Royal Mail’s eagerly anticipated collective defined contribution (CDC) pension scheme, developed in collaboration with the Communication Workers Union (CWU), launches today. But its rollout has sparked ongoing discussions regarding the intricacies of its regulatory framework.
CDC experts that were involved in the creation of the scheme for Royal Mail are voicing the importance of ensuring transparency, robust member protection, and clear communication regarding the scheme’s benefits. They say these measures are deemed crucial to mitigate potential misunderstandings about income fluctuations and associated risks, particularly during challenging market conditions.
Angela Gough, head of corporate pensions at Royal Mail, commented on the significance of this initiative, stating, “The Collective Plan is the future of pensions in Royal Mail. It’s the first of its kind in the UK, and we’ve worked hard with the CWU and Unite to make it possible.”
Structure
CDC works by pooling contributions from employers and employees, enabling collective investment and the sharing of risks and rewards. The income generated from these investments is adjusted for inflation, contributing to stable retirement income. The Royal Mail CDC website emphasises that the scheme aims “to grow your money in order to pay bigger benefits to you, though this is not guaranteed.”
CDC combines fixed contributions from defined contribution (DC) models with collective investment to stabilise returns and mitigate the impacts of individual market volatility.
Senior consultant at First Actuarial Derek Benstead explains: “The DC of the name means the contributions are defined but the collective of the name means the contributions are invested collectively.”
According to Aon partner and CDC specialist Chintan Gandhi, these schemes are designed with “structural resilience”, allowing them to withstand adverse market conditions without significant impact to members.
“The likelihood of cuts in CDC is low for well-designed CDC schemes targeting inflationary increases. The way that CDC has been designed ensures that over time that builds resilience into the scheme. This resilience is critical, especially in volatile economic climates, where the need for stability and predictability is paramount for retirees.”
He adds: “It’s payable for life and doesn’t require them to have to make any big, complex financial or investment decisions. This approach alleviates the burden of investment choices that can often lead to confusion and anxiety for employees.”
Adjustments to pensions each year depend on investment performance, inflation, and life expectancy, aiming to balance risks and returns more favourably for the average employee.
CDC schemes can adopt more aggressive investment strategies due to their pooled nature and longer time horizons, allowing for potentially higher returns that benefit all members.
Gandhi says: “Pooling risk gives CDC schemes the scope to hold more return-seeking investments. The time horizon of a typical whole-life CDC scheme will be longer than the lifespan of an individual DC member. This collective investment strategy allows for greater resilience against market fluctuations and can enhance overall returns, making CDC a more attractive option for long-term retirement planning.”
CDC v DB & DC
CDC schemes are distinct from defined contribution (DC) schemes, where individual employees manage their accounts and bear all investment risks. CDC aims to reduce this individual risk and provide a sense of community among members by pooling investments.
Benstead points out that investment return volatility poses a significant risk in DC schemes. Two individuals contributing the same amount could end up with vastly different retirement outcomes due to market conditions at the time of retirement.
He says: “The best pension outcomes from DC pots are four times the worst pension outcomes for the same contribution history.”
Gandhi adds: “The pooling mechanism in CDC fosters a sense of community and shared success among members, rather than individual competition.”
CDC schemes also differ from defined benefit (DB) schemes, which guarantee payouts based on salary and years of service. DB schemes place the financial burden primarily on employers while CDC schemes distribute responsibilities among all members, making them potentially more sustainable.
Benstead explains that while CDC pensions aren’t guaranteed like DB pensions, they offer more predictability than DC pensions. The pooled investments can adjust payouts for sustainability, which is appealing to employers as they aren’t required to guarantee pension amounts.
But one major advantage of CDC schemes is their provision of lifelong income, similar to DB pensions. Once started, pensions continue for the retiree’s life, alleviating concerns about outliving savings.
“This makes CDC potentially more sustainable in the long run, as it can adapt to changing economic conditions without placing undue burden on any single party,” Gandhi notes.
Outcomes
According to research by Aon, CDC schemes can significantly enhance retirement security for participants, potentially offering higher income levels compared to traditional DC schemes.
Gandhi explains, “Our research estimated that whole-life CDC is expected to deliver over 30 per cent higher outcomes than DC. CDC schemes should be able to elicit change over the next several decades in a more responsible, sustainable, ESG-oriented way.”
He says this highlights CDC’s capacity to meet retirees’ financial needs while aligning with modern ethical investment practices.
Additionally, CDC simplifies the concept of retirement income, making it easier for members to plan and understand their financial requirements as they approach retirement.
“CDC pensions are always expressed as annual income amounts that should actually make it a lot easier for them to understand whether they’re saving enough for retirement. By framing retirement savings in this way, we empower individuals to make more informed decisions about their future,” Gandhi adds.
CDC schemes also promote greater equity in retirement income distribution, ensuring that all employees have equal access to reliable retirement income and helping to reduce disparities in retirement savings and outcomes.
“CDC will give everybody equal access to an income for life in retirement. By levelling the playing field, CDC can contribute to a more equitable society, where retirement security is not dependent on individual financial savvy or market performance.”
Employee value
Gandhi suggests that CDC schemes enhance the employee value proposition for employers, making it easier to attract and retain talent.
“What we’re seeing is that it really does represent a differentiator in the labour market. Not needing to make complex decisions promotes financial and emotional wellbeing during the working and retired phases of life. Employers who provide these schemes not only contribute to the financial security of their employees but also enhance their overall satisfaction and loyalty.”
But clear communication regarding CDC benefits is crucial for managing member expectations and ensuring they understand how benefits can fluctuate based on performance.
“It’s really important with CDC to communicate to members what the nature of their benefit is. If there is underperformance over a given period, then pension increases will naturally need to slow down. They need to be made aware of the fact that there could be a chance that their benefits are cut.”
Regulatory framework
A solid regulatory framework is essential for the successful implementation and operation of CDC schemes, “The key thing here is regulation and legislation,” says Benstead. This regulation may deter small employers from creating their own schemes but could facilitate multi-employer options.
Gandhi stressed that “It’s only with visibility of the entire regulatory regime where the providers can judge whether they can introduce multi-employer whole-life CDC schemes, which is ultimately the intention. Regulatory clarity will enable the growth of CDC, making it a viable option for employers and employees alike.”
Gandhi notes that high standards of disclosure and transparency within CDC schemes are essential for fostering member trust and ensuring that benefit decisions are made fairly and accountably.
“CDC has a very high bar of disclosure, all of the decisions taken in relation to benefit adjustments each year will have that kind of high bar of disclosure being subject to them. This level of transparency helps members understand the financial health of their scheme and the reasoning behind any changes in their benefits.”
Learnings from abroad
Gandhi highlights insights gained from examining international models of collective schemes, which have informed the UK’s approach to CDC. Understanding different contribution structures can help mitigate risks effectively.
He says: “The contributions in the UK are categorically money purchase. This mitigates the risk that if there is a period of underperformance, then the current workforce is going to be asked to pay more for other parts of the membership. By learning from other countries, we can create a more effective and fair system that protects the interests of all participants.”
According to Benstead, the UK aims to learn from the challenges of the Dutch pension system, which has faced issues of prioritising pensioners over non-pensioners with UK model seeking to ensure fairness across all members.
Future
The complexity of regulation makes it challenging for individual employers to establish their own CDC schemes. Strict regulations ensure realistic benefit illustrations and payouts, which can discourage employers from launching schemes that serve only their workforce. Benstead notes that without competition, these regulations may seem excessive.
Despite these challenges, there is optimism for the growth of CDC schemes, particularly through multi-employer trusts. Initial adopters are expected to emerge from sectors with a history of defined benefit pensions, such as utilities and charities. “In five years, we will see a significant batch of first movers,” Benstead states.
Experts believe CDC schemes could become standard in the private sector, addressing the pension crisis left by the decline of defined benefit plans. They argue that the Royal Mail scheme exemplifies how sustainable pensions can be provided while ensuring employer stability, though it is tailored specifically for its workforce.