The consultation on collective defined contribution schemes has recently closed, and the government must now decide whether to table enabling legislation to make such pension plans a reality.
As a reminder, CDC schemes (or at least the one that Royal Mail has in mind) have fixed contributions, a target benefit, and pool investment and mortality risks.
As many have pointed out, this is analogous to with-profits in the accumulation phase, followed by a with-profits annuity in decumulation.
Like with-profits funds, for CDC schemes we would like to see:
- Independent oversight to ensure that all scheme members are treated fairly;
- A process to manage any conflicts of interest that might arise between different stakeholders, for example members, employees, trade unions, the employer and trustees;
- Effective and fair setting of target benefits.
In the early 2000s, the FSA set out two new requirements for the management of with-profits and the fair treatment of customers.
Firstly, firms were to develop and publish Principles and Practices of Financial Management. The PPFM set out how an insurer runs its with-profits business, how it calculates bonuses, how it tracks underlying asset share for each policyholder, and how it allocates the fund fairly between different cohorts of members, and so on.
Secondly, firms were required to establish with-profits committees, with at least half of their members made up of independents.
With-profits committees must ensure the interests of with-profits policyholders are appropriately considered. Specifically, they must consider the financial state of the fund and whether bonus rates and payouts are fair, both absolutely and between different cohorts of policyholders.
Similar solutions are now required for CDCs, otherwise conflicts of interest will result in poor outcomes, as they have in the past for such schemes in the Netherlands. Without clear governing rules and principles, and without an independent committee to ensure those rules and principles are fairly applied, history tells us the outcome for members of UK CDC schemes will be far from ideal.
Pressure to maintain pensions-in-payments for as long as possible, in the hope that recovery of asset values is just around the corner, has proved problematic for Dutch CDC schemes. With the benefit of hindsight, Dutch schemes continued paying the same level of benefits to retired members longer than they should have.
On their own, the trustees may make poor decisions. Some of the trustees will be employer representatives, who may have the employer’s interests most at heart, and some will be union officials and employees who will want to make sure their members’ pensions are protected at all costs.
Being new, CDC has the unique benefit of hindsight to learn from the past. The past tells us that good rules for accrual and payment of benefits, allied with strong independent oversight, are the right way to go.
John Lawson is head of financial research at Aviva