It does not take long to read The Pension Regulator’s (TPR) list of authorised collective defined contribution (CDC) schemes in the UK, since it comprises just one name.
The Royal Mail Collective Pension Plan (RMCPP) received authorisation on 13 April 2023, which the Minister for Pensions, Laura Trott, declared: “a landmark moment [which] is just the beginning”.
But the Department for Work and Pensions’ (DWP) enthusiasm is not wholly shared by the UK pension industry with many questioning whether there is widespread employer appetite for CDC.
Single and connected employers have been allowed to set up a CDC since last August, but the lack of schemes on TPR’s authorised CDC list suggests a lack of interest.
Part of the slow progress lies in the sheer volume of work involved in setting up a single employer CDC scheme. It took years to get the RMCPP authorised, and the Communication Workers Union, who represented members in the switch, says there are still “some further areas that need resolving before the plan is launched and we continue to work with Royal Mail Group in our engagement with the government to ensure this happens as soon as possible”.
Muted appetite
Steven Cameron, public a airs director at Aegon, says CDC may be the preserve of employers with the largest workforces, and more than likely those that are looking for an alternative to defined benefit (DB) provision.
“I suspect that unless you’re a very, very large employer it’s unlikely that you would want to go down the CDC path,” he adds. “They would probably offer a DB scheme, and there aren’t many of those left in the private sector, so the demand [ for CDC] is limited.”
This view is shared by Clare Altman, managing director of individual retirement at Standard Life, part of Phoenix Group, who says employers are concerned about CDC’s complexity and how to manage employees’ expectations that the schemes provide guaranteed income.
“We are aware that many employers do not see CDC as something they want to engage in for understandable reasons. They have spent time and effort in ensuring auto-enrolment compliance and save for the most paternalistic of employers, there is no up-side to them of CDC.”
Cameron adds that he has seen no evidence of public sector DB schemes considering a move to CDC either. “I’m not aware of that being something that is being discussed,” he says. Chintan Gandhi, partner and head of CDC at Aon, agrees there are thresholds that determine the viability of CDC.
“CDC needs to be well scaled because it involves risk-sharing, and that means having several thousands of employees or members, or several millions, and in some cases, billions of pounds in assets under management.”
But he argues that the appeal of collective arrangements extends beyond employers solely offering DB. Gandhi says CDC offers benefits which he calls “the three Es”: efficiency, employee value proposition and ESG.
“Efficiency comes from the better bang for your buck CDC offers,” he adds. “Our research shows that on average savers can achieve a 30% higher income using CDC compared to an annuity. CDC also improves the employee value proposition because there is a greater chance [than with DC] of being able to retire with an income for life, so it helps with recruitment and retention.
“Finally, when pooling contributions and investment returns together you can take a longer time horizon, and increase the opportunity set to invest in a more sustainable and responsible way.”
All this, Gandhi says, makes CDC an attractive proposition, and there is evidence employers are considering risk-sharing options. “Results from an Aon poll reveal that 10% of employers are already pursuing CDC with a further 14% considering collective arrangements as part of their next benefits review,” Gandhi says.
Expanding opportunities
Yet given the size constraints of setting up CDC, the government believes the opportunity to o er the schemes needs to be extended to multi-employer arrangements and master trusts. In March a DWP consultation closed, which had invited the industry to comment on how a CDC framework could be adapted to allow more employers of all sizes to offer CDC schemes, and to allow more flexibility in design.
Echoing pensions minister Trott’s excitement following the authorisation of RMCPP back in April, the DWP tells portfolio institutional: “We have seen the positive effect of these schemes in other countries and our plans to extend our CDC framework will enable more pension savers to achieve the retirements they want.”
However, the DWP continues to consider responses and says it will respond in due course.
Again, as with the viability of CDC for single employer schemes, there is some scepticism that appetite exists for collective saving within a multi-employer or master trust framework.
In its response to the consultation, the National Employment Savings Trust (Nest), which is the UK’s largest master trust and acts as the default arrangement for employers under auto-enrolment, said: “We haven’t seen any evidence of an appetite among employers to deliver CDC so far”, although it added that “employers are thinking about, and interested in, how to help their employees have a smoother path into retirement”.
The story is similar at Now Pensions where Stefan Lundbergh, head of DC platform, says: “I don’t need to hire bouncers to keep the entrance clear for people who want to come in and talk to us about CDC.
