Readers may well ask why so much attention has been paid to a new type of pension called CDC. It is highly controversial but despite all the articles, seminars and legislation, not a single CDC scheme has been set up, nor is likely to be till well into next year when Royal Mail look set to launch a scheme for 140,000 postal workers.
This article sets out to explain what CDC is, why it is controversial and what are the prospects for it becoming a central part of the UK pension eco-system. Hopefully it will excite you to think about your own workplace pension and whether some of the features of a CDC scheme would be helpful to your staff. If you can’t think of any application, you may well say that CDC is a fuss about nothing.
The first thing to say about CDC schemes, is that it sets out to provide people who join one, with a wage in retirement that lasts as long as they do. This is something that workplace pensions haven’t been able to offer since the demise of private sector DB.
The second thing to say is that CDC does not rely on an insurance company standing behind the scheme – if things go wrong, the only insurance the scheme can call on is the “collective”, the combined fund created by defined contributions paid over time. This is what makes CDC so controversial as it introduces an element of risk-sharing that is between members rather than with an insurance company or an employer.
Critics of this approach say that it encourages risk-taking rather than risk-sharing and that such schemes are likely to rely on “inter-generational transfers” from younger workers to older workers.
Those who support the idea of CDC say that it is simply reverting to the principals that made defined benefit schemes so popular and that the problems that such schemes have had this century is because they have moved away from the principle of mutuality that underpins CDC.
This argument is rather abstract so long as no CDC schemes are in place. Royal Mail wants to use CDC as a means to provide postal workers with a pension without bankrupting the employer and was forged from a bitter dispute between unions and management. Similar disputes could find CDC resolution, for instance for university employees in the USS pension scheme and even railway workers whose industrial action is partly about pensions. CDC look as if it could be a way of finding a third way for staff used to being offered a defined benefit, a similar benefit, without guarantees.
Another way of looking at CDC is as an alternative way of getting paid a pension from your workplace savings in a DC scheme. Annuities are well known for paying relatively low levels of income, because the income payable has to be guaranteed by an insurer. The alternative way of getting paid an income from your pension pot is through drawdown where you instruct your pension provider to pay you a fixed amount or a percentage of your pot into the future. It’s up to you to make sure the money lasts as long as you do.
CDCs could be set up as an alternative to an annuity or to drawdown and pay a lifetime income at a better rate than an annuity. People choosing this option would have to accept that because the CDC fund is simply the collective pots of thousands of savers, it can only pay out as much as the pot can sustain over time. So there is again a new risk here, which is that the income promised may have to be reduced if the fund does not grow as planned.
The same issues come into play when CDC is used as a “decumulation only” plan. Those who argue for guarantees argue that it is mis-selling a high rate of income without proper insurance while those who advocate pension freedom see CDC as a fudge which “disengages” savers from their responsibility to manage their later life finances individually.
Research from Nest and from consultancies such as Aon and Willis Towers Watson suggests that CDC is likely to be popular with members of workplace pensions who are prepared to take some risk of their pension income rising and falling with the markets, but who aren’t happy to manage their own pension drawdown. Aon estimate that over 60% of savers they polled described a CDC style pension when asked what they wanted.
The success of CDC will depend on the capacity of the pension industry to package the idea in a way that people understand and trust it. So far, it has been arguing about CDC with itself. But with CDC applications beginning in August and with the first scheme opening in early 2023, the argument will need to be had with the people whose pensions might get paid by CDC.
What do you think?