The UK’s first CDC scheme, the Royal Mail Group’s Collective Pension Plan, is currently being implemented. Royal Mail has selected EQ’s pension administration software, Compendia, as its technology to support the administration of their new pioneering scheme.
CDC provides employers and trustees with a viable alternative to the two current options of defined benefit (DB) and defined contribution (DC) schemes, combining many of the advantages of both. It aims to improve retirement incomes for employees while also providing cost certainty for employers - as employers’ contributions are fixed - but it comes with challenges too.
Here are the top highlights of what a CDC scheme can offer.
Benefits for employers:
1. No guarantees or covenants
Most employers want to provide their employees with good incomes in retirements but are unlikely to want to take on additional risk. In CDC schemes, employer and employee contribute to a collective fund that provides an income in retirement. Crucially, the risk of benefits not being paid lies with the collective participants, not with the employer.
2. Cost certainty
For employers the contributions are fixed, providing cost certainty. CDC schemes are likely to be more expensive to run than DC but even these additional costs are likely to be predictable.
3. Design flexibility
Once established, CDCs could be designed in different ways depending on employer and employee needs. For example, some are considering CDCs that are more similar to DC and other will have some characteristics of DB, such as the Royal Mail’s which has many Career Average Related Earnings (CARE) features. Each scheme will have scope for individual tailoring of contribution rates, investment choices and other factors.
Benefits for members:
1. The potential for better returns
CDC schemes could give members a higher average retirement income compared to a DC scheme with the same contributions. This is because the CDC fund can look at different and longer term investment strategies and negotiate lower investment fees based on their size and scale. There is some research that suggests the difference in CDC income at retirement over DC could be quite significant.
2. Clearer planning
Annual revaluations will give members a clearer idea of how much they could retire on when compared to a typical DC scheme. There is also likely to be less volatility of investments as a result of the collective nature of the investments.
3. Easier journey from employee to retiree
Unlike in DC where members have to decide on how to draw their pension - usually pension drawdown, annuity or a combination of both - CDC retirees can leave their pension in the CDC and receive the pension based on the value of their fund directly from their CDC provider. The same care and approach will still be taken in the decumulation as in the accumulation of their pension fund. Member will still avail from all the benefits of the collective nature of the CDC and will not have to incur the cost or the risk of taking their fund to the private investment/advisory market.
4. Smoother, simpler investments
Investing in a large collective investment fund helps smooth investment volatility so individuals’ pension levels - pre- and post-retirement - are relatively stable and as stated above, CDC members don’t have to make investment decisions before or after they retire.
5. Investment governance and decision making
The CDC fund is managed by an experienced board of trustees who will modify the asset allocation of the fund. Adapting it to the prevailing investment market conditions and the objectives of the CDC Fund on an ongoing basis. The CDC board of trustees make these decisions with support from investment experts.
6. Track record of resilience
Other countries such as Canada, Denmark and the Netherlands have seen a positive effect from introducing CDC schemes. For example, CDCs have been particularly popular with staff and unions in the Netherlands, where many schemes have shifted to the model. When introducing CDCs in the UK, the government said these other countries have shown that, if well designed and run, CDCs can provide a better retirement outcome for members, and can be more resilient to market shocks.
7. Further background
The CDC has generated much interest among UK companies, and unions have also welcomed it cautiously. If successful, CDCs could catch on quickly and benefit millions of pension savers, pensioners and their employers, but companies will also face some challenges in implementing CDC schemes. These include writing clearly defined rules to ensure transparency and fairness from the start, and when adjusting valuations and benefits.
According to the Pensions Policy Institute, it will be important to ensure risk is spread evenly among generations in the scheme. The first UK schemes will be voluntary, so fairness, trust and transparency will be even more important to encourage members to opt-in. Other challenges will be in communicating how the new schemes work to members; and setting contribution rates to ensure the right level of funding.
Tackling these issues with a robust scheme design feels particularly important given our current economic challenges such as a potential looming recession and the cost of living crisis.
CDC schemes will initially be suitable for larger employers with over 5,000 employees. However, with further changes to legislation, multi-employer CDC schemes or master trusts are likely to become available, making collective defined contributions more accessible for smaller employers.
Are CDCs the future?
CDC is starting to become a talking point among UK companies, and a topic of interest across some of our client base. There will, of course, be challenges in implementing a new scheme type, and it’s something we are watching closely.
Find out more
It will be intriguing to see how this new type of pension scheme provision develops over the next year. If this is a topic of interest, please speak with your EQ relationship manager or contact us to discuss in more detail.