The fact we have a new Labour government is perhaps a surprise to nobody, however in the land of ‘what next’ many surprises may await.
As the new administration turns its attention to the question of what next in pensions, a critical debate needs to be bought to a conclusion: how should pensions decumulation be designed for the mass-market of auto-enrolment savers?
For too long now the policy space has tried to walk two paths at the same time, when in reality the landscape of pension decumulation in the UK is at a crucial crossroads.
As the new Labour government seeks to reform and optimise the retirement system, two fundamentally different approaches are on the table:
- the collective defined contribution (CDC) approach that has primarily been driven by the Department for Work and Pensions/The Pensions Regulator; and
- the ‘choice architecture’ approach of investment pathways and targeted support promoted by the Treasury and the Financial Conduct Authority.
Each offers distinct advantages, yet their incompatibility necessitates a decisive choice before the industry embarks on costly implementation of one approach only to find that the policy space has decided it prefers the other.
CDCs
The CDC approach centres on pooling pension contributions from multiple members to provide a collective retirement income. This model emphasises risk-sharing, collective investment, and target benefits.
By pooling resources, CDC schemes aim to offer a stable and predictable income for retirees, mitigating individual risks related to investment performance and longevity.
While there are those who argue that CDC could sit alongside the existing drawdown options as just another product choice, in reality, to be effective and economic it needs to be enacted at scale.
In essence, CDC schemes provide a form of social insurance within the pension framework, aiming to offer members a more secure financial future.
Choice architecture
In contrast, the choice architecture approach focuses on creating an environment that helps individuals make better decisions regarding their pension decumulation.
This approach includes providing a limited number of well-defined options, behavioural nudges, and targeted support/advice to guide retirees through complex choices.
It seeks to empower individuals by offering flexibility and personalised support, allowing them to tailor their retirement income strategies according to their unique circumstances and preferences.
While both approaches aim to improve retirement outcomes, their fundamental differences make them incompatible at the mass market level.
The CDC approach is rooted in collectivism and shared responsibility, pooling risks and resources to create a unified strategy for all members. This requires centralised management and robust governance to ensure fair risk-sharing and benefit adjustments.
On the other hand, the choice architecture approach values individualism and personal choice, relying on a decentralised, flexible system with sophisticated tools and advisory services to support individual decision-making.
Regulating each approach
The regulatory frameworks required for these approaches also differ significantly. A CDC system necessitates new regulations focused on collective governance, funding standards, and benefit security.
In contrast, the choice architecture approach requires regulatory frameworks that support diverse financial products, consumer protection, and access to advice.
These divergent regulatory needs further underscore the incompatibility of implementing both approaches simultaneously.
