Those looking to host a successful dinner party are commonly advised to avoid discussing sex and politics in the dining room. For events where the diners are predominantly corporate pensions experts, hosts may want to add collective defined contribution (CDC) to the list of taboo subjects.
This alternative to defined benefit and defined contribution pension schemes is about to arrive in the UK after years of debate, and while some are excited about their arrival, others don’t share their enthusiasm.
Making waves
CDC schemes made headlines in the UK back in 2018 when Royal Mail struck an agreement with the Communication Workers’ Union following years of struggling with the financial burden of backing a defined benefit scheme. The company entered talks with union representatives after concluding it could no longer afford to shoulder the expense of offering a DB scheme.
After weeks of negotiations both parties agreed that a defined contribution option was an inadequate replacement and that a CDC option would be more palatable for employees. Royal Mail, meanwhile, would benefit from greater clarity over its future pension contributions. It has been billed as a win-win.
In a press statement, Communication Workers Union deputy general secretary (Postal) Terry Pullinger said the union was proud to be at the forefront of such innovation and predicted that CDC options would prove to be “a watershed moment” in pension provision.
He added: “DB is the gold standard… and should be maintained wherever possible. However where it cannot, there have to be more options than simply DC schemes.”
While these arrangements are already available in Canada and the Netherlands, the UK has, to date, never embraced collective DC. For employers such as Royal Mail to be able to offer these pension schemes, government- approved legislative changes have been required.
In March 2019, the UK government announced it was backing the “pioneering proposals” and had confirmed that primary legislation was to be laid down to allow other companies to follow suit in offering this kind of pension arrangement to their employees.
The government stated that these CDC schemes would appeal to companies seeking to offer a good employee pension “without having to hang on to enormous pension liabilities”.
Bespoke tailoring
Enthusiasts championing the wider-use of CDC schemes say that companies will need to take a bespoke approach, warning that the Royal Mail’s CDC scheme should not be viewed as a template.
“The UK has to focus on considering how best to ensure that these schemes achieve longevity, which will be to the benefit of all stakeholders,” explains Buck head of retirement consulting Vishal Makkar.
“One example has been developed in the UK, where many decisions were made for circumstance-specific reasons with bespoke modelling – before legislation has been defined.
“Our concern is that this becomes the solution which morphs into the UK CDC scheme design standard, without proper consideration as to what are the optimum characteristics for this kind of scheme.”
Makkar’s comments are echoed by KPMG pension director Scott Kendrick who says while other companies will be closely watching the success or otherwise of the Royal Mail CDC solution, other options will need to be developed as this will not suit everyone.
“We will need legislation and a collective push from industry to develop other flavours of CDC,” he says. “The emergence of CDC is possibly a little late on the UK scene. While I think that many companies with open defined benefit pension schemes will closely scrutinise CDC as an option, I think most will ultimately end up with defined contribution arrangements.”
Decumulation debate
The real heat of the CDC debate surfaces when consultants give their views on the use of CDC in the decumulation phase. Those championing CDC say that CDC income solutions could become a popular decumulation option for conventional DC schemes.
Proponents say they offer the potential for a higher life-long income than an annuity, as the underlying investment policy takes a longer-term time horizon, allowing CDC schemes to hold riskier assets.
“Compared with a drawdown solution, CDC income takes away from the member the challenge of generating an income that lasts a lifetime, meaning the member does not need to decide an investment policy and a rate of drawdown to generate their income in retirement,” says Aon senior partner Kevin Wesbroom.
Retirees in a CDC income solution would be forecast a future level of benefits, based on the long- term performance of the underlying assets in the scheme.
“For some members – typically those with higher levels of retirement savings – they may want a combination approach with part of their savings applied via CDC to generate a basic level of income, but flexibility with the remainder through drawdown,” adds Wesbroom.
But these proposals don’t sit easy with everyone. KPMG’s Kendrick – who is broadly positive towards CDC drawdown solutions – says they could work but “it’s a qualified yes”.
“It would need some clear health warnings,” he says. “There are obviously risks of competing products offering ever-more attractive terms. We all know the lessons of the nineties, when some with-profits schemes appeared to pay scant regard to their underlying guarantee. Volatile markets exposed this.”
Not for everyone
Kendrick says he believes CDC drawdown arrangements are likely to be more popular for DC members than those in defined benefit arrangements, although he concedes that “some might also consider CDC”.
William Fitchew, senior consultant at XPS Pensions Group says that the current form of CDC that the UK government is legislating for will not suit DB members eyeing a transfer to achieve a “flexible” income.
“Initially, the form of CDC being legislated for will only enable schemes of the broad form proposed by Royal Mail,” says, Fitchew.
“Longer term, the government may legislate to allow greater flexibility and innovation in CDC schemes, possibly including some commercial CDC schemes, but CDC schemes like the Royal Mail scheme will not offer a flexible income, as the target benefit will be set out in the scheme’s rules.
“The income paid from a CDC scheme might be variable, but this would be controlled by the trustees of the scheme and would depend on the scheme’s funding position rather than on member choices.”
Fitchew adds that CDC schemes, such as the Royal Mail one, will not be compelled to accept transfers, so they may not even be available to those looking to transfer their defined benefits.
Eyes wide open
Even those who are excited by the prospect of CDC schemes becoming more commonplace in the UK market admit there is a need for close regulatory scrutiny in
the early years. There is widespread acknowledgment that any new schemes need to make clear the negative impact of underperforming assets on the amount that future pensions will pay.
Broadstone technical director Dave Brooks says the complicated nature of CDC schemes means not everyone will understand that CDC drawdown arrangements have periods where they may need to give “bad news” where pension incomes may be reduced. Such a scenario has already played out in other markets. In the Netherlands, where CDC has been commonplace for years, schemes reduced their pension payments after the financial crisis to repair solvency levels. Dutch savers reacted angrily to the news, with younger scheme members saying they were being treated unfairly.
While clear scheme communications can reduce the “surprise element” of such necessary tweaks, savers will always be disappointed when their pensions fall.
And, as CDC is brand new in the UK, the regulator will have to work especially hard to ensure that members of these pioneer schemes know exactly where they stand.