Prospects are glowing for collective defined contribution schemes

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he likelihood of the new Collective Defined Contribution scheme rules being enshrined in new pensions legislation in 2019 are now very high, as the idea which gained traction towards the end of Sir Steve Webb’s time as Pensions Minister back in late 2014, is now a leading candidate for a Pensions Bill in the Queen’s Speech next May.


The issue that dogged all Steve Webb’s attempts to get CDC taken seriously over four years ago was the nagging doubt that any employers would want such a hybrid scheme.

Apparently several expressed that view in private inside Department of Work & Pensions buildings and showed no overt enthusiasm for the new concept in public. But that was then. Now there is a new reality.

We have one massive employer – Royal Mail – in the starting blocks and ready to go with CDC.

So, the issue moves from whether anyone wants CDC, to which types of businesses would CDC be most suitable for – and of course an adviser needs a recommended scheme to be suitable for both the employer and its employees.

A quick look at employee review site Indeed reveals that postmen apparently work long hours, do a lot of standing in their job, get only short breaks, suffer from dreadful managers and bad weather.

Years of service

Despite all that, lots of postmen and women put in many years of service. My local postie has been putting the letters through our front door since before we moved in over 20 years ago now.

This is probably the key to suitability. A business where many staff stay for the long term will have enough people present through different economic cycles that they can genuinely spread the experience of good and bad times across the membership - a key part of CDC.

Key points

Collective defined contribution schemes are becoming more of a reality
The Royal Mail has agreed with staff to set up a CDC scheme as a successor to its defined benefit scheme
There needs to be clear communication with members about performance and fees
And staff that rub along well with each other – another factor revealed in those Royal Mail reviews – will be much happier that they all get a broadly average return, without worrying too much about whether they were a receiver or giver of cross-subsidies.

Initially at least, they will also need to be large employers to spread the extra costs of high quality trusteeship and actuarial valuations over enough members without needing high charges.

For reasons that I do not understand, the government currently proposes that master trusts will be specifically excluded from operating CDC schemes. So, for now at least, there’s no point in small employers planning to club together into one multi-employer CDC scheme.

The DWP has now thrown its full weight behind CDCs – producing a detailed consultation paper framing the legislation needed for CDC and in particular the new Royal Mail scheme.

They are clearly staking an early claim for space in the post-Brexit legislative calendar. Insiders suggest we could even make the first CDC scheme live in 2020.

So, if a new type of workplace pension is being introduced into the UK, why is this still needed now that we have the freedom to move between Defined Benefit (DB) and Defined Contribution (DC) schemes, especially as auto-enrolment is such a success in getting nearly 10m people saving, albeit largely at the prescribed minimum contribution levels and investing in low-risk default funds?

Is the emerging CDC a response to:

Declining access to (and number of) DB pension schemes?
Desire by employers to reduce or eliminate large long-term pension liabilities implied by running final salary pensions as a growing negative balance sheet item?
Concern that DC pensions open less engaged savers to the prospect of under-saving for retirement?
The answer could be Yes to all of the above. But nevertheless, despite the fact that CDCs are already in quite wide use in Denmark (enrolment into a CDC is compulsory there for employees) and the Netherlands (it has 260 CDC schemes operating today), the concept might not have made it over the North Sea but for The Royal Mail working in close concert with the Communication Workers Union to create the necessity for it.

Royal Mail Pension Plan

Let me explain. Like many large DB schemes, the Royal Mail Pension Plan closed to new members in 2008 as the firm detected that rising DB liabilities were looking unaffordable longer term.

By April 2012, the company managed to pass responsibility for historic pension liabilities from the RMPP to the Government.

Then, following consultation with RMPP members in early 2017, it announced its decision to close the RMPP to future accruals in March 2018.

Following this announcement from October 2017, The Royal Mail and the CWU began negotiating on behalf of postal workers for future pensions, pay and conditions, all mediated by The Advisory, Conciliation and Arbitration Service.

