However, in a CDC scheme, where the trustees invest with a horizon right through to the predicted eventual death of the pensioner, the de-risking happens much later.
Indeed, a typical CDC scheme could retain 100 per cent growth assets right up to retirement age, and then taper that down to safer assets over the first 20 years of retired life.
Taking the CDC scheme as a whole, this means a much higher proportion of investments will be in higher returning assets, contributing to higher retirement incomes.
Sharing of idiosyncratic mortality risk
The retirement income from a CDC scheme is a collective experience. So, all pensions in a specific CDC are paid from the same pool of assets.
Some members will die before their life expectancy, and the remaining assets that were being held by the scheme against their liability are then used to pay the pensions of those members who live beyond their expected lifespan.
This is very different from income drawdown, where each saver consumes only their own retirement pot, a little at a time each month. Income drawdown savers that die early leave a pot behind for their estate, but they were unable to enjoy it themselves during their retirement.
In contrast, every penny of a CDC scheme is used to pay someone’s retirement income, other than where lump sum death benefits have selected by the member.
By sharing the mortality risk, the CDC scheme gives all members the highest possible monthly income, whereas income drawdown savers are left with an Icarus-like problem of either not drawing enough for fear of running out or drawing too much each year for fear of not enjoying retired life to the full.
This is called the ‘idiosyncratic mortality risk’. We know some people will live longer and others shorter, but death is random so you can not predict your age of death with any certainty. The CDC scheme is sharing this risk between all the scheme’s retired members.
Sharing of systemic mortality risk
A further aspect of mortality risk happens when some external intervention fundamentally changes the mortality landscape. Actuaries call this systemic risk.
This may be for the better, such as the current NHS trials of cancer-spotting tests, which could hugely improve early detection of cancers and accurately identify their location – thereby improving the life expectancy of all pensioners.
Equally, systemic risk can be negative such as the Covid-19 pandemic, which sadly precipitated a large number of excess deaths, especially amongst the pensioner population.
