Inter-generational cross-subsidies in the UK’s first CDC pension scheme

The UK’s first collective defined contribution pension scheme will shortly be launched.
Three types of inter-generational cross-subsidies in this scheme are identified, explained and illustrated. One of them, arising from financial unfairness, means that the first generations in the scheme have highest replacement ratios, on average. Another enables pension smoothing, by the transfer of risk from the old to the young. In turn, this allows pensioners to be protected from the volatility of a higher risk investment strategy. The third cross-subsidy reduces the impact of actual economic outcomes being different to those expected.
Pension outcomes under a model of the CDC scheme are compared to those of three defined contribution-based alternatives. The comparison is done for each generation in the scheme. The results suggest that longevity risk-sharing alternatives, such as pooled annuity funds, may provide a similar or better outcome than the CDC scheme, depending on the generation studied.