The recent enquiry by the work and pensions select committee has reignited the debate about the future of collective defined contribution schemes.
Whether these sort of schemes can be incorporated into the current UK pensions landscape is a moot point. Let’s consider some of the arguments for and against CDC.
First of all, it is important to understand that CDC schemes differ from traditional DC schemes in that they do not produce individual pension pots. Instead, they invest in a larger collective pot, which provides an income to individuals during their retirement.
CDC schemes also differ from defined benefit schemes in the sense they do not guarantee certain incomes. Instead, they have a
target amount they pay out, based on a long-term, mixed risk investment plan.
CDC is not a magic bullet if your pension budget is too low. The first priority has to be to set aside enough retirement savings.
CDC covers a wide range between DC and DB – some are more DC-like and some more DB-like. In the Netherlands, they have a range of models in operation but none are what we would call DB and very few are what we would call DC.
Collective investing and risk sharing between the members is expected to produce better outcomes for individuals overall, while employers stand to gain significantly by not having to shoulder the cost of making good large deficits in funding.
That said, critics are questioning how CDC will work with the introduction of pension freedoms – notably whether this would stymie the ability to take lump sums and/or transfer out prior to retirement. If this were to be allowed and people start to take out large sums of money, would this not weaken the shared pooling of risk and ultimately cause the scheme to fail?
The proponents say not. With a CDC scheme, each person would have a share of the fund which would be their property right. This would be the same as a transfer value based on the benefits expected in the future, discounted back to the present (as CDC benefits are ultimately set by reference to the funds available).
Members would therefore be entitled at any point to transfer out right up to retirement (or even, in theory, post-retirement). That, they say, would allow pension freedoms to operate normally. However, if indeed that were the case, it would work better with a large scheme rather than a smaller one.
Looking beyond the technical and operational issues, it may be the attitudes and wishes of both sponsors and members that will determine the future of CDC.
Will there be much demand from employers, particularly those who have already moved to the safe harbour (for them) of conventional DC? Will members be comfortable about the possibility (unlikely as it may be) of having their pensions in payment cut back?
We shall no doubt find out in due course. Meanwhile, the debate
Malcolm McLean is senior consultant at Barnett Waddingham