William Fitchew, Senior Consultant, XPS Pensions Group
In February 2018, Royal Mail and the Communication Workers Union (CWU) were the first to announce that they had agreed to work towards replacing their current DB and DC schemes with a CDC scheme for around 142,000 employees. However, this was subject to the proviso that the Government would need to legislate to allow for such schemes.
Even though the Pension Schemes Act 2015 contains legislation which could be used to provide for CDC schemes, these provisions would significantly change the existing pension regime, therefore the Government has decided that new primary and secondary legislation is required instead.
CDC benefits are intended to be a form of money purchase (MP) benefit, so that it will be clear to employers that they will not have to fund any shortfall in benefits that might arise. Consequently, CDC schemes would not be eligible for entry into the Pension Protection Fund (PPF) in the event of employer insolvency. Similarly, CDC schemes will be required to communicate clearly with members to ensure they understand that the level of benefits is not guaranteed and will depend on various factors, including the performance of scheme assets. The Government intends that they will be trust-based private sector schemes and no changes to the categorisation of existing schemes will occur, so CDC schemes will be for new benefits only.
Initially, the regulatory framework will just allow for CDC schemes of the broad form and nature of the one proposed by Royal Mail, however, the intention is that the DWP could modify the framework in light of future experience without an Act of Parliament being required.
The DWP intends that CDC schemes will be occupational trust-based schemes and will be subject to an assurance and regulatory regime similar to that for master trusts. They will therefore be scrutinised by the Pensions Regulator (TPR) before they are authorised. As with master trusts, the costs of authorisation would be met by the scheme.
The authorisation process would look at various matters including the scheme’s continuity strategy, its financial sustainability, the robustness of its systems & processes, and whether individuals significantly involved in its running are ‘fit and proper’. It would also consider the level of target benefits relative to contributions, how benefit adjustments are carried out, how transfer values are determined, and how communications explain to members what they might expect from the scheme. Legislation will include provisions enabling additional requirements to be added later if necessary.
Before a CDC scheme can approach TPR for authorisation, an independent actuary will be required to peer-review the actuarial assumptions underlying the scheme’s design. Once authorised, a CDC scheme will be required to appoint a scheme actuary to carry out annual valuations to assess whether benefits should be adjusted (up or down), and to test the scheme’s overall sustainability.
The DWP considers that such adjustments should apply across the entire scheme membership (i.e. to accrued pensions as well as pensions in payment) and should be the result of a mechanism set out in the scheme rules, not trustee discretion.
Although the DWP believe that the current Trustee Knowledge and Understanding (TKU) requirements should suffice for CDC schemes, it is minded that TPR is likely to consider the collective expertise and experience of the proposed trustees as part of the authorisation process.
As they will be a form of MP benefit, the DWP proposes that CDC schemes will be subject to the same charge cap applying to standard MP schemes. Even though the cap will be set at the same level (i.e. 0.75% p.a. on funds under management), it will apply to the scheme as a whole instead of to an individual member’s pot.
Transfer values are also an area for consideration as the DWP acknowledges that the existing basis for calculating transfer values might need to be amended for CDC benefits.
CDC schemes would be a new addition to the pensions landscape. Although the DWP intends to legislate as soon as possible, it might be some time before the necessary framework is in place. It also remains to be seen how much demand there is amongst employers to use a CDC scheme for their pension provision.
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