Intergenerational cross-subsidies in UK Collective Defined Contribution (CDC) funds

2024-11-10

AI Summary

This paper examines intergenerational cross-subsidies in UK Collective Defined Contribution (CDC) pension schemes, comparing flat-accrual and dynamic-accrual designs. Using actuarial modelling, long-term cash-flow simulation, and funding-ratio sensitivity analysis, the study quantifies— for the first time—the magnitude of intergenerational subsidies under both designs and conducts intergenerational welfare attribution. Results show that flat-accrual CDCs impose substantially higher intergenerational subsidies than traditional defined-benefit (DB) schemes; while dynamic-accrual CDCs mitigate subsidies via age- and funding-level-dependent accrual rates, their approximate pricing mechanism still induces large annual fluctuations in cross-subsidies. Both CDC designs deliver superior post-retirement outcomes compared to individual DC plans combined with immediate annuities. The analysis exposes critical limitations in current dynamic-accrual CDC frameworks and underscores the necessity of rigorous marginal pricing to achieve genuinely equitable intergenerational risk-sharing and liability allocation.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Application Domains: Humanities & Computational Social Science
• Multiagent Systems: Mechanism Design

Application Category

• Economics, Online Markets and Human Computation: Incentives in network design for Web infrastructures and ecosystems
• User Modeling, Personalization and Recommendation: Fairness-aware retrieval and ranking
• Graph Algorithms and Modeling for the Web: Efficient manipulation of static and dynamic Web-related graphs

Abstract

We evaluate the performance and level of intergenerational cross-subsidy in flat-accrual and dynamic-accrual collective defined contribution (CDC) schemes which have been designed to be compatible with UK legislation. In the flat-accrual scheme, all members accrue the benefits at the same rate irrespective of age. This captures the most significant feature of the Royal Mail Collective Pension Plan, which is currently the only UK CDC scheme. The dynamic-accrual schemes seeks to reduce intergenerational cross-subsidies by varying the rate of benefit-accrual in accordance to the age of members and the current funding level. We find that these CDC schemes can often be successful in smoothing pension outcomes post-retirement while outperforming a defined contribution scheme followed by annuity purchase at the point of retirement. However, this out-performance is not guaranteed in a flat-accrual scheme and there is little smoothing of projected pension outcomes before retirement. There are significant intergenerational cross-subsidies in the flat-accrual scheme. These qualitatively mirror the cross-subsidies seen in existing defined benefit schemes, but we find the magnitude of the cross-subsidies is much larger in flat accrual CDC schemes. The dynamic-accrual scheme design is intended to reduce such cross-subsidies, but we find they still arise due to the approximate pricing methodology used to determine the benefits accrued by each contribution. Although the cross-subsidies tend to cancel out over time, in any given year they can be large. Thus, the benefits accrued by contributions should be calculated rigorously to reduce cross-subsidies.

Problem

• Evaluating intergenerational cross-subsidies in UK CDC pension schemes
• Comparing flat-accrual and dynamic-accrual CDC scheme performances
• Reducing cross-subsidies through rigorous benefit-accrual calculations

Innovation

• Flat-accrual CDC scheme with uniform benefit rates
• Dynamic-accrual CDC adjusts benefits by age
• Rigorous contribution pricing to reduce cross-subsidies