By late November 2017, the ACAS report recommended both sides commit to the introduction of a single CDC pension scheme and won their joint agreement to this settlement. Aiming for a “best of both worlds” solution, the scheme holds out the prospect of a target pension for life, plus a tax-free cash sum on retirement - all for a fixed cost from both employer and employee.

With a following wind, posties will get a pension of one eightieth of each year’s salary, plus CPI increases. As the Royal Mail provides one in every 90 jobs in the UK, this is a significant swing of the pendulum away from their current DC scheme back in the direction of DB.

In addition, the power of ‘longevity pooling’ and ‘collective security’ will work together to deliver the prospect of higher median retirement incomes, largely because of lower volatility. A 2009 Government Actuary’s Department study found that the median improvement in outcome offered by CDC “is as high as 39 per cent for some members.”

A 2012 paper by the Royal Society of Arts (RSA) indicated a 37 per cent boost to retirement income outcomes through CDC.

Royal Mail bosses also like the idea of the CDC because it passes risk of the pension under performing through to the employee member.

In other words, if we have another financial shock along the lines of the Great Recession, the employer does not need to add the resulting liabilities in red on their balance sheet and have to start borrowing more to keep guarantees in place. Instead, what trustees must do is adjust the benefit accordingly.

So even after you have retired, you have the prospect of your pension income from your CDC going down and quite possibly staying down for some considerable time if the next downturn is anything like the last.

Experience of the Netherlands

The problem, discovered in the Netherlands back at the beginning of the Great Recession in 2008-2009, was that members had been exposed to such a long run of outperformance and rising retirement incomes, that they had come to consider inflation-busting pension benefit rises almost as a right, which of course they were not.

Members had to take the hit when markets went south. Understandably, there was considerable dissatisfaction among members which rumbled on for years.

What this evidence from the Netherlands confirms is the very significant member communications challenges that CDCs present to those planning to run these sorts of schemes from 2020.

The recent Work and Pension Committee report on CDCs acknowledges this and proposes the following remedy: “We recommend that all CDC schemes be required to publish their rules for calculating and distributing member benefits in a standardised format.

"Provide data for the Pensions Dashboard…and report publicly their funding position and strategy at least annually.” (Page 24)

The ABI concurs by saying that by mistaking target pension rates for guarantees, and therefore not understanding that members bore funding risk, was “arguably the greatest risk of CDC.”

I reckon that as we move inexorably into the digital age, static paper-based annual publication of funding positions, investment strategies and rules for calculating and distributing member benefits will prove inadequate.

CDC members, particularly those in decumulation, will need to know as soon as possible if their monthly retirement income amount is due to go down, so they can plan for that loss of income.

Even small reductions will require clear advance warning. And while Royal Mail hopes to smooth large reductions over three years, any reduction can be troublesome for those with no safety cushion to fall back on.

At the time that pensions are reduced, trustees should consider including handy hints on how to trim expenses and live on a smaller pension.

But even before we get to any reductions, communications should perhaps be extolling the virtue of setting aside a little of the pension in good times in a liquid savings account so that retirees are prepared in advance of (what many see as inevitable) falls at some point in retirement.

Anyone who has enjoyed Andrew Lloyd Webber’s ‘Joseph and the amazing technicolour dream coat’ will understand this virtue.

By the same token, rises in performance are a good opportunity to encourage and reinforce membership loyalty – informing accumulating members of any upward adjustments of anticipated retirement income levels for example.

Finally, given concerns associated with bringing a new and complex type of pension into life in the UK, it is perhaps reassuring that ‘super-trusteeship’ is also promoted by the WPC.

CDC scheme trustees look set to require authorisation by The Pensions Regulator which will also be keeping a very close eye on not just the content but also the efficacy of communications to CDC scheme members.

Adrian Boulding is director of retirement strategy at Dunstan Thomas