Should CDC be back on the table?

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At a glance

The WPC has reignited the CDC debate in its consultation
Supporters like CDC’s focus on income and less volatility in outcomes
CDC should enhance the current pensions landscape, not replace it
As the Work and Pensions Committee's consultation on CDC closes, Stephanie Baxter asks whether it could offer a viable alternative in the binary pensions system
The debate on collective defined contribution (CDC) is still very much alive and kicking in the UK.

Last year, the Work and Pensions Committee (WPC) launched a new inquiry into the merits of this idea, the role that 'defined ambition' CDC could play in the pension landscape, the potential benefits to savers and the wider eco-nomy, and what legislative and regulatory framework would be required.

Upon launching its consultation in November, chairman Frank Field said the committee was aiming to "retain some of the best features of company schemes in a different age when employers are no longer willing or able to sustain the burden of final salary promises to employees, who could club together and pool the risk themselves."

The Pension Schemes Act 2015 introduced by the coalition government classed ‘shared risk/defined ambition' or CDC as a distinct pension category, but regulations to bring them into force have not yet been introduced. In 2015, the government said the plans would be dropped indefinitely in order to avoid distraction from other major reforms such as auto-enrolment and the pension freedoms.

Divides opinion
These structures, which are commonplace in the Netherlands, Canada and Denmark, continue to divide opinion in the UK pensions sector. This is clear from industry responses so far to the WPC's consultation on CDC, which closes on 31 January. CDC covers a range of different possible benefit structures, and includes variations where there is some form of promise or guarantee on part of a final income.

Many of the responses published on the committee's website point out the various benefits of CDC as an alternative middle ground solution to pure DC and DB, notably the focus it places on income and leading to less volatility in the outcome. However, there are concerns about yet more complexity and the intergenerational cross-subsidies of a Dutch-style system where the contributions of younger members could be used to provide benefits for retirees rather than secure deferred benefits for younger members.

The Pensions Management Institute's (PMI) survey of its members including consultants, trustees, administrators, actuarial, legal and investment professionals, found 53% of 99 respondents believed CDC would improve workplace pension standards.

Some 43% said it would leave members free of having to make investment decisions, 36% said that it would increase pensioner incomes, while 31% said members would be largely unaffected by costs and charges.

Not panacea for DB
The WPC's consultation asked whether "seriously underfunded" DB schemes could be resolved by changing their pension contract to CDC, similar to the Dutch approach. However, there appears to be widespread agreement that CDC is not a panacea for stressed DB schemes.

Some 57% of the PMI's members surveyed said if underfunded DB schemes were allowed to be converted to CDC, it would potentially be detrimental for members, with regulation and maintaining funding being the main issues.

KPMG pensions partner David Fairs, who was chairman of the industry working group that looked at flexible DB schemes under Steve Webb's defined ambition initiative back in 2012, points out that even then people were saying it was "too little, too late".

"Since 2012 many more DB schemes have closed down - if you argued it was too late then, it's definitely too late in 2018. In 2012, Webb was trying to capture companies that still had DB and were accruing benefits but were thinking about moving to DC. He was trying to provide something in the middle."

Although not convinced of widespread support to introduce Dutch-style CDC, he believes defined ambition structures could be used as an alternative for members to transfer benefits from severely underfunded DB schemes, but this should be the member's decision.

"The challenge is we have this very binary arrangement that something is either DC, and as soon as you guarantee any element of it then it's DB, and then becomes subject to all the accounting, funding rules etc, and suddenly becomes very burdensome for the employers."

He adds: "Where we are today with relatively few schemes in that position, as many have closed to future accrual, if you enacted the legislation, you wouldn't get a mad rush of people looking to set these up. I don't see the government thinking there will be enough wanting to do it that will justify the amount of parliamentary time to get it done."

However, there may be some demand from the last few employers still running DB schemes. For example, Royal Mail is moving closer to introducing a CDC-style arrangement as a compromise with unions to plans to close the post service's DB scheme. The proposed agreement, described as being "on the cusp of something special", is now expected to be put to members shortly.

"Having a major high profile example would be a very visible precedent for the rest of the industry to monitor," says PMI technical consultant Tim Middleton.

Freedom and Choice
There is strong agreement on the potential for CDC to be the basis for decumulation products. Post-pension freedoms, the industry is still behind on developing innovative products for people living longer than their savings or turning their pension pots into an income for life.

The Pensions and Lifetime Savings Association's (PLSA) response says while CDC does not speak to the central issue in UK pensions - which is that contributions are too low - it does point out these arrangements could play a part in the decumulation phase.

Aon Hewitt believes CDC schemes would immediately incorporate Freedom and Choice by allowing members to transfer out just before retirement and using their savings in lump sum form, to buy an annuity or to make use of income drawdown.

"CDC does end up with a solution where you get a pension for life, not where your money lasts as long as it lasts," says the consultancy's senior partner Kevin Wesbroom. "Partly, that it is a solution that works in Freedom and Choice, which has opened up a whole set of other decisions that people now have to decide. Individuals have to decide between annuity, drawdown, lump sum etc. For a lot of people, this is just too much."

For him, freedom means the freedom not to have to make a choice. "The freedom from not having to make complicated decisions will be worthwhile, and the reduced exposure to ups and downs of markets will be key."

Given that primary legislation to support CDC is already on the statute books, some are calling on the government to produce the necessary secondary regulations to permit these schemes.

The PMI's Middleton says: "CDC is imminently doable in the UK; it's really a question of having the willpower within government to make it happen. There are no significant technical obstacles, we can do this and it would work very well. Statistically, we've seen from the example of Denmark and The Netherlands where member outcomes are significantly better than those in the UK. We can achieve something comparable; we just need the commitment and will to do it."

However, as many of the responses pointed out, CDC should complement and enhance the current pensions landscape, not replace it. We must learn from the lessons of other CDC systems to create a bespoke UK model that solves the well-documented intergenerational issues. While the WPC and Royal Mail have reignited the debate, there is much work to be done.