how can CDC can boost pensions for millions?
This is the first in a series of blogs which will address some of the questions being asked about CDC schemes. The 20 questions in this blog have been collated and addressed by Con Keating in the hope that we may move the debate over CDC forward.
This would mean we will need the help of Parliament to capture the full potential of CDC pension arrangements. With that in mind Con and I actively seek feedback, comment, criticism, and further questions.
These initial questions are taken from the ten posed by me in an earlier blog and sent to the expert witnesses who appeared at the recent Work & Pensions committee hearing – many of which were not addressed in that session. Others were asked in the hearing.
The different numbering in effect indicates the source. My questions are posed in blue typeface, the WPSC’s in green and Con’s responses in black. The blog starts with a clear call to Government; CDC is a game changer that needs to be enabled.
Why CDC needs further legislation to become a mass market pension solution.
The existing legislation enables and permits only a very narrow range of the possible designs and uses of these schemes – occupational schemes for single (and connected) employer companies.
These CDC schemes are tax approved (i.e. now called registered pension scheme under the Finance Act 2004) occupational pension schemes for the purposes of Section 1 of the Pension Schemes Act 1993 established under irrevocable trust and to be authorised and regulated by the Pensions Regulator under the Pension Schemes Act 2021.
The 1993 Act creates the need for an employer. The insurers are already used to this in the DC Master Trust world and a nominal employer can be used to get the scheme up and running to fall within the OPS definition.
It is possible to envisage other arrangements which avoid the occupational scheme limitations, and they may prove optimal for some arrangements such as “sponsor- independent” schemes. It is also possible that many of the questions may be resolved in the design of scheme rules.
- The Government’s draft regulations are designed to enable the launch of single employer CDC schemes, such as the planned Royal Mail scheme. Should the government broaden the scope of collective defined contribution regulations?
Yes
2. If so, how and when?
A phased expansion of the legislation would be advised, commencing with multi-employer and master trust arrangements. Work on this should begin immediately. See also Q2 below.
3. Is their potential for sector-wide CDC schemes? For example, a scheme covering the care sector.
Yes, there should be considerable demand for sector wide arrangements. However, I would recommend that membership of these for employers be voluntary not mandatory (unlike the Dutch arrangements). It is also possible to envisage schemes which are linked not by occupational status but by some other common bond or affinity grouping.
A related question:
4. Could such a scheme operate within the occupational pensions framework or would it be considered a “non-workplace” pension scheme? Can we properly describe a non-guaranteed non-sponsored pension scheme such as CDC – a pension or is it a collective with-profits annuity?
It would perhaps be best for these independent schemes to operate in a contract-based environment. It really does not matter how we describe them, but I would prefer pension as we refer to DC pensions. They are not annuities in the insurance sense as there are no guarantees of any income
5.The Pension Schemes Act 2021 legislates for occupational CDC schemes, which are regulated by the Pensions Regulator. Is there a case for allowing contract-based CDC schemes, which would be regulated by the Financial Conduct Authority?
Yes
Incidentally, the treatment of CDC schemes within the FSCS compensation regime would need some thought if contract-based.
6. Should master trusts be able to offer collective defined contribution options?
Yes
7. Could a CDC scheme operate on the basis outlined above but sit within a master trust , using the DC savings scheme as a feeder and effectively becoming the master trust’s default spending option?
This would be logical and efficient.
8. Could CDC options be a default product for people currently saving into a defined contribution (DC) scheme through auto-enrolment?
They certainly could be, and the legislation should permit this. However, we would note that the terms on which such transfers in were accepted or not should be a matter for scheme rules.
9. Were a CDC scheme to operate independently of an employer sponsor, how would it be positioned against the FCA’s investment pathways; might it be a 5th investment pathway?
It really should be considered as a fifth pathway.
10. Would members be able to transfer their DC savings pots into a CDC scheme without needing to take advice, or would it be better to require advisory clearance as happens with DB transfers?
Advice on a DC to CDC transfer should not be necessary, in contrast to DB to DC transfers. The pension saver is gaining some optionality and should not be penalised in terms of the value of their ‘pot’. They are certainly gaining in terms of the returns available to them arising from the higher risk-bearing characteristics of the collective.
11. What are the risks that would be reduced by offering CDC as a way to spend retirement pots?
One of the principal advantages of an open CDC scheme is that it possesses a higher risk-bearing capacity that an individual, which means that it does not need to seek ever more secure investments as a member ages. This is the source of much of the investment outperformance of CDC schemes relative to individual DC. The principal risk which is eliminated is the idiosyncratic longevity of the member.
12. Is there a demand for CDC schemes as an alternative to annuities or drawdown?
There should be very substantial demand when this is permitted.
13. How likely is it that many DC savers would choose a CDC decumulation product without support to do so?
The case for decumulating in this way for all DC savers, other than those who believe they can manage the performance of their investments exceptionally well, is extremely strong – few would need advice.
14. What would the impact be on other retirement products such as annuities and SIPPs, if CDC competed for DC saver’s pots?
It is likely that the demand for these products would decrease. However, the extent of this will depend upon the rules adopted by CDC schemes and prevailing market conditions.
15. Could a CDC scheme in payment offer a transfer value to purchase an annuity or to a SIPP?
This is a matter for scheme rules, but there is no objection in principle.
16. Would a CDC scheme be considered to be a workplace pension if it operated without a sponsor? If not, would it be subject to the charge cap?
This is a matter for legislation but in principle the charge cap should apply.
17. Is there a commercial reason for operating a CDC scheme independently of a sponsor?
We may expect commercial suppliers of pension services to provide services for profit, just as with other arrangements. In addition, it is possible that some groups may wish to create member mutual organisations to provide CDC schemes on a not-for-profit basis.
18. What lessons should the UK learn from the international experience of CDC schemes?
Perhaps the only thing to take from overseas experiences is the need to communicate clearly and frequently with scheme members.
- Unlike annuities and defined benefit schemes which provide a promised income, CDC schemes provide a predicted income which can increase or decrease depending on the performance of the scheme funds. We have been told that inadequately communicating this to savers is a key risk of CDC schemes. How significant is this risk?
The communication failure risk is extremely significant. The Dutch experience where cuts were needed in the GFC was that members, who had been inadequately informed of this possibility, took it extremely badly and considerable damage was done to the credibility of the Dutch pension system.
19. How does the risk of poor decision making because of inadequate communication from a CDC scheme compare with the same risk for savers in DC schemes?
The reality is that the risks of a DC scheme are not explained to DC savers at all well. This begins with calling them pensions when they are in fact just tax advantaged savings schemes. The decumulation options are usually poorly understood – for example, few have any idea that maximising lifetime post tax income is more likely to be achieved by opting for UFPLS (uncrystallised funds pension lump sum) rather than withdrawing all of the tax free lump sum on retirement.
20. What would the impact of an event such as the 2008 financial crisis or coronavirus have been on the incomes of CDC members?
The events of 2008 would not have presented a major problem, as a standalone event. For some schemes small cuts to indexation or pension payments may have been necessary. However, schemes should have fully recovered by 2011 and been able to reinstate pensions at previous rates. However, 2008 marked the end of a very unusual decade – the UK equity market lost 1.4% pa over the decade from 1999 – and the analysis of that greater period will the subject of the next blog in this series.
Coronavirus has not been a problem as may be judged from AON’s analysis of DB scheme funding shown below:
