After several years of discussions with politicians and the industry, in January this year the Pensions Regulator (TPR) published its first draft of planned CDC legislation.
The consultation closed in March and it is expected that trustees will be able to apply for authorisation to launch a CDC scheme from August.
Pensions minister Guy Opperman is a vocal supporter of the CDC concept, saying at an event in March that the model has “the potential to transform the UK pensions landscape and deliver better retirement outcomes”.
Rona Train, partner at Hymans Robertson, says there has been a “growing sense of urgency” around developing the CDC concept, illustrated by announcements from both TPR and the Department for Work and Pensions supporting its introduction this year.
The pooling of longevity risk is one of the key benefits of the CDC model, as it brings benefits to both sponsoring employers and scheme members. Traditional DB put all this risk on the employer – benefits had to be paid for the lifetime of the member, however long they lived. Regular DC savers hold this risk themselves and must save enough to pay for their retirement – including any healthcare needs.
“This uncertainty of whether they need pension savings to last them, say, 10 or 30 years, can swamp investment risk,” says Natalie Winterfrost, chair of CFA Society UK’s Pensions Expert Panel. “The pooling of individuals’ longevity risk, while avoiding the limitations of buying an annuity, is one of the undeniable benefits that CDC should be able to bring.”
Rethinking retirement
Longevity risk pooling promises to introduce a new way of thinking about the decumulation phase of pension schemes.
Hymans Robertson’s Train believes CDC has the potential to address several issues including the cost involved in the retirement transition from accumulation to decumulation, small pot sizes, and poor education around choice and longevity risk.
“The ability to pool longevity and investments to deliver more income has strong appeal if introduced with a strong communications wrapper,” says Train – but the introduction of a ‘third way’ must be handled carefully.
Retirees are already “overwhelmed” with options and can struggle to make decisions, she explains. Those organisations considering introducing CDC should consider prioritising communication and digital engagement strategies “before the introduction of yet another complexity”.
Helen Ball, head of DC and partner at law firm Sackers, also highlights communication as a vital element of CDC’s success. “Like the London bus tours we see roving around the City, we can expect there to be a need for suitable ‘hop-on/off’ points for members, clear communications, and straightforward member choices,” she explains.
“A link in with appropriate member guidance, so they understand what they are heading for in retirement, probably would not go amiss either.”
A CDC decumulation option, while suitable for some retirees, will not be for everyone, says David Brooks, technical director at benefits consultancy Broadstone. While the same can be said for other decumulation options such as drawdown or annuities, he argues that policymakers should be looking into “DC decumulation in general”.
“We have a wave of people for whom DC is all they have, and they are going to need help in determining the best thing to do with their funds to give them a reliable income into later life,” Brooks says. “The only current solutions appear to be drawdown or annuity. CDC may find a place with those options, but there remains a sceptical view whether the model stands up. The policymakers may need to work on their own modelling to [get] some proof that it works.”
Brooks contends that CDC schemes will need to demonstrate they can be as secure as an annuity and generate an income on a par with drawdown.
“This is a stiff challenge,” he says. “Perhaps a fair challenge is for a CDC decumulation design to demonstrate it can complement the existing options, [providing] part – but not all – of a person’s retirement income.”
For some providers, a cheaper route may be available that echoes some of the benefits of CDC, Train adds, without the need to introduce new terminology and concepts to retirees. Some providers, for example, could construct a product with similar benefits to CDC using a combination of insurance and investment products.
Challenges ahead
While TPR aims to open its doors for CDC applications from August, there are questions around whether there will be significant take-up. RMPP (Royal Mail) has championed the model and hopes to open its scheme this year, but despite prominent support from consultants such as Aon and First Actuarial, there have been no other organisations expressing firm interest in CDC.
Train says her firm’s analysis has shown “a number of areas of concern”, despite the undoubted enthusiasm for CDC. Scheme design is crucial, she points out, and variations in how CDC schemes are constructed run the risk of muddying the waters for members.
“Furthermore, achieving good member outcomes during the early years of establishing a scheme is likely to be more challenging than for an established scheme in a steady state,” Train adds. Establishment and regulatory costs will likely be high, and with success linked to the scheme’s ability to achieve economies of scale, the potential audience for CDC schemes will likely be “narrow”.
On top of this, TPR’s draft code is “onerous” for trustees, according to Winterfrost, with a “high level of sophistication and engagement” needed.
Brooks also highlights the lack of concrete interest in the CDC model, outside of the Royal Mail Pension Scheme, which has championed the concept since 2018.
He says: “What sort of CDC market will develop among employers looking to reward current employees that have already gone down the route of closing their DB scheme and opening a DC scheme? There
are often warm sounding words, but actual interest is still thin on the ground.”
Winterfrost agrees, adding: “While CDC is all about pooling risk, at the moment authorisation can be sought only by a scheme that is intended to be used by a single [employer] or connected employers. This really constrains the number of schemes that could consider CDC and there is no doubt that the first one or two CDC schemes will be watched very closely. This may all help to explain why there has been relatively little new public expressions of interest in CDC.”
Multi-employer versions of CDC schemes have been discussed – especially as they will be more likely to reach scale quicker – but are not yet in the pipeline.
TPR’s new CDC rulebook will need to provide flexibility but without introducing too much complexity, Brooks says, which risks making it incomprehensible to members.
Speaking in March, pensions minister Guy Opperman reiterated his enthusiasm for the CDC model, but acknowledged that a significant amount of work was needed to get the concept off the ground.
“I firmly believe we should capitalise on the enthusiasm that is building for extending CDC to other types of pension scheme, such as multi-employer schemes and master trusts,” Opperman said. “I am keen to move quickly, but we must get this right if it is to work.”
As the industry awaits TPR’s finalised CDC code, those keen to see the model succeed should brace for a busy period ahead.