The UK’s Department for Work and Pensions (DWP) is bringing forward legislation to define and regulate the introduction of collective defined contribution (CDC) pension schemes.
CDC pension schemes allow contributions to be pooled and invested to give members a target benefit level that enables the sharing of longevity risk between members.
They are different from defined benefit, as the latter guarantees an income stream in retirement, which a CDC does not. Instead, the latter has a target amount members have to pay, based on long-term plan with mixed risk investments.
The DWP received several submissions to its consultation paper – Delivering Collective Defined Contribution Pension Schemes – with companies such as Royal Mail and the Communication Workers Union enquiring about introducing such schemes for their employees.
The department said that this type of scheme could be favourable for companies with a large workforce, such as Royal Mail which currently has over 140,000 members of staff.
How it would work
According to the DWP, a member’s pension would be calculated according to:
- Estimating how much money is needed to meet the benefits credited to each member,
- Adding up the values for each member to determine the total assets available,
- And if the assets do not match the benefits credited to all members, measures will need to be taken so that the total value of benefits is equal to the total value of the scheme’s assets.
The attractiveness of the CDC scheme lies in the fact that it can provide savings and income to its members, give longevity protections and could allow trustees to choose a higher proportion of higher return assets.
But many are not convinced
Some respondents highlighted concerns about the investment risk of CDC schemes.
Additionally, the collective nature would not be beneficial to employees at different stages of their lives. As one respondent suggested, “it is nigh impossible to treat a 20-year-old member and an 85-year-old member the same”.
This means that if a company chooses to roll out a CDC scheme, its members will pay in different levels of contributions depending on their age. The aim, however, is that they will all receive the same pension benefit when they retire.
Another critic of the scheme mentioned that since employees do not have a say as to where the fund is invested, it could clash with a member’s religious or social beliefs and they would not have any alternatives to choose from.
Everything ‘still unclear’
Simon Eagle, a director at Wills Towers Watson’s retirement business, who also advised Royal Mail on its CDC proposition, said: “Until CDC goes from a theoretical possibility to a lawful option, we won’t know how much demand there might be, but there are good reasons for employers to take a proper look.
“If an employer can’t take pension risk on its balance sheet but wants to set employees up with an efficient retirement income – albeit a variable one – rather than just an investment pot, CDC will be the way to do that.”
However, while many believe it to be an innovation in the UK pension landscape, other think there is just no place for CDC schemes.
“The industry is divided on the relative merits of CDC, which originated in the Netherlands,” Steven Cameron, pensions director at Aegon, said.
“Supporters point to them offering greater certainty to individuals compared to defined contribution (DC) with the potential to pool investments and reduce charges.
“Critics point to the complexity of explaining the scheme’s benefits to members and their incompatibility with pension freedoms. Individuals are told what their ‘target benefit’ is but this is not guaranteed, and it is likely that actual benefits will be different from the initial target, making planning difficult,” he added.
“Most worryingly, there is a very significant risk that monthly pension income once in payment could fall. There is also the potential for one generation of members to subsidise another.”
CDC could mean lack of scrutiny
Matthew Arends, head of UK retirement policy for Aon, said: “We see the DWP’s response to the CDC consultation as an endorsement of the broader concept of collective DC benefits for the UK – something we have been advocates of for many years. Much of what we see in the response confirms the direction of travel set out in the consultation itself.
“However, one thing that surprised us is the lack of additional controls over the setting of the actuarial assumptions to value the CDC target benefits – the DWP indicates that the Institute of Actuaries’ existing Work Review requirements will apply.
Arends added that “this could mean that there will be no external scrutiny of actuarial assumptions for CDC schemes until they are published after the actuarial valuation is complete”.
“As the actuarial assumptions will directly determine the pace of pay outs to members, we were expecting that more explicit, external review and ratification of the assumption setting would be required. This would increase public confidence in CDC schemes.”
CDC vs Brexit
While, the DWP is trying to bring CDC schemes into legislation, the entire process could be halted by the shadow of Brexit, Tom Selby, senior analyst at AJ Bell, warned.
“Brexit remains the only show in town in Westminster at the moment. We know CDC is coming but we have, at this stage, no idea when.
“The government is taking a pragmatic approach to bringing forward this new regime, focusing almost entirely on creating a framework which will allow Royal Mail to provide collective pensions to its 140,000 UK staff.”
Selby added: “It would be sensible to use this opportunity to review communications across the retirement spectrum to ensure consistency and simplicity for members. If we do ever get to this stage, it is unclear how such arrangements might differ materially from traditional with-profits schemes run by insurance companies.”