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With CDC schemes ever closer to becoming a reality in the UK and retirement income guarantees disappearing, Adrian Boulding says sponsors and trustees need to rise to the challenge of member communications
The likelihood of the new collective defined contribution (CDC) scheme rules being enshrined in new pensions legislation in 2019 are now very high. The idea that gained traction towards the end of Sir Steve Webb's time as pensions minister back in late 2014 is now a leading candidate for a Pensions Bill in the Queen's Speech next May.
The Department for Work & Pensions (DWP) has now thrown its full weight behind CDCs - producing a detailed consultation paper framing the legislation needed for CDC and, in particular, a new scheme for Royal Mail. It is clearly staking an early claim for space in the post-Brexit legislative calendar - indeed, insiders suggest we could even have the first CDC scheme live in 2020.
If a new type of workplace pension is being introduced into the UK, though, why is this still needed now that we have the freedom to move between defined benefit (DB) and defined contribution (DC) schemes? And also while auto-enrolment is such a success in getting nearly 10 million people saving - albeit largely at the prescribed minimum contribution levels and investing in low-risk default funds?
Is the emerging CDC a response to:
* Declining access to - and number of - DB pension schemes?
* A desire by employers to reduce or eliminate large long-term pension liabilities implied by running final salary pensions as a growing negative balance sheet item?
* Concern that DC pensions open less engaged savers to the prospect of under-saving for retirement?
In truth, the answer could be ‘yes' to all of the above. Nevertheless, despite the fact CDCs are already in quite wide use in Denmark (enrolment into a CDC is compulsory there for employees) and the Netherlands (the country has 260 CDC schemes functioning), the concept might not have made it over the North Sea but for Royal Mail working in close concert with the Communication Workers Union (CWU) to create the need for it.
Let me explain. Like many large DB schemes, the Royal Mail Pension Plan (RMPP) closed to new members in 2008 as the firm detected rising DB liabilities were looking unaffordable longer term. By April 2012, the company managed to pass responsibility for historic pension liabilities from the RMPP to the government.
Then, following consultation with RMPP members in early 2017, it announced its decision to close the RMPP to future accruals in March 2018. Following this announcement from October 2017, Royal Mail and the CWU began negotiating on behalf of postal workers for future pensions, pay and conditions, all mediated by The Advisory, Conciliation and Arbitration Service (ACAS).
By late November last year, the ACAS report recommended both sides commit to the introduction of a single CDC pension scheme - and won their joint agreement to this settlement. Aiming for a "best of both worlds" solution, the scheme holds out the prospect of a target pension for life plus a tax-free cash sum on retirement, all for a fixed cost from both employer and employee.
With a following wind, posties will receive a pension of one-eightieth of each year's salary plus CPI increases. As Royal Mail provide one in every 90 jobs in the UK, this is a significant swing of the pendulum away from its current DC scheme back in the direction of DB.
In addition, the power of ‘longevity pooling' and ‘collective security' work together to deliver the prospect of higher median retirement incomes, largely because of lower volatility. A 2009 Government Actuary's Department study found the median improvement in outcome offered by CDC "is as high as 39% for some members". A 2012 paper by the Royal Society of Arts indicated a 37% boost to outcomes through CDC.
Royal Mail bosses also like the idea of the CDC because it passes the risk of the pension underperforming through to the employee member. In other words, if we have another financial shock along the lines of the great recession, the employer does not need to add the resulting liabilities in red on their balance sheet and start borrowing more to keep guarantees in place. Instead what trustees must do is adjust the benefit accordingly.
So, even after you have retired, you have the prospect of your pension income from your CDC going down and quite possibly staying down for some considerable time if the next downturn is anything like the last.
The problem, discovered in the Netherlands back at the beginning of the great recession in 2008/09, was that members had been exposed to such a long run of outperformance and rising retirement incomes they had come to consider inflation-busting pension benefit rises almost as a right, which of course they were not. Members had to take the hit when markets went South. Understandably, there was considerable dissatisfaction among members, which rumbled on for years.
What this evidence from the Netherlands confirms is the very significant member communications challenges CDCs present to those planning to run these sorts of schemes from 2020. The recent Work and Pension Committee report on CDCs acknowledges this and, on page 24, proposes this remedy: "We recommend that all CDC schemes be required to publish their rules for calculating and distributing member benefits in a standardised format, provide data for the pensions dashboard … and report publicly their funding position and strategy at least annually."
The ABI concurs by saying that, by mistaking target pension rates for guarantees - and therefore not understanding that member bore funding risk - was "arguably the greatest risk of CDC".
As we move inexorably into the digital age, static paper-based annual publication of funding positions, investment strategies and rules for calculating and distributing member benefits will prove inadequate.
CDC members, particularly those in decumulation, will need to know as soon as possible if their monthly retirement income amount is due to go down, so they can plan for that loss of income. Even small reductions will require clear advance warning and, while Royal Mail hopes to smooth large reductions over three years, any reduction can be troublesome for those with no safety cushion to fall back on.
At the time that pensions are reduced, trustees should consider including handy hints on how to trim expenses and live on a smaller pension. Even before we get to any reductions, however, communications should perhaps be extolling the virtue of setting aside a little of the pension in good times in a liquid savings account so that retirees are prepared in advance for what many see as inevitable falls at some point in retirement. Anyone who has enjoyed ‘Joseph and the Amazing Technicolour Dreamcoat' will appreciate this virtue.
By the same token, rises in performance are a good opportunity to encourage and reinforce membership loyalty - for example, informing accumulating members of any upward adjustments of anticipated retirement income levels.
Finally, given concerns associated with bringing a new and complex type of pension into life in the UK, it is perhaps reassuring that ‘super-trusteeship' is also promoted by the Work and Pension Committee. CDC scheme trustees look set to require authorisation by The Pensions Regulator, which will also be keeping a very close eye on not just the content but the efficacy of CDC communications to members.
Adrian Boulding is director of retirement strategy at Dunstan Thomas