Jacqui Woodward, Senior Consultant, XPS Pensions Group
The agreement, which would see around 142,000 employees move to a CDC scheme, was subject to the not insignificant proviso that the government would need to legislate to allow the operation of CDC schemes.
What is a CDC scheme?
Currently there are two types of employee pension schemes, DC and DB. Under a traditional pure DC scheme, the member bears the bulk of the risks whereas, under a typical DB scheme the employer takes on these risks. The last 10 to 15 years have seen a trend of employers moving away from DB provision towards DC with a corresponding transfer of risk from the employer to the member. The introduction of automatic enrolment has resulted in a growing use of DC schemes over the last six years.
A CDC scheme is one in which risks are shared between members. Typically, the employer would pay a fixed rate of contributions and a level of DB pension would be targeted but no guarantees are made. The actual benefit amount paid would depend on the funding position of the scheme and, where this was poor, pensions in payment might not be increased or might even be reduced.
As with all forms of pension provision, CDC schemes have some possible advantages and disadvantages.
Advantages:
• The sponsoring employer would, in theory, have certainty over the level of contributions it pays into the scheme.
• Administration and investment management costs might be lower as a result of economies of scale.
• Typical DC schemes tend to move from equities into lower-risk, lower-return assets as an individual approaches retirement (known as ‘lifestyling’). CDC schemes might be able to remain fully invested in equities for longer, which might lead to higher returns.
• Depending on the scheme’s design, it might be possible to pool longevity risk without having to cover the cost of the insurer’s profit margin and capital buffer.
Disadvantages:
• It may not be straightforward to communicate to members how a CDC scheme works. Members might view a benefit target as being guaranteed.
• There will be inter-generational cross-subsidies which might be perceived as unfair by members.
Current legislation
At present, much of the UK’s pension law treats anything that is not pure money purchase as being DB. In 2009, the then Labour government looked into CDC schemes, but decided not to take any further action, citing concerns about whether such schemes could manage intergenerational risks fairly, the extent to which their stability was dependent on a continuing stream of new contributions and low expected demand from employers.
The Coalition government consulted in 2012 on some possible risk-sharing schemes, including so-called defined ambition (DA) schemes, as well as CDC schemes. DA schemes would allow risks to be shared between the employer and members whereas CDC schemes typically involve risks being shared between members but not the employer. Consequently, the framework for certain risk-sharing schemes, including both DA and CDC, was put on the statute book via the Pension Schemes Act 2015 (PSA2015) although none of the relevant provisions have, to date, come into force. So, as it stands, CDC schemes are not currently permitted in the UK.
The key recommendation made by the Work & Pensions Select Committee (WPC) is that, rather than bringing the provisions of PSA2015 into force, which would be ‘disruptive’ and according to the government could take up to two years, the government should instead amend the existing definition of money purchase schemes.
The WPC also makes a number of other recommendations on matters the government should consult on including benefit adjustment and risk-sharing policies and transfers out from CDC schemes. The government have indicated that they will launch a consultation on a legislative framework for CDC schemes this Autumn.
Conclusion
As we wait the consultation, it is currently not clear whether or when legislation might be changed. Whilst the Royal Mail agreement is a first and there have been some positive noises from the current pensions minister, it remains to be seen whether there is now significant demand for CDC schemes from employers and whether legislation will be changed.
Employers interested in following Royal Mail’s lead will either have to wait and see whether the law is indeed changed to allow CDC schemes or explore using an alternative form of risk-sharing.
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