What is CDC and does it matter?

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A Collective Defined Contribution scheme pools the contributions and pays a variable pension to members from the common pool. Unlike a conventional DC scheme, there are no individual investment accounts which ring fence each member’s contributions and investments.

Collective Defined Contribution Schemes are back in the news. There are two reasons for this:

  1. The Workplace and Pensions Committee have set up an enquiry into CDC
  2. Royal Mail and the CWU intend to move to a CDC basis for pensioning 140,000 staff

Most readers will struggle to remember what all this fuss is about. The history of CDC in this country is as follows:

2009 The DWP concluded that the Government should take no action on CDC schemes.

2014 The DWP drafted a Pension Schemes Bill that included a section on Defined Ambition. This was enacted in the Pensions Schemes Act 2015, enabling CDC schemes in principle.

2015 Shortly after the passing of PSA15, Baroness Altmann, the new Pensions Minister announced that no further work would be carried out on the secondary regulations needed for CDC schemes to get going.

2017 Frank Field announces an inquiry into CDC following a recommendation by the independent mediator of CWU/Royal Mail’s pension dispute that Royal Mail adopts CDC.

Undoubtedly there will be considerable scepticism within the pensions industry about whether a system where discretion is given to a manager and an actuary could be sustained over time

From this timeline, it is clear that CDC is marmite. To its friends (and I chair the Friends of CDC working group) it can be useful in three ways

  1. As a halfway house between DC and DB pensions – offering people scheme pensions without the onerous guarantees on employers
  2. As a means for those saving through workplace individual DC pensions to spend their pension pot in an organised way (e.g as a non-guaranteed scheme pension)
  3. As a means for people to aggregate DC pots, including the proceeds from CETVs and exchange them for scheme pensions.

These are the six criteria which the DWP considered before dismissing CDC in 2009:

  1. The modelling results support the claims of enhanced performance on average from CDC schemes (criterion 1)
  2. and of some increased predictability of outcomes compared to DC schemes (criterion 2).
  3. However, there is significant doubt on the ability of such a scheme to manage risk successfully in a way which is fair to different generations of scheme members (criterion 3)
  4. and doubt remains on the extent to which the stability of CDC schemes is dependent on a continuing stream of member contributions (criterion 4).
  5. The legal implications of operating CDC schemes in the UK raise significant doubt on the potential for CDC schemes, as proposed, to exist in the UK given existing European legislation (criterion 5).
  6. Finally, demand for CDC schemes from employers (criterion 6) is likely to be limited, but could involve some DC schemes opting for a potentially better pension outcome for their employees if CDC schemes existed, and especially if other employers in their industry also offered CDC schemes. However, employers (including DB scheme sponsors considering closing their schemes) seem to be reluctant to subscribe to a new type of pension scheme which their employees may not fully understand.

One of these criteria (5) falls away with BREXIT, however – the substantive issues (3), (4) and (6) remain.

Risk management within a CDC Scheme (3) needs care. The fundamental structure of a CDC scheme is that it converts defined contributions into a regular pension with monies invested on a collective basis – as they would be in a with-profits arrangement.

CDC schemes plan to spend the contributions and investment returns over their members’ retirements. Obviously, investment performance and longevity will be different to that assumed in the planning, and the payment plan will need regular revision, say annually. The risk is that uneven investment performance could lead to poor pension increases for a period of time or, rarely, a pension reduction, leading to member dissatisfaction.

One actuary told me that if he ran the scheme he’d expect to be wrong 100% of the time but that he’d be over-distributing as much as under-distributing and never to a great extent. The optimistic view is that people can live with some degree of smoothing provided it’s clear that no one group is discriminated against. Pessimists will point to past experience and complaints from perceived “losers” in countries where a form of CDC operates.

The other criterion against which CDC is believed to fall short is an alleged lack of employer support.   This is a speculative criticism. Until CDC is introduced to the market place, we will not find out what the take up will be. There are many employers with closed DB schemes and open individual DC schemes for which CDC could be an acceptable replacement scheme for the employees in DB and a superior scheme for the employees in individual DC.

The situation at Royal Mail is an interesting counter to this view. Here the employer is acceding to a demand by 87% of members not for defined benefits but for “a wage for life”. Terry Pullinger, the CWU deputy secretary conducting negotiations on behalf of members is clear that any settlement has to be based on a pension, but the security of that pension is negotiable.

Britain’s adoption of pension freedoms in 2015 has opened demand for a new kind of CDC – one where there is no employer and the scheme is funded purely from member contributions – particularly from transfers.

Concurrently, the success of auto-enrolment has led to demand from the new master trusts to offer scheme pensions. Operationally, the payment of pensions would work as a pensioner payroll of a DB plan, but the annual level of pension would be set – not against an agreed formula such as CPI increases, but dependent on the scheme manager’s discretion based on an actuarial valuation.

Undoubtedly there will be considerable scepticism within the pensions industry about whether a system where discretion is given to a manager and an actuary could be sustained over time. This brings us to final main objection – “whether a CDC scheme could maintain a continuing stream of member contributions”.

This is an extremely hard objection to argue against as any view of the ongoing popularity of a pension system, is tarred with the brush of failure of such a system at some time or in some place.

Ironically, the best model to compare the current vision of CDC – at least in the classic sense, is the UK DB pension system before the imposition of stronger guarantees which started in 1984 and has culminated in the closure of almost all schemes to new entrants in recent years.

Sceptics will argue that the status of schemes before 1984 where benefits were promised and not “guaranteed” was intrinsically unsustainable. They will point to countries where pensions are set against what the fund can afford rather than a guaranteed amount as creating social discontent. Both viewpoints have some merit and the debate which is likely to play out over the coming months will no doubt be heated!

However, Friends of CDC – and I am one, will point to the fact that however many times CDC has been written off, it seems to bounce back again showing the kind of resilience needed from a pension product.

While some had thought that the introduction of Pension Freedoms would finally do for CDC, the concept seems to have been brought to life by the apparent failure of many people with large transfer values to find an obvious replacement for the annuity.

Despite the importance of providing moderated solutions to schemes such as Royal Mail, the revival of interest in CDC may ultimately lie in the need to give people “freedom from freedoms”.

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11 years providing financial advice to individuals directly and through employers. 14 years within insurers working with advisers to provide better DC and DB outcomes. 25 years left to make a difference!

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