Are CDC pension schemes “a game changer”?

Amber Rudd, the Secretary of State for Work and Pensions, has announced a “revolutionary” new workplace pensions scheme – Collective Defined Contribution (CDC) – that she claims will result in improved investment returns for workplace retirement savers.

This is a potentially significant development, which could ultimately involve billions of pounds and affect thousands of workers and employers, notably large unionised workforces. Given the recently low UK savings and business investment rates and the substantial deficits in many defined benefit schemes, it could also have a major impact on labour force relations, intergenerational fairness, capital allocation and the asset management sector.

Cross party and union support

The scheme, originally proposed by the Royal Mail and the Communication Workers Union (CWU) will be introduced, “as soon as parliamentary time allows.” What is interesting is the proposal has support from the Government, the Royal Mail, the unions and, we are told, it has “cross-party support”.
Already operational in Denmark and the Netherlands, CDC schemes offer a middle ground between the declining Defined Benefit (DB) schemes and Defined Contribution (DC) schemes.

For many businesses, the introduction of this new scheme will allow them to provide pensions provisions to their employees without the burden of huge pension liabilities. There is no guaranteed benefit at retirement, rather a target benefit meaning that pensions payments will fluctuate depending on the performance of the investments. Therefore, although risk is pooled, it nonetheless falls to investors, not employers.

Pooled risk

Proponents of the CDC scheme cite a number of advantages including improved investment returns because risk is pooled, regular and relatively reliable income in retirement and reduced risk for scheme members, while cutting costs and red tape for employers. They also suggest there will be benefits for the wider economy such as the prospect of these schemes investing in longer-term assets including infrastructure projects.

The pooling of risk might also provide an excuse for the Government to raise the lifetime and annual contributions caps.
The new scheme could also be transformative for the asset management industry if it entices greater participation in savings, resulting in the potential creation of vast new funds.

Too big to fail

However, whilst the introduction of the new scheme has been hailed as a “revolutionary reform” – a number of questions remain unanswered.

Already concerns have been raised about whether this new scheme would sit easily in the UK’s pensions system or whether it is more at home in a more unionised society. Other questions have been raised about whether this is the most effective way to encourage greater savings into pensions, how will the risk profile of such schemes be managed for the benefit of all members, what demand will there be for such schemes and does it offer investors sufficient choice.

Hargreaves Lansdown has warned that CDC schemes are “similar to the with-profits funds” which let down investors in the past. It has also said that large CDC schemes could become “too big to fail” and that the Government would have to stand behind them. This makes sense. The additional political risk for large quasi-public sector funds must ultimately sit somewhere.

The Dutch and Danish schemes are highly regulated with contributions and returns effectively governed by their central banks.

Notwithstanding the numerous questions, the CDC seems initially to be a constructive development for the provision of pensions in large quasi-public sector businesses such as the Royal Mail and for the Government. Switching to an entirely defined contribution scheme would be powerfully resisted by the trade unions. As the first scheme of its kind in the UK it will be interesting to see how the Royal Mail one fares and whether other businesses or government schemes would follow suit.

Here is a truly revolutionary suggestion. If they are such a good idea, perhaps Members of Parliament could lead by example and switch their notoriously generous pension plan, where employer contributions are approaching one third of salary, into a CDC scheme.

By Charlotte Walsh and George Trefgarne