Keeping up with the latest developments in the workplace retirement plan world, we have some news from the other side of the pond: The United Kingdom is the latest country to employ what’s called a “Collective Defined Contribution pension scheme,” a type of hybrid retirement plan combining some elements of both defined contribution and defined benefit plans.
The new type of pension scheme launched in the UK today is designed to give workers increased confidence about their retirement income and providing employers with predictable costs while also being more resilient to economic shocks, such as those caused by the pandemic, than the increasingly popular defined contribution plans.
Guy Opperman, the Minister of Pensions, introduced regulations in the House of Commons today to begin the process of establishing the legal framework for the new pensions.
“I am very pleased that these schemes will soon be able to operate in Great Britain,” Opperman said in a report posted by UK news hub site Brinkwire.
“We’ve seen the positive impact of these schemes in other countries, and it’s clear that when they’re well-designed and well-run, they can provide a positive outcome for savers while also being resilient to market shocks,” he added. “I have no doubt that CDCs will benefit millions of pension savers in the coming years.”
The regulations follow the UK Pension Schemes Act 2021, which permitted employers for the first time to launch CDC plans, also referred to as collective money purchase plans.
In a CDC plan, income is secured by pooling plan participants’ assets and investments, and participants bear the longevity and investment risk, while the sponsoring employer bears all the risk in defined benefit plans.
CDC plans have been used in other countries including the Netherlands, Denmark and Canada, but prior to this, all workplace pensions in the UK were either DB or DC plans.
Why a CDC?
Supporters of CDC schemes believe their introduction will result in a better retirement outcome for participantscompared to traditional DC models.
The key advantages of CDC schemes, as outlined in a Dec. 9 brief from global legal practice Dentons, are considered to be that members “collectively bear the investment and other risks of the CDC scheme, members can expect to receive a higher average pension than from a defined contribution scheme (for the same level of contributions), and the build-up of pension benefits are more certain for members than a traditional defined contribution scheme. CDC schemes also spread the longevity/mortality risk between all members rather than just being borne by each individual member.”
In practice, CDC schemes have more in common with DC plans as contributions are fixed and there is no guaranteed or fixed level of benefits. “However, CDC schemes ‘target’ a specified level of benefit. As with defined contribution, the attraction for employers remains that they will only be required to make fixed contributions to the CDC scheme and do not have any further liability (other than in relation to expenses) to ensure that the member receives a particular level of benefits,” the Dentons brief explains.
More from the brief:
The CDC scheme target pension is determined as the pension which is expected to be provided based on the employer and employee contributions and investment return. The aim is that the pension is not fixed each year but that the amount should be adjusted each year in line with inflation. The members will still have the choice of whether to take benefits from the CDC scheme or to transfer them to access drawdown or to purchase an annuity.
A key difference from defined contribution schemes is that members do not have individual funds in which they choose the assets they are invested in. Instead, like the defined benefit scheme structure, all employer and member contributions, and investment return are pooled within a single fund. This could provide the advantage that, as the CDC schemes will be able to access more long-term and illiquid investments, they may provide a better investment return.
If the CDC assets prove insufficient to pay the target pensions for members, the brief notes lower pension increases could be targeted, or a lower level of overall target could be set. Even pensions in payment may be reduced if there is a deficit.
CDC popularity uncertain
The Dentons brief concludes that the main challenge facing CDC schemes will be whether employers consider them to be a better offering than traditional DC offerings and defined contribution master trusts. Master trusts are likely to pose the biggest risk to the success of CDCs because they both offer fixed costs to employers and are subject to the Pension Regulator’s supervisory regime.
The structure and benefits provided under CDC schemes can be complex, and therefore employers may favor placing their employees in more traditional schemes in which the benefits can be easily explained.
The first CDC scheme established under the UK Pension Schemes Act 2021 is expected to be by the Royal Mail Group in 2022. Advised by Willis Towers Watson and Aon—and working in collaboration with a union—Royal Mail has been developing a CDC for the past couple of years with goals that it was sustainable, affordable by the company, and secure for members.
European publication IPE reported in October 2021 that the new pension scheme will be made up of a CDC section and a cash lump sum section (similar to the existing DB cash lump fund, currently worth £1.2bn), with virtually all employees in both.
Within the CDC, members will contribute 6%, and the Royal Mail 13.6%, of pensionable pay. Members will accrue 1/80 pensionable pay each year in the CDC section, and 3/80 in the cash fund. The benefits will be a guaranteed lump sum from the cash fund plus an income in retirement, which will fluctuate depending on investment returns and demographics.
“We see the introduction of CDC to the UK as a real positive, helping to meet a demand that neither DB nor individual DC can meet,” Shriti Jadav, CDC director, Willis Towers Watson, told IPE. “We believe that, in time, CDC could play a key role in the UK pensions landscape.”
Veteran financial services industry journalist Brian Anderson joined 401(k) Specialist as Managing Editor in January 2019. He has led editorial content for a variety of well-known properties including Insurance Forums, Life Insurance Selling, National Underwriter Life & Health, and Senior Market Advisor. He has always maintained a focus on providing readers with timely, useful information intended to help them build their business.