CDC Pensions -a new pensions A-lister?


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With collective defined contribution (CDC) pensions introduced in the Queen’s Speech, Tom Jackman from the pensions team at our British member firm Sackers, is interviewed about the practical challenges associated with CDC schemes in the UK.

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CDC Pensions -a new pensions A-lister?

  1. 1. CDC pensions--a new pensions A-lister? Publication Date: 17 June 2014 | Author(s): Tom Jackman Member Firm(s): Sacker & Partners LLP (Pensions) 
 Countries: Netherlands, United Kingdom Analysis Original news Collective pension schemes to be introduced in UK, LNB News 02/06/2014 22 Daily Telegraph, 2 June 2014: Pensions minister Steve Webb has announced plans to offer Dutch style collective pension schemes--he has said the plans will be included in the Queen's speech this Wednesday. Collective pension schemes would allow savers to put cash into collective pots which Webb says would provide greater value for money. What exactly is a CDC scheme and how does it differ from other group schemes currently available in the UK? A CDC scheme is a bit like an A-list celebrity--it doesn't have an exact definition, but those in the know will recognise it when they see it. CDC schemes typically aim to provide a benefit that looks and feels like something from a defined benefit (DB) scheme (eg a career average 'CARE' style benefit, based on building blocks of pension for each year of pension saving) but without the absolute benefit promise associated with a traditional DB scheme. This means that the employer's costs can be fixed, so from the employer's perspective a CDC scheme need not be any riskier or more expensive than a traditional defined contribution (DC) scheme. The risk that there is ultimately not enough money to fund the target benefits is borne by the members. However, whereas in a conventional DC scheme the funding risk is borne by each member individually, in a CDC scheme the contributions are invested collectively and the risks are shared between the members. The risk sharing is usually achieved by carrying out regular valuations and reducing the target benefits if the funding position falls below a certain level. The target benefits can be 'topped up' again if the funding position recovers. Perhaps the most well-known example of this is 'conditional indexation', where the revaluation of past service benefits can be withheld unless there are sufficient funds in the scheme. What does the government seek to achieve by allowing this type of scheme? The government wants better outcomes for members. Higher retirement incomes mean that pensioners have more money to put into the economy, pay more tax and are less likely to rely on means-tested benefits. With DB pensions seen as unaffordable by most employers, CDC aims to provide the same
  2. 2. certainty of cost for the employer as a conventional DC arrangement, but with better outcomes for members. What can we learn from other jurisdictions' experience of CDC? The Dutch model is probably the best developed and is a helpful example because the Dutch pensions system as a whole is more readily comparable to the UK's than a lot of other jurisdictions. But even in the Netherlands, CDC is still in its infancy. I think it's too early to draw firm conclusions about its overall success, but we can learn from the implementation and reception of CDC in the Netherlands. Dutch CDC schemes are typically industry-wide and are compulsory for employees. That has proved controversial. The risk-sharing and level contribution rates means that younger employees are arguably being forced to subsidise their older colleagues. That may come to make more sense when members spend their entire working life in a CDC scheme, but for the time being it is somewhat anomalous and particularly unpopular against the background of economic austerity. It is also important to keep in mind that the majority of Dutch employers were operating a form of DB scheme prior to moving to CDC, and the decision to move to CDC rather than traditional DC was due, in part at least, to significant pressure from the Dutch unions. That is in contrast to the UK, where the majority of private sector employers have already made the move to DC, and where the unions are generally less influential. What are the legal and regulatory obstacles to implementing CDC schemes in the UK? The UK would need to make a number of technical changes to facilitate CDC. Conditional indexation is a good example--you would need to disapply some of the existing preservation legislation (which provides minimum levels of revaluation for the deferred benefits of early leavers from a pension scheme), but you would also need a new framework to make sure it works properly and fairly. It might be a bit of a bumpy ride, but if a particular model for CDC is well-defined, I think that the government could work with the industry to meet whatever technical challenges it might pose. The practical challenges may present more significant problems. What are the practical challenges associated with CDC schemes in the UK? CDC relies on risk-sharing and economies of scale. So in theory it is at its most effective when lots of members participate in the same CDC scheme. Put simply, employers need to offer them (on as large a scale as possible) and members need to join them and stay in them. If the government is trying to persuade employers to offer CDC now, its timing couldn't be much worse. The public sector is allegedly committed to CARE for 25 years, while private sector employers are implementing auto-enrolment (almost exclusively with DC arrangements). It is hard to imagine that employers will want to fundamentally revisit their pension arrangements again so soon after auto-enrolment (and communicating auto-enrolment to their workforce) when there is no obvious benefit for the employer. If employers do offer CDC, would it be on a sufficiently large scale? Because employer costs are
  3. 3. fixed, there is no reason in principle why UK employers shouldn't participate in the sorts of industry-wide schemes which are common in other European jurisdictions, but again it isn't clear that UK employers have any incentive to make the shift to bigger schemes. In theory, the better outcomes expected from CDC schemes should attract members to join them and perhaps even be a factor in recruitment and retention (thereby providing an incentive for employers to offer them after all). However, given current levels of public engagement and understanding, that seems somewhat optimistic. If CDC schemes are used as auto-enrolment vehicles, getting employees to join is straightforward, but persuading them to stay in could be more difficult. The concept of reducing benefits is alien to the UK system with and its protection of 'accrued rights', so reducing benefits below target levels could prove very controversial. The fear is that members could start to lose faith in CDC if benefit targets are reduced, even if the reduced targets are far better than what they could expect to get from an individual DC arrangement. If members leave in large numbers, the risk-sharing could quickly fall apart. If the government were truly convinced that CDC offered the best way forward, it could compel members to stay in the scheme, but that really would be a sea change for UK labour relations where principles of individual choice and freedom have dominated over the more collectivist, paternalistic approach still prevalent in much of Europe since the 1980s. How might the introduction of CDC affect the UK pensions market? CDC does have the potential to change the landscape quite significantly. If taken up on a large scale, we could see: o industry-wide schemes o different investment strategies to those of individual DC arrangements o features such as conditional indexation becoming the norm and, most importantly o better member outcomes at an acceptable cost to employers But if CDC isn't taken up on a large scale, it could be an obscure backwater which doesn't really impact on the big picture. Other models already exist in the UK, such as cash balance, which bridge the gap between DB and DC but these haven't proved popular with employers. What should pensions lawyers do next? For now, it's 'wait and see'. If the government is serious about CDC, the first challenge will be to establish the legal and regulatory framework. Pensions lawyers, together with actuaries, investment consultants and others in the industry, would need to have significant input into that process to help ensure that it will work at the practical level. Of course, advising clients on CDC schemes could be one of the main areas of work for years to come if it is taken up on a large scale. But that is an awfully big 'if'.
  4. 4. This article was first published on Lexis®Library on 2 June 2014. Taken from the Ius Laboris Knowledge Base: About Ius Laboris Ius Laboris is an alliance of law firms offering employers cross-border employment and pensions law advice. It has 1,300 specialist HR lawyers in over 150 cities and 44 countries. Ius Laboris offers access to the best local HR law experts in one global team with 20% more ranked employment lawyers (Chambers & Partners, November 2013) than any other global HR legal services organisation. Further, Ius Laboris has 50% more recommended lawyers than its nearest rival in a recent survey in PLC's employment law guide. Clients include many household names as well as multinational companies in all sectors ranging from energy, retail and technology to pharmaceuticals. For more information on Ius Laboris, please visit