Delivering Collective Defined Contribution schemes
The government has backed plans for the first Collective Defined Contribution (CDC) scheme in the UK after the pensions industry, insurers and other bodies welcomed the move proposed by Royal Mail and the Communication Workers Union (CWU).
In a CDC scheme, a member’s pension is broadly calculated as follows:
- estimating how much money is needed to meet the benefits already credited to each member
- adding up the values for each member to determine the total assets available to meet the credited benefits to all members
- if the assets available do not equal the benefits already credited in respect of all members, make corresponding adjustments to (i) the current payment of benefits to each pensioner member and (ii) the benefits credited to active and deferred member, so that the total value of benefits already credited is equal to the total value of the scheme’s assets.
The benefits to CDC scheme members, as a result of the collective nature of the funds and the way they’re managed, are:
- Members should receive some cushioning against volatility
- Members would not have to make their own investment decisions.
The benefits and risks that providers of CDC schemes should be aware of when creating their products were outlined in the original consultation document and are summarised below:
- Provide a savings and income in retirement option within one package that is potentially attractive to those people uncomfortable making complex financial decisions at the point of retirement
- Enable the sharing of longevity risk between members, thus providing each individual member with an element of longevity protection without the cost of accessing the insurance market
- May achieve greater scale than some non-pooled schemes and be able to invest at lower cost as a result
- May allow the trustees to adopt an investment allocation which is tilted towards a higher proportion of higher return assets over the member’s lifetime than may be usual in an individual DC scheme, although the emergence of the drawdown market may see trends in the individual DC space follow a similar path over time
- Uncertainty around benefit levels, ensuring appropriate communication to members - a key principle of CDC schemes is that the benefit level offered can only ever be an estimate based on current facts. It is not guaranteed by the employer. Members will need to recognise from the outset that the benefit levels illustrated may not be achieved and that the level at which pensions are paid or prospectively payable may go down, while the rate at which benefits are uprated each year will be subject to a degree of uncertainty.
- Risk sharing and inter-generational issues - cross-subsidisation is an inherent feature of CDC schemes, with the type of cross-subsidy dependent on the scheme design. As in a defined benefits (DB) scheme, the actuarial value of the benefits being built up can vary according to the age of the member. For example, where flat rate contribution and accrual rates apply, accumulating credits within the scheme for younger members is likely to be less expensive because it is assumed that there is a longer time-period in which to achieve sufficient investment returns on the contributions paid before such members begin to receive a pension income. Older members, however, may be more costly for the fund because there is a shorter time-frame to achieve real investment returns. However, younger members may get less value from flat-rate contributions under such an approach if they decide to transform their credits within the scheme into a transfer value.
The government recognises there is growing interest in CDC schemes, and the Work and Pensions Select Committee recently recommended that the government should act quickly to legislate to allow the schemes.
The Government’s immediate priority is to get the Royal Mail scheme bedded in as a first test of CDC provision. They then plan to structure legislation to allow them to move promptly to other forms of CDC benefit provision. The government will work with interested parties to develop a legislative framework for some of the other models suggested, particularly decumulation-only vehicles and DC Master Trusts.
The full response document can be accessed below.