Collective Defined Contribution Schemes (CDC) are back in the news. There are two reasons for this
- The Workplace and Pensions Committee have set up an enquiry into CDC
- Royal Mail and the CWU intend to move to a CDC basis for pensioning all 140,000 staff
Most readers will struggle to remember what all this fuss is about. The history of CDC in this country is a tortuous one and easily forgotten!
2008 Following a consultation on “risk sharing”, the Government set up a second consultation on “CDC”
2009 The DWP concluded that in the for six different reasons, the Government should take no further action on CDC schemes.
2014 The DWP drafted a Pension Bill that included a section on Defined Ambition, this was enacted in the Pension Schemes Act 2015 , The Act was intended to encourage and enable ‘shared risk’ pension schemes and ‘collective benefits’.- including CDC
2015 Shortly after the passing of PA15, Baroness Altmann, the new Pensions Minister announced that no further work would be carried out on the secondary regulations needed for CDC schemes to get going. She did however say the Government would return to the subject
From this timeline, it is clear that CDC is marmite. To its friends (and I chair the Friends of CDC working group) it can be useful in three ways
- As a halfway house between DC and DB pensions – offering people scheme pensions without the onerous guarantees on employers
- As a means for those saving through workplace pensions to spend their pension pot in an organised way (e.g as a non-guaranteed scheme pension)
- As a means for people to aggregate DC pots, including the proceeds from CETVs and exchange them for scheme pensions.
But there remain the six reasons that the DWP dismissed CDC in 2009
- The modelling results support the claims of enhanced performance on average from CDC schemes (criterion 1)
- and of some increased predictability of outcomes compared to DC schemes (criterion 2).
- However, there is significant doubt on the ability of such a scheme to manage risk successfully in a way which is fair to different generations of scheme members (criterion 3)
- and doubt remains on the extent to which the stability of CDC schemes is dependent on a continuing stream of member contributions (criterion 4).
- The legal implications of operating CDC schemes in the UK raise significant doubt on the potential for CDC schemes, as proposed, to exist in the UK given existing European legislation (criterion 5).
- Finally, demand for CDC schemes from employers (criterion 6) is likely to be limited, but could involve some DC schemes opting for a potentially better pension outcome for their employees if CDC schemes existed, and especially if other employers in the industry also offered CDC schemes. However, employers (including DB scheme sponsors considering closing their schemes) seem to be reluctant to subscribe to a new type of pension scheme which their employees may not fully understand and remain sceptical of their potential liability if investment performance is poor.
One of these criteria (5) falls away with BREXIT, however – the substantive issues (3), (4) and (6) remain.
Risk management within a CDC Scheme (3) is a precarious business. The fundamental structure of a CDC scheme is that it converts defined contributions into a regular pension with monies invested on a collective basis – as they would be in a with-profits arrangement.
CDC schemes look to insure against people’s money running out by ensuring that pensions in payment and transfer values fairly reflect each member’s equity in the arrangement. Obviously, the risk is that the calculations go wrong and the scheme either overpays (as happened to with-profits, or underpays – meaning the scheme builds up a surplus but creates dissatisfied members.
One actuary told me that if he ran the scheme he’d expect to be wrong 100% of the time but that he’d be over-distributing as much as under-distributing and never to a great extent. The optimistic view is that people can live with some degree of smoothing provided it’s clear that no one group is discriminated against. Pessimists will point to past experience and complaints in countries where CDC operates from perceived “losers”.
The other criteria against which CDC has failed in the past, is to do with employer support. In the past, the view has been that CDC would replace DB and this has prohibited most employers from touching it with a bargepole. Employers are well aware that any pension scheme labelled “money purchase” can be deemed “DB” for accountancy purposes and put employers on the hook for deficits between what is available and what has been promised.
The situation at Royal Mail is an interesting counter to this view. Here the employer is acceding to a demand by 87% of members not for defined benefits but for “a wage for life”. Terry Pullinger, the CWU deputy secretary conducting negotiations on behalf of members is clear that any settlement has to be based on a pension, but the security of that pension is negotiable.
While the RM/CWU model is perhaps “classic CDC” as understood by some Canadian States, Holland and some Scandinavian schemes, Britain’s adoption of pension freedoms in 2015 has opened demand for a new kind of CDC – one where there is no employer and the scheme is funded purely from member contributions – particularly from transfers.
Concurrently, the success of auto-enrolment has led to demand from the new master trusts to offer scheme pensions. Operationally, the payment of pensions would work as a pensioner payroll of a DB plan, but the annual level of pension would be set – not against an agreed formula such as CPI increases, but dependant on the scheme managers discretion.
Undoubtedly there will be considerable scepticism within the pensions industry about whether a system where discretion is given to a manager and an actuary could be sustained over time. This brings us to final main objection – “whether a CDC scheme could maintain a continuing stream of member contributions”.
This is an extremely hard objection to argue against as any view of the ongoing popularity of a pension system, is tarred with the brush of failure of such a system at some time or in some place.
Ironically, the best model to compare the current vision of CDC – at least in the classic sense, is the UK DB pension system before the imposition of guarantees which started in 1984 and has culminated in the closure of almost all schemes to future accrual in the past five years.
Sceptics will argue that the status of schemes before 1984 where benefits were promised and not “guaranteed” was intrinsically unsustainable. They will point to countries where pensions are set against what the fund can afford rather than a guaranteed amount as creating social discontent. Both viewpoints have some merit and the debate which is likely to play out over the coming months will not doubt be heated!
However, Friends of CDC – and I am one, will point to the fact that however many times CDC has been written off, it seems to bounce back again showing the kind of resilience needed from a pension product.
While some had thought that the introduction of Pension Freedoms would finally do for CDC, the concept seems to have been brought to life by the apparent failure of many people with large transfer values to find an obvious replacement for the annuity.
Despite the importance of providing moderated solutions to schemes such as Royal Mail, the revival of interest in CDC may ultimately lie in the need to give people “freedom from freedoms”