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Earlier this summer, the House of Commons Work and Pensions Committee (WPC) published its report on Collective defined contribution (CDC) pensions – in which it recommended the Government should prioritise legislative changes to allow employers to establish CDC schemes.
by Danny Wilding, FIA, Partner at Barnett Waddingham
CDC promises a shared-risk approach to retirement benefit provision with advantages for employers and members. This sits in contrast with the current alternatives where risk is borne primarily by one party or the other. Danny Wilding asks: could this result in a flow of employers entering into the risk-sharing arena?
Private pension provision in the UK currently takes one of two polar extremes, with the majority of risks borne by either the sponsor (DB) or the individual member (DC):
Defined Benefit (DB) – where a benefit is promised in advance and paid from a collective fund
Defined Contribution (DC) – where employer and employee contributions are invested for the individual member to purchase a pension at retirement
The Government sought to introduce a middle ground (“Defined Ambition”) via the Pension Schemes Act 2015, but appetite was not sufficient and the drafted provisions were never brought into effect.
What is CDC?
CDC seeks to address some of the perceived weaknesses of DB and DC, as well as taking some of the best aspects of each. In particular:
“Collective” – The nature of CDC means that investment, longevity and inflation risks are shared between the participants of the scheme, rather than borne by the individual alone
“Defined Contribution” – Employer (and employees) contribute a set amount into the scheme, with, in theory, no opportunity for deficits to arise
There is a broad spectrum of possible CDC scheme designs. Members could invest in a fund which pooled returns to reduce volatility (much like a “with-profits” fund), or the so-called “Dutch model” which targets a defined pension but with the ability to scale benefits according to the scheme’s funding position.
Whilst no such scheme currently exists in the UK, CDC arrangements are well-established in both the Netherlands and Denmark.
Example – based on the Dutch CDC model
Target pension of 1/80th of salary per year of membership
Fixed contributions (as a percentage of salary) from members and employer(s)
Target pension increases in line with price inflation before and after retirement
Annual assessment of funding position
If investment returns are in excess of those required to pay an inflationary increase, a larger increase can be granted across the scheme
Lower (or negative) investment returns would result in a smaller increase (or perhaps a decrease) in benefits
The ability to scale back the pension promise avoids the possibility of a deficit arising
Why the interest now?
Royal Mail announced in 2017 that it intended to close its DB scheme to future accrual from 31 March 2018. This led to discussions with the Communication Workers Union (CWU) on what retirement benefits would be offered for current and future employees instead.
Following mediation, the CWU and Royal Mail agreed in principle to pursue the introduction of a CDC scheme for all staff. The proposal was met positively by the Government, who recognised that it might now be worthwhile to consider legislation to allow a CDC scheme for such a large employer (the Royal Mail has around 150,000 employees)
The inquiry findings
The committee examined written evidence from 42 respondents, including Barnett Waddingham, and oral evidence from a number of individuals, asking for responses on:
Will CDC deliver “tangible” benefits to savers compared with other models?
Could CDC work alongside the desire for individual freedom and choice?
Would CDC add to complexity and confusion?
Will savers understand the ambition aspect of CDC?
How would CDC be regulated?
Is there sufficient appetite for CDC?
Would CDC funds have a “clearer view” towards investing for the long term?
In examining the evidence, the committee largely settled on the Dutch model as their preferred CDC approach, and their debate focussed on the intricacies of this design.
The WPC concluded that the introduction of CDC could represent an attractive alternative to DB schemes, and would not diminish individual freedom and choice. They recommended that:
The Government should use its existing powers to amend the statutory definition of “money purchase” benefits to incorporate collective benefits arrangements (rather than enacting the ‘Defined Ambition’ clauses drafted into the Pension Schemes Act 2015)
The Government should consult on the intergenerational fairness aspect of CDC schemes, the mechanism for calculating transfer values, and whether transfer values should be permitted for pensions in payment
CDC schemes should be required to adopt a standardised format for rules on calculating and distributing benefits, and be required to publish their funding position at least annually
The Government should consult on whether trustees and their advisors would require a specific qualification to run a CDC scheme
The Government should consider whether The Pensions Regulator (TPR) should oversee CDC schemes
Regulations should allow for the creation of mutual, multi-employer and standalone CDC schemes
The Government is expected to respond later this year, though remains likely to be preoccupied with ‘Brexit’ in the meantime.
Whether this then leads to a new era in workplace pension provisions is difficult to foresee – much will depend on whether the Royal Mail proposal is given the green light and, once up-and-running, whether it is viewed as a success. Nevertheless, although for many the option of shared risk comes too late (as the migration from DB to DC is well entrenched), others may well seize the opportunity to embrace the CDC revolution.