Articles - Frequently asked questions on CDC

 

While still new to the UK – with Royal Mail launching the first scheme in 2024 – CDC combines the potential for higher retirement income with the security of an income for life, closely supporting policy objectives. As interest in CDC builds, this FAQ page provides a clear, accessible introduction. It explains how CDC works, its key benefits and challenges, and the different design approaches emerging in the UK. Whether you are exploring CDC for the first time or looking to build your understanding, this guide offers a practical starting point.

 

In the years before retirement, a typical DC scheme follows a "lifestyling" strategy i.e. gradually reducing investment risk in advance of retirement to prepare for annuity purchase or drawdown. This level of derisking is not necessary in a whole of life CDC scheme where there is no change in benefit at retirement.

 

After retirement, a whole of life CDC scheme does not provide a guaranteed level of income and so is able to continue to invest in return-seeking assets longer into retirement before more gradually derisking. The extended exposure to growth assets means significantly higher outcomes can be expected – by up to around 55%.

 

For members joining a Retirement CDC scheme i.e. purchasing a CDC pension at retirement, post-retirement assets can also remain invested for longer, leading to higher expected outcomes. Additionally, even though members could be in the same DC scheme pre-retirement, their investment strategy would sensibly stay "on risk" for longer if it is known that the strategy is to move into CDC rather than to purchase an annuity. Overall, we estimate this approach would deliver on average 40% higher expected outcomes compared to an annuity, of which around 15% relates to pre-retirement investment strategy. We explain this more in our white paper from 2024: Reimagining pensions in the UK.

 

A. When you join a CDC scheme you will be told what the target, sustainable level of pension increases is — this will typically be linked to CPI inflation, and is the rate of increase that is expected to be able to continue to be paid each and every year into the future based on the current population. The level of pension increase is not guaranteed.

 

Each year, the scheme checks whether its assets are sufficient to cover the expected cost of pensions already built up, using the current target pension increase and best estimate assumptions. If the value of the assets is higher than the cost of providing the pensions, then pension increases rise (both the current increase and the target for future years). Similarly, if the value of the assets is lower than the cost of providing the pensions, then pension increases reduce.

 

For example, if a scheme was fully funded and had target pension increases of CPI, but then suffered a market shock, leading to, say, a 20% fall in asset values. Assuming the average term to payment of pensions was 20 years, this 20% asset loss could be made good by applying increases of CPI less 1% going forward, rather than CPI, for the scheme to remain fully funded. This mechanism is how scheme experience is smoothed over time.

 

A. Because pension increases are always set on the current population, and increases are calculated based on what is affordable over the lifetime of the current scheme, with sufficient scale they can cope with closure by running on without affecting current income levels. If a CDC scheme became too small to be cost effective to run on, it could wind up – providers must hold assets to meet the expenses of this.

 

A. Yes. Several countries already operate CDC pension arrangements or similar, particularly in retirement CDC. Canada has long-standing Retirement CDC arrangements, most notably the University of British Columbia Faculty Pension Plan, which has paid variable lifetime incomes for decades. Recent legislative changes have also enabled new longevity-pooling (tontine-style) products.

 

The Netherlands has used collective risk sharing pensions for many years and, under its new pension system, will continue to provide variable incomes for life through collective pools in retirement. Although labelled as DC, these arrangements function as Retirement CDC schemes.

 

Australia does not formally use CDC, but policy and regulation are increasingly encouraging retirement income products that pool longevity risk, and collective lifetime income solutions are an active area of development. So while the terminology differs, CDC-style risk sharing schemes already exist internationally, particularly to provide lifetime income in retirement, and they offer useful lessons for the UK.

 

A. With profits schemes have been widely criticised for being opaque –  and in the past, the increases or bonuses awarded were on a largely discretionary basis allowing room for commercial judgements to be made. CDC is more transparent for a number of reasons:

 

A. The collective nature of the scheme means that investment and longevity risk is shared between large groups of members. This enables the provision of a smoothed income over the whole of each member's retired life and the potential to invest in return-seeking assets for longer, meaning a higher expected outcome.

 

It also means that like a defined benefit (DB) scheme, some members will get greater benefit from being part of the scheme than others. For example, those that live longer will receive more pension payments in total i.e., short lived members subsidise the long lived, a "cross subsidy". All members benefit from the safely net a lifetime pension provides.

 

Single-employer CDC designs are also like DB schemes in that older members build up pensions of higher actuarial value than younger members.

 

When there are periods of higher or lower asset returns, the effect of these is spread over time, and affects younger members more than older members. In single employer schemes it also affects members who built up pensions at different times.