In October 2018, the Department for Work and Pension (DWP) launched a consultation to “shape future legislation” of Collective Defined Contribution Schemes (CDC). The aim of the consultation is to gather views from across the pension industry and ensure that CDC schemes deliver a viable alternative option to the traditional choice of either Defined Benefit (DB) or Defined Contribution (DC) schemes for both employers and employees.
For a number of years now, as the costs of running DB schemes escalated due to increased longevity, soaring costs, onerous pension regulations and challenging economic conditions, employers have closed their DB schemes and opened a DC scheme for their employees. This puts a cap on the costs for the employer and removes the requirement to value the pension liabilities in the Company accounts.
However, there has been a noticeable shift in opinion within the pension industry that traditional DC arrangements may not fulfil all members’ requirements for an income in retirement. Following the introduction of pensions freedoms in 2015, the traditional route of purchasing an annuity with a DC pot has become significantly less attractive. The alternative of accessing a DC pot via a flexi-access drawdown payment can potentially leave people with a large sum of money and no real idea how long they will need the money to last or how to reinvest it in the meantime.
CDCs are an alternative pensions vehicle and are not new – they are widely used in the Netherlands, Denmark and parts of Canada, and the merits of them have long been debated in the UK. They work by pooling the collective employee and employer contributions together in a combined fund – more akin to a DB arrangement. However, in a CDC scheme, members get to choose how their funds are invested and the investment choices are available at a lower charge than a non-pooled arrangement.
The pension benefits are available at retirement are calculated by the Scheme Actuary who considers the rate of pension members can reasonably expect to receive, given the rate of contributions promised to the scheme. The answer drives the rate at which pensions are paid. From an employer funding perspective, it would remain a DC scheme. The key point to note, is that if investment returns do not achieve the expected level of return, then the benefit payable to the member is reduced accordingly. This point is crucial, and clearly if CDC are to provide a truly viable alternative, communications with members will be critical.
The consultation asks a number of questions of the pension industry to gauge the appetite for CDCs, to understand the problems and complexities of CDCs and to seek views as to how these problems could be overcome. These include the possible minimum size for a CDC to be viewed as having sufficient scale to effectively pool longevity risk, if CDC should be legislated as a DC scheme, the best ways to manage risk, any additional communications and information requirements for CDCs and how CDCs would fit within the automatic enrolment regime. As part of the consultation, it has been confirmed that in order to protect the investments and to ensure costs are controlled, the DWP is proposing that all CDC pension schemes will be subject to a charge cap of 0.75%, set at the same level as DC schemes.
From within the industry, reaction to the consultation has been positive, with the acknowledgement that a new method of pension provision can provide a sound and reasonable solution, whilst acknowledging that there are many hurdles to overcome before a final path is set. CDCs are not without their critics. Some argue that they are inter-generationally unfair, as if a scheme overestimates the amount its assets will return, it must adjust its liabilities by cutting its pensions promise for some or all future members. Other argue that CDCs are untested in the UK and against the spirit of pensions freedom.
Whatever the result of the consultation, which runs until 23 January 2019, it is clear that the government has thrown some real backing behind the CDCs as a viable alternative to the traditional DB and DC arrangements and so the pension industry await further developments with great interest. ●
Martin Strevens, Consultant