Collective DC: the dawn of a new era?
Earlier this year the Pension Schemes Act 2021 provided the long awaited statutory framework for Collective Money Purchase (“CMP”) schemes, commonly referred to as Collective Defined Contribution (or “CDC”) in the UK. This was followed with a draft set of regulations to implement a new authorisation and supervision regime for CDC schemes.
So what is CDC?
CDC is a type of DC arrangement where member and employer contributions are invested in a single collective fund rather than individual pots, with members receiving a pension from the scheme at retirement based on the value of assets in the scheme.
A CDC scheme offers a target (as opposed to a guaranteed) level of pension benefits.
They are being promoted by the government as a “third way” between traditional DB schemes and individual DC schemes.
What are the advantages of CDC?
- more predictable costs than DB schemes as there is no obligation on employers to make additional contributions should the level of assets fall short of the benefits that need to be paid – members bear the risk.
- the opportunity to provide a compromise solution between the unknowns of a DB scheme and the benefits of collective investment and benefit provision that aren’t available in an individual DC scheme.
- no need for members to make complex decisions about investments or the options for converting funds into an income stream in retirement as, unless a member chooses otherwise, a CDC scheme will provide a pension from the scheme.
- members should enjoy an element of cushioning from volatility, as investment risk is adjusted for over time and longevity risk is pooled across the membership.
- scope for CDC schemes to invest in a wider range of assets, including illiquids such as infrastructure, which could offer better returns.
- as the Pensions Minister’s foreword to the DWP’s consultation on the (extensive) draft regulations says, CDC schemes “provide the potential of a more efficient way of delivering income for retirement”.
What are the disadvantages of CDC?
CDC pension benefits can fluctuate; they are not guaranteed. This applies to both projected pension benefits and those already in payment.
The rate or amount of benefits payable is subject to periodic adjustments to balance the value of the assets of the scheme and the amount expected to be required to provide benefits to the members of the scheme collectively. Therefore if circumstances change eg investment performance changes, benefit levels could change. This is a complex message to get members to understand and requires regular actuarial valuations and potential adjustments.
What are the key risks of CDC?
The key risk is intergenerational inequality.
There could be unfairness between different cohorts of members if circumstances change during the running of the scheme and benefit levels have to be adjusted. In particular younger members could suffer and end up subsidising older members whose pensions have already been paid. The draft regulations aim to address this to an extent by setting out certain parameters which all CDC schemes must operate within, with schemes showing increasing signs of intergenerational unfairness expected to close to new members.
There is also the risk of financial unsustainability, as CDC schemes will not be eligible for the PPF and employers are not required to make up any shortfall in benefits.
So could this be the dawn of a new era of CDC schemes?
Not quite…or at least not yet.
Leaving aside the risks, the costs and resources needed to establish a CDC scheme, get authorisation from TPR and adhere to the ongoing supervision requirements will mean that CDC is really only a potential option for the largest most well-resourced employers or master trusts.
At the moment, the draft authorisation and supervision regulations only apply to single or connected multi-employer CDC schemes. However, the Pension Schemes Act 2021 contains powers to make regulations to enable CDC models such as decumulation-only vehicles, commercial master trusts and industry-based multi-employer schemes to be brought into the authorisation and supervision regime in the future. The Government plans to “turn [its] attention to the growing demand for these other types of provision” in due course. Time will tell if there is uptake in this sphere.