The Government’s consultation paper 'Reshaping workplace pensions for future generations' suggested a number of innovative ‘Defined Ambition’ proposals to reform the UK’s workplace pension scene including legal changes allowing for the establishment of Collective Defined Contribution (CDC) schemes. The Pensions Minister, Steve Webb, has been an advocate of CDC as a means of extending low-cost workplace pension coverage to a wide spread of employees and the latest issue of Placard, the discussion paper of the Association of Consulting Actuaries (ACA), explores the ins and outs of CDC. Building on its surprise Budget pension reforms, the Government is expected to announce its response to the consultation shortly.
Collective Defined Contribution (CDC) pension schemes provide a pension based on a formula, typically based on career average earnings. This pension is subject to indexation only to the extent affordable with the ability to also apply benefit reductions in the event of a funding shortfall. The ‘DC’ part of the name comes from the fact that employer contributions are fixed and the ‘collective’ part from the fact that all risks are spread across the membership through one pooled investment fund. These arrangements are probably best known for being the most common type of private sector provision in the Netherlands, although a number of other countries also adopt collective models. It is argued that the fixed nature of employer contributions renders such schemes more sustainable than defined benefit schemes.
The Netherlands have not always operated CDC schemes. Most Dutch pension provision used to be defined benefit (DB) in nature but the rules were relaxed to allow many schemes to switch to CDC. It is widely claimed that the Dutch CDC system is better than DC provision in the UK’s and this is at least in part because CDC arrangements are meant to be able to provide a significantly higher pension (perhaps up to a third) for an equivalent level of savings compared to ‘traditional’ defined contribution (DC) schemes in the UK. This is cited as being due to a number of reasons: greater freedom of investment, less volatility due to the spreading of risks, not being tied to purchasing annuities in the open market and lower fees once scale is achieved.
The main challenge to the Dutch system is that it is potentially unfair across the generations; younger members bear the risk that their benefits will be reduced in future if older members’ benefits are preserved today. Indeed in 2009, the Department for Work and Pensions (DWP) concluded that it would not pursue its investigations into CDC partly due to the risk of an unacceptable level of intergenerational unfairness. These unclear ownership rights and lack of transparency are two of the main difficulties with the current system in the Netherlands and are probably why a number of pension schemes are switching from CDC to pure DC arrangements.
In this issue of Placard, Kevin Wesbroom (Partner, Aon Hewitt) explains why he supports CDC and Richard Jones (Principal, Punter Southall Transaction Services) points out some of the myths with CDC and discusses some of its potential drawbacks.
Commenting on CDC, ACA Chairman, Andrew Vaughan, who also heads the Defined Ambition Industry Working Group set up by the DWP to provide input to the November 2013 consultation paper, said:
“The ACA has been a strong supporter of allowing greater freedom in workplace pension design and risk sharing, which is why we welcomed the ‘Defined Ambition’ initiative and consultation, which includes proposals to encourage CDC and a more flexible approach to defined benefit arrangements. These workplace pension reforms if enacted would complement and support the Chancellor’s latest proposals to boost pension savings in a more flexible environment.”
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