The UK pensions industry faces another major shake-up with the proposed introduction of retirement-only CDC arrangements.
This reflects a new focus from policymakers and regulators on decumulation, with the recognition that in a largely DC pensions world, individuals are often left to fend for themselves. As a result they need options that offer greater certainty of adequate retirement outcomes, particularly in the wake of pension freedom rules.
Collective defined contribution (CDC) schemes, which pool savings into a collective fund giving workers regular pension payments for life, were given the green light by government this October, alongside a consultation on retirement-only CDC schemes (or retirement CDC).
Minister for pensions Torsten Bell says: “Too often people approaching retirement are left navigating complex choices and shoulder risks they shouldn’t have to face alone. By expanding CDC to more employers and consulting on retirement CDC, we are helping build a fairer pensions system that gives people confidence their hard-earned savings will last, and they can enjoy their retirement.”
The six-week consultation seeks feedback from the industry on how retirement CDC might be facilitated by trust-based pension providers, and to improve the government’s understanding of the specific regulatory challenges that this scheme design might pose.
Overcoming challenges
Immediate responses to the announcement of the consultation were positive, with consultants and providers noting an appetite for retirement-only CDC.
Findings from Aon’s joint research with Aegon, covering more than one thousand individuals, showed almost one in three expressed a preference for a CDC pension as an alternative to drawdown and annuities.
Meanwhile Shriti Jadav, CDC expert at WTW, says around half of the employers with whom the consultancy has engaged want to explore retirement-only CDC further.
“There is an acknowledgement from many employers that the current options at retirement for DC savers are inadequate when it comes to offering a ‘do it for me’ solution with an attractive level of income for life. Retirement CDC offers a solution to one of the major current issues with DC pension provision – without requiring a wholesale change to schemes or any increase in costs for employers or employees,” Jadav says.
But appetite alone is not enough to drive retirement-only CDC schemes into existence. There are a number of challenges that the government and industry will need to overcome.
First, for retirement-only CDC schemes to get off the ground, providers will need to demonstrate they can build scale, and do so quickly.
Since the government is only looking to occupational schemes to offer retirement-only CDC, the significant scale and operational demands mean they will largely be the preserve of master trusts.
However, given the potential operational and administrative complexities of offering retirement CDC, even the master trusts are a way off demonstrating their capabilities in this area.
Mark Futcher, partner and head of DC pensions at Barnett Waddingham, says: “Operational readiness also matters. Administration and governance frameworks for CDC are still developing and will require investment and bespoke solutions. Before widespread adoption, the industry needs to ensure those systems are robust and scalable.”
Master trusts considering offering retirement-only CDC will need to contend with the tried and tested world of annuities and drawdown, and there is no guarantee that even where CDC is available that members will take it.
Dale Critchley, policy manager, Aviva Workplace Savings, says: “Achieving scale is probably the number one challenge. The use of a CDC option as, or as part of, a default pension benefit solution points towards the answer, but the flows of retirees from even large schemes can be relatively modest. When you factor in that default pension solutions and retirement CDC are untested, in a world where other options are available, it makes asset and member flows into CDC difficult to predict.”
Chicken and egg
Chintan Gandhi, partner and head of collective DC, at Aon, says that schemes are stuck in a ‘chicken and egg dilemma’ as they await clarity from The Pensions Regulator (TPR) on how it will regulate the promotion and marketing activity of retirement CDC schemes and whole-life multi-employer CDC schemes.
“We are still awaiting a consultation from TPR on its extended CDC Code. This includes the potential need for TPR to approve this activity retrospectively – and may make it challenging for prospective providers to share anything of substance with trustees of DC schemes as part of the development phase. Given any authorisation application to TPR will need to have regard to a prospective provider’s expectations to build scale through commitment from DC schemes, it could be difficult to overcome the ‘chicken and egg’ dilemma here,” he says,
Consequently, Gandhi calls for ‘a swift extension’ of TPR’s CDC guidance to cover both whole-life multi-employer CDC schemes as well as retirement CDC schemes.
“It is only with visibility of the entire regulatory regime that any prospective provider can judge whether they can introduce scalable CDC schemes to the masses – and in a way that is commercially viable.”
Competing forces
A potential threat to retirement-only CDC take-up comes from an issue with the timing of reform. The Pension Schemes Bill introduces the guided retirement duties, which require DC trustees to offer a default decumulation solution for retirees which includes longevity protection and regular income.
This Jadav says is “exactly what retirement CDC is designed to do”, yet since these are not formally available, trustees will need to implement alternative default solutions in the meantime.
While periodic reviews of the default are then expected, Jadav says that once a default solution is in place, inertia and competing priorities will hinder possible switches to retirement-only CDC.
“This may delay the widespread availability of retirement CDC and mean that many members will unnecessarily miss out on the benefits of retirement CDC, simply because it wasn’t available at the right time. The timing gap thus risks locking into less optimal solutions and slowing innovation beyond the length of the delay in introduction itself.”
Uphill battle
Trustees also face an uphill battle in communicating CDC to members, used to DC or DB schemes, who may be unfamiliar with collective risk sharing.
Futcher says this is an area that needs more attention in the consultation. “Front-loaded communication frameworks will be needed to help savers understand collective risk,. Governance and oversight of benefit adjustments, transfer rules that protect both members and scheme funding, and ensuring the administration ecosystem can scale efficiently all require careful consideration.”
There is also concern that introducing CDC is a distraction from improving existing DC benefits, especially since retirement CDC will not be available to the retail market.
Futcher notes: “It will be important to ensure that CDC does not inadvertently draw resource and regulatory focus away from further enhancing DC, which remains the system most savers rely on. CDC should complement, not crowd out, continued improvement in existing provision.” Whether retirement CDC delivers a silver bullet in terms of better outcomes for members will only become clear once schemes are in place, suggesting much is resting on this consultation.
Critchley says: “The success of retirement-only CDC will depend on the attractiveness of the initial income, especially when compared to annuities, and how successfully schemes deliver on their promises.”