“CDC is an acquired taste; I don’t think it’s going to be mainstream,” he adds. “Maybe if it had been an alternative to DB 20 years ago, but it’s a bit late now. There is already a solution that works with traditional master trusts, so why move to something else?”
The challenge in the way of wider take up, says Aegon’s Cameron, is ensuring equity and fairness within a multi-employer CDC arrangement since there will be considerable differences in expected longevity across the membership that need to be reconciled.
“Different employers participating in CDC will pay different contributions, and the demographics of the workforce will be different, as will mortality experiences. Is it fair to pool investment and mortality risk given the variation in the membership?”
Cameron adds: “The actuarial discipline required will be far greater [than with conventional pension schemes] because of the need to ensure equity and fairness across the members.”
However, according to a straw poll conducted by Willis Towers Watson (WTW) at a pension conference held in November last year, employers expressed interest in accessing CDC through master trusts.
More than nine out of 10 (93%) attendees thought that CDC decumulation would be of interest to retirees, and four-fifths (79%) wanted to facilitate it for their members. Of that 79%, nearly three-quarters (72%) say they would want to do so through a master trust.
Simon Eagle, senior director and head of WTW’s CDC pension team, says: “What I take from those results is that employers expect CDC to become available through master trusts, and I expect the industry to respond to that by servicing the market.”
Standard Life’s Altman also envisages CDC as part of the master trust offering, noting that there are “considerable advantages for individuals and its right that the government explores how scale could be achieved and risks could be managed.
“If we can find a way of overcoming these challenges in ways that have wide-spread support then I can see CDC taking a bigger role in the UK pensions landscape, although those are not inconsiderable issues to overcome,” she says.
Brand new solution
Where there is more consensus on the possible benefits of introducing CDC to the UK market is in decumulation-only arrangements, and which form a key part of the DWP’s consultation.
The DWP says decumulation-only CDC “could provide those approaching retirement with an income product that allows them to share investment and longevity risk. In addition, a CDC decumulation fund has the potential to provide, on average, better returns than the traditional options of annuities or drawdown”.
This is because their longer-term investment horizons mean they will be able to invest more in higher return seeking assets for longer. This, the DWP argues, means members can be confident that they have a fully managed investment fund, providing them with an income for life although the annual benefit level is not guaranteed.
Cameron says decumulation-only CDC “is definitely worth exploring” since, to a degree, it combines the flexibility of drawdown with the security of an annuity.
“An annuity gives you a guaranteed income for life but no flexibility, drawdown gives you huge flexibility but no guarantees that you won’t run out of money. CDC is somewhere in between; you will be sure to get something for the rest of your life, but there’s no certainty on the amount you receive.”
Eagle agrees, adding: “There is lots of research that people want an income for life in retirement, but relatively few buy an annuity because they haven’t been good value. Decumulation-only CDC would be a new option that could fill the gap.”
Further, decumulation-only CDC can be combined with taking tax-free cash and keeping some of the pot invested in flexible drawdown.
“Thinking has moved on in favour of a more blended approach that allows people to achieve the best of an annuity and drawdown,” Altman says. “We expect to see significant innovation and product development over the next couple of years, and welcome CDC being part of the pensions saving toolkit.”
Levelling the playing field
The government’s central motivation for considering expanding CDC is to bring the DC member experience closer to that enjoyed by DB members. However, simply offering risk-sharing among members will not achieve parity alone.
“The only thing that can level the outcomes between DB and DC is contributions,” Lundbergh says. “If you don’t pay the same amount [as DB] you’re not going to get the same outcome, whether it’s from CDC or traditional DC.”
Yet since CDC schemes can be a higher-risk investment strategy which, in theory can provide a significantly higher pension for the same level of cost as a DB arrangement, and significantly more income than buying an annuity.
Looking at the RMCPP, WTW calculated the expected pension provided would typically be 40% higher than a DB environment and 70% higher than with a DC-insured annuity.
“So while CDC can’t level the playing field between DB and DC overall, it has the potential to improve member outcomes in general,” Eagle says.
Collective DC offers a genuine third way in UK pension savings. It has the flexibility of DC with some of the certainty of DB, but whether there is great demand for such an alternative is unclear.
Certainly, if CDC advocates want to see the arrangements get off the ground in any meaningful way, their focus will have to be on communicating its benefits to employers and their workforces.
As Altman concludes: “Getting communication right is front and centre to making this work.”
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