12 February 2018
This article was featured in the March 2018 issue of the magazine.
Henry Tapper, director of First Actuarial, discusses the implications for pensioner payroll
One of the most surprising developments in retail financial services has been the return of with-profits as a way to drawdown a pension.
The with-profits drawdown market is owned by Prudential; its with-profit fund had £32.6 billion of assets under management in September 2017. According to the Association of British Insurers at the end of 2016 it had 30% of the advised income drawdown market.
If the Prudential’s with-profits fund was an occupational pension scheme, it would be among the ten biggest in Britain; but it is not a pension fund. According to advisers, Prudential offers a certainty of income derived from the size of the fund, its investment strategy and the capacity of the Prudential to reserve against market down-turns through ‘smoothing’.
While investors can drawdown at a steady rate with a reasonable confidence that they can keep a steady income going, the fund does not provide protection against the problem of living too long. This problem, which has been described by one economist as the nastiest, hardest problem in finance, is so hard that it has brought 140,000 postal workers and the Royal Mail to the point of striking.
Throughout 2017, the Communication Workers Union argued for their members to get a pension scheme that paid them a ‘wage for life’; with 87% of Royal Mail’s pension membership prepared to go on strike to get it. Royal Mail didn’t want to have the stress of insuring 140,000 workers’ longevity on its balance sheet so instead offered their workers a cash sum at retirement.
Eventually, the Advisory Conciliation and Arbitration Service moderated an agreement which had elements of both a defined contribution (DC) workplace pension and a defined benefit (DB) occupational scheme. The new scheme looks like being the first to be written as a collective defined contribution (CDC) plan which can be thought of as a with-profits fund that pays a regular income for as long as the member lives.
...if the scheme makes no profit, pensions may remain level or even go down
This has interesting implications for payroll. If a CDC scheme is taking on the obligation of paying a wage for life, it is setting up a pensioner payroll that is different. In any other kind of pension, including an annuity and the state pension, the pension is guaranteed to be paid according to certain conditions. These guarantees would not apply to a CDC pension which will pay out according to the returns on the fund. It is effectively working on a with-profits basis so if the scheme makes no profit, pensions may remain level or even go down.
Secondly, people can transfer in to a CDC pension and immediately draw a pension, as they would do if they were to purchase an annuity – an option not usually available from an occupational pension scheme.
Finally, a CDC scheme, being a variant on workplace pensions, can use the tax concessions available under the pension freedoms. For instance, CDC members might be given the opportunity to take their tax-free cash sum before commencement or have it paid as an additional element of each periodic payment (an ‘uncrystallised funds pension lump sum’).
All of which sounds very different technically and will undoubtedly present those running CDC pensioner payrolls with a new set of challenges.
However, from the perspective of a CDC member, a CDC pension will provide a very similar experience to an occupational pension scheme. Money will be transferred from the scheme to the member’s bank account in a series of payments (typically monthly) and adjusted periodically (typically annually) at the discretion of those running the scheme. In an emergency, a scheme might need to change a payment mid-year, but modelling suggests that such events would be very rare.
Breaking the guarantee that a pension cannot go down is radical and it is likely that there will be much controversy surrounding the setting up of the Royal Mail CDC scheme. If Royal Mail pioneers CDC, it is likely that others will follow; both the New Airways Pension Scheme and British Telecom are both likely to close to future accrual in the next few months.
Meanwhile, people are taking pension transfers in unprecedented numbers from DB schemes. Add to this the growing demands of those retiring with mainly DC pension accrual and it’s clear that demand for CDC is unlikely to diminish.
So far, I have seen no discussion of the implications of such schemes for payroll, so this article may be breaking new ground. To incorporate all the bells and whistles of pension freedoms, a CDC scheme would need to incorporate several processes and controls available to people using pension drawdown, together with the normal features of pensioner payroll, including pay as you earn and real time information reporting.