OK, so in UK pensions we have had our DBs and DCs and AVCs and GPPs. And now the new-kid-on-the-block to solve our savings and pension ‘crisis’ is CDCs. That’s Collective Defined Contribution schemes, for those of us still worrying about how we are going to sort out our own pension to be able to afford to retire, never mind anyone else’s.
Last week the government managed to extract itself sufficiently from its own Brexit crisis to give Royal Mail the go ahead to launch the UK’s first CDC, a type of occupational pension which somewhat ironically, is common in countries such as the Netherlands and Denmark.
So what are CDCs and why might UK employers and HR professionals want to consider offering this type of plan to their employees? My friends at the Pensions Policy Institute recently produced an excellent guide supported by Royal Mail which helpfully answers these questions.
We in Britain are living longer and not saving enough and, in some cases, accessing our pension early, creating this escalating crisis. We are being forced to retire later with smaller pension pots and the level of pensioner poverty is rising. ONS figures show that there are just 1.2 million retired Brits under 65, down from 1.6 million in 2011. A decade ago, just 434,000 over 65s were still in work, compared to 10.1 million today.
The decline of final salary defined benefit pensions and their replacement by defined contribution and personal pension plans, in which the employee carries all the risk, has been a key contributor to this crisis. Average employer contribution levels in defined contribution (DC) schemes are less than half of those in defined benefit (DB) plans.
Active membership of open private sector DB schemes fell to 0.5 million in 2016, down from 1.4 million a decade earlier. Women in particular have been hit hard, with a significant state pension age increase and a widening gender pension gap of more than 50 per cent. Debate rages around the reasons for this switch, with employers citing excessive regulation and escalating scheme costs and trade unions alleging cost cutting and individualisation and casualisation of work, with strikes in protest at the changes in employers ranging from BMW to the Atomic Weapons Establishment
CDC schemes in many senses offer a middle ground between DC and DB plans and it is significant that Royal Mail and the Communications Workers Union (CWU) have been campaigning together to bring about this legislative enablement, following their DB scheme closure.
CDC schemes vary in their detailed features, but they all have two defining features evident in their nomenclature.
The first is they are collective. Risks are shared collectively between the scheme’s members rather than individually, reducing the risk for an individual employee of investing their own fund and potentially improving the investment returns across a much larger total fund.
Second, they are defined contribution, with contribution rates (employer and employee) defined in advance. So there is no ongoing liability, as under DB plans, for the employer to pay more in the future to cover the escalating costs of benefits, while members gain greater certainty about the retirement income they will achieve than would be possible in a DC scheme.
The Pensions Policy Institute’s modelling suggests that CDC schemes can produce higher and less volatile pension outcomes, with a 10 per cent contribution rate able to produce a retirement income compared to working life income of between 27 and 30 per cent, versus a pension of between 12 and 21 per cent of pay with an individual DC scheme.
Sounds too good to be true? Of course, there are risks and potential downsides. They don’t avoid the debates over intergenerational fairness which helped to support the closure of DB plans, and ensuring that no group benefits disproportionately at the cost of another will be difficult. Cross-subsidisation between generations in order to smooth investment performance could lead to controversy and even a refusal by younger members to join the scheme (discontinuity risk) if not done fairly and transparently.
Communication with members is always a challenge with occupational pensions, but understanding who is responsible for what under this hybrid approach is undoubtedly complicated. Scheme governance and maintaining a certain level of continuity and long-term perspective, with targets being set and revisited regularly, is also a major hurdle to be faced.
To be fair to the Department of Work and Pensions and the time it is taking to get the appropriate legislative framework in place for employers to set up CDCs, coherence with the existing pensions landscape, especially pension freedoms, is also a major challenge. Even for Royal Mail the various legislative changes and approvals mean their scheme is still likely to be some years away from full implementation.
Nonetheless, as arguments in favour of more balanced stakeholder rather than shareholder-dominated capitalism grow and the HR functions face growing criticisms for ‘selling out’ on the workforce, CDC’s offer a way for employers and their staff jointly to take responsibility for their financial security in retirement, thereby contributing to higher levels of employee engagement and performance.
As Jon Millidge chief risk and governance officer puts it: “Royal Mail and our union, CWU, agree that CDC is the right option for our 141,000 employees. One of the key elements in developing our scheme has been to ensure decisions are made in the interests of all scheme members, without bias to any particular group.”
Dr Duncan Brown is head of HR consulting at the Institute for Employment Studies