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Collective defined contribution schemes back in the limelight

31 May 2018

Collective Defined Contribution pension schemes (CDCs), once championed by Steve Webb whilst Pensions Minister in David Cameron’s Coalition government, are enjoying a resurgence of media coverage due to pension changes taking place at the Royal Mail.

Employers should not therefore be surprised if they start getting the odd employee enquiry on the subject, so it is advisable that they are familiar with how the concept works and its likely relevance to the UK marketplace.

Whilst CDCs could prove a useful option for UK corporate pensions going forwards, it is unlikely they will revolutionise our marketplace and, even if they do, it will certainly not be happening overnight because they cannot be introduced without an Act of Parliament paving the way.

However, the necessary legislative change is now on the cards as a result of Royal Mail’s recent confirmation that it will go ahead with a new pay and pensions structure voted for by some 110,000 employee members of the Communication Workers Union.¹

The Royal Mail Pension Plan has been closed to future accrual in its current form and, once the necessary legislative changes have gone through, will be replaced by a new CDC scheme that will run alongside a defined benefit (DB) cash balance scheme.¹

Once the example has been set it is entirely possible that more employers will follow suit. Indeed, a recent poll conducted by Employee Benefits magazine found that 55% of respondents expected this to happen.¹

Nevertheless, whilst a degree of interest may emerge, there are a number of reasons why we are not expecting the floodgates to open.

CDCs, which already exist in the Netherlands, Denmark and Canada, effectively offer a half-way house between DB schemes – where the employer takes the investment risk – and defined contribution (DC) schemes –  where the investment risk is taken by the employee. 

They offer the employees a notional pension income which only enjoys soft guarantees rather than absolute certainty.  The investment and longevity risks of thousands of employees are pooled together until death, as opposed to until retirement, and returns can be smoothed in a similar way to a with-profits plan.

Bearing in mind the painful lessons that the UK has learned from the with-profit endowment mis-selling scandal, particularly with regard to customers not understanding the difference between a promise and a guarantee, it would be no surprise if employers were cautious about CDC schemes.

Indeed, there have already been some ominous precedents set in the Netherlands when CDC pension payments were cut in the aftermath of the 2008/9 financial crisis.

Opponents of CDC schemes also point out that much past research showing that they can produce returns at least 30% higher than standard DC schemes has become largely outdated by the raft of pension changes in the UK in recent years that have led to lower charges and greater flexibility.

In particular, the removal of the requirement to take an annuity has diluted one of the main attractions of CDCs, which is that pension money remains fully invested until death.

Additionally, critics tend to highlight a difference in cultures and existing pension structures between the UK and countries that already accommodate CDCs. For example, the Netherlands has a much greater degree of unionisation and has industrywide schemes that are mandatory for employees to join. It also has, unlike the UK, historically enjoyed a general acceptance of the CDC practice of one generation subsidising another.

We do not rule out the CDC route proving viable in the future for very large master trusts and feel that it may have some appeal to employers closing DB schemes and wanting to go only half-way to a DC scheme.

But we feel it is unlikely that employers that already have DC schemes are going to want to return to taking more risk, and we do not expect CDCs to become a mainstream solution for UK workplace pensions.

If you would like to find out more about the pros and cons of offering a CDC scheme or about how Chase de Vere can explain them to your workforce as part of a more general financial education programme then please do not hesitate to contact us on 0345 300 6256 or complete this simple form and we’ll call you. 


¹ Employee Benefits