The Government has decided to offer a new type of employer-sponsored pension scheme that will entail all the members sharing the risks. Collective Defined Contribution (“CDC”) will be schemes with a target level of benefit where the contributions are fixed. Surpluses and deficits will be addressed by adjusting members’ benefits rather than by altering the contribution rate. In this way risks are pooled between scheme members (though the employer does not share the risks), rather than each member having to bear the risks relating to his own pot.
The advantages for members of such arrangements are:
- they may expect a regular and relatively reliable income in retirement and
- as risk is pooled between scheme members, CDC may well also provide more generous pensions on average than standard DC saving.
CDC schemes are used widely in the Netherlands and Denmark and the Royal Mail and the Communications Workers Union intend to establish such a scheme, for which they have provided a detailed scheme design. In the light of this, the Government has concluded that new primary legislation is required to enable CDC schemes. The new legislation will make clear that CDC schemes provide money purchase benefits only. It will also be tailored to the type of scheme proposed by Royal Mail.
Proposed legislative requirements
The Government proposes to require that CDC schemes be:
- trust-based occupational schemes with their main place of administration in the UK,
- registered with HMRC and
- authorised by the Pensions Regulator, who will consider, amongst other things, the capabilities of the proposed trustees.
Recognizing that CDC benefits are money purchase benefits:
- schemes will be required to make clear to members that the target benefit is not guaranteed,
- schemes will not be eligible for PPF compensation and
- a charge cap, at the same rate as that applying to qualifying schemes, will apply, on a scheme-wide basis.
Initially, only single or associated employers will be able to set up a CDC scheme, although it is possible that this will be extended to master trusts in the future. The authorisation process for CDC schemes is likely to be similar to that for master trusts, though with additional areas for assessment, such as communications, funding and investment arrangements, member options and winding-up provisions. Respondents to the Government’s consultation argued that:
- master trusts, that will have gone through a similar authorisation process, should also be allowed to operate CDC schemes and
- a pooled decumulation vehicle operating as a CDC scheme would be a useful alternative for those retiring from individual DC schemes.
Schemes will have to appoint a Scheme Actuary and obtain annual valuations to support the target level of benefit. They will also need sufficient scale to pool longevity risk for benefits in payment, although a minimum scheme size will not be set in legislation.
In theory, schemes could hold a “capital buffer”, to absorb a deterioration in funding without having to adjust members’ benefits. However, the Royal Mail design does not involve such a buffer, so the initial legislation will not provide for capital buffers (although it will also not preclude them). Scheme rules will have to describe the mechanism for adjusting benefits and adjustments will be required to be applied to all members’ (actual or prospective) benefits.
Scheme rules will have to be clear on what will prompt the winding up of the scheme, including a trigger relating to scheme sustainability. CDC schemes will also be required to have an accompanying strategy explaining how this process will work, including how members will receive a share of the fund. Schemes will also have to show that they could be sustained were contributions to cease.
Transfer values should be available for those who wish to leave the scheme, determined on a share-of-fund basis.
Based on experience in the Netherlands, the Work & Pensions Select Committee identified the opportunity for CDC schemes to invest in patient capital, such as infrastructure, in line with the Government’s stated desire.
Comment
The Government laid enabling legislation some years ago, to allow for the introduction of this type of scheme – but then abandoned the project. It is a shame now that the re-introduction comes after all employers have had to choose a scheme to implement auto-enrolment. How many of them will wish to change their method of provision and contemplate CDC at this stage? We suspect that this particular horse has bolted.