contributions to an “open access” CDC
scheme
2. Multiple employers in a master trust can have ring fenced
sections
◦ each run as a single employer CDC scheme
3. Multiple employers can share in a common target benefit pool
with a common contribution rate

34. CDC for individuals and the self employed
• “Open access” CDC is possible
◦ Could be provided by master trusts
◦ NEST is the Universal Service Provider for employers auto-enrolling
their employees into a pension scheme
◦ NEST could open a CDC section
• Open access CDC provides the self-employed with access to a
pension scheme with similarities to the schemes long available
to the employed

35. Find out more about CDC
Derek Benstead FIA
0161 348 7451
derek.benstead
@firstactuarial.co.uk
Henry Tapper
07785 377768
Henry.h.tapper
@firstactuarial.co.uk
www.henrytapper.com

36. Disclaimers and warnings
• This material has been prepared by First Actuarial LLP (FA) who take full responsibility for it
• FA are not financial advisers but are regulated by the Institute and Faculty of Actuaries in
respect of a range of investment business activities.
• Any figures in this presentation are illustrations only and are designed to explain how
investments including pensions operate.
• The content of this presentation is designed to provide you with helpful information
regarding and nothing in it should be regarded as providing you with any specific advice or
recommendations.
• If you require specific advice or help regarding your financial planning, please contact an
Appropriately Qualified Financial Adviser.
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Registered address: First Actuarial LLP, Mayesbrook House, Lawnswood Business Park, Leeds, LS16 6QY
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