Those buying an annuity pass this systemic risk to their insurance company as part of the price of the annuity. But insurers charge handsomely for taking this risk, because it is an unknown one, giving annuity providers little scope to lay-off this type of risk to another party, other than to pass it at a premium to yet another insurer or re-insurer.
Moreover, while the insurer takes a premium from the saver for the risk that a cancer cure might mean everyone lives a little longer, if the converse applies, as with Covid, they do not pay out any more to policyholders. They simply pocket the difference as additional profit.
However, a CDC scheme retains the systemic mortality risk. No insurance premiums are paid outside the scheme and money that would have flowed as profit to an insurer’s shareholders is retained for the CDC members.
The scheme will instead share the systemic mortality risk intergenerationally. If the current generation of pensioners live longer than the actuary expected, it is the next generation that pays for them.
Vice versa, if the scheme experiences excess deaths then the excess money will flow to the next generation of scheme members. The next generation of retirees should benefit in terms of their retirement income
CDC pension income amount is not guaranteed
This may seem like a negative for CDC members, but this lack of a guarantee, unlike annuities, means that CDCs do not have to hold large capital reserves against future liabilities.
Because if investments made by scheme trustees generate below expected returns, then CDC scheme trustees will balance this by declaring a lower rate of pension increase from the next valuation.
Exceptionally, if lowering the rate of pension increase does not re-balance the scheme, the trustees can reduce the amount of pension too.
By contrast, the large capital reserves that annuity providers must hold in case of a period of poor investment returns have to be put up by insurers’ shareholders.
Those shareholders expect double digit returns on their investment and these returns are paid for by the annuity purchaser. They are baked into the annuity price and shareholders will enjoy those returns via enhanced share dividends.
The flexibility of CDC avoids these costly reserves, leaving more money available to pay CDC members’ pensions.
Expenses
CDC schemes will be run by trustees as large occupational pension schemes, either for large single employers or for smaller employers clubbing together to generate scale within a master trust, or for individuals joining collectively on their retirement.
The CDC scheme’s trustees will negotiate with all service providers, using their scale to secure low prices for servicing, investment, legal costs etc. The daily valuation, daily trading and daily cash reconciliation of DC are replaced by an annual CDC valuation.
