CDC Pensions – a complex solution that delivers simplicity for employees.
Complexity is the bugbear of getting people to save for their retirement. The need to save is easily explained, but the simplistic solutions of the past, at least to the retiree, of defined benefit pensions and state pensions are either no longer viable (DB schemes) or are under huge pressure from changing demographics (state pensions). The new approaches being undertaken to resolve the level of under saving in the retirement market are a lot more demanding of financial expertise.
Take, for example, the UK’s auto-enrolment strategy. This has been, by any measure, an outstanding success. Over 13 million people have been auto-enrolled, and the drop-out rate of 9% has been far lower than was predicted. However, there is one downside – the majority of joiners drop straight into the default funds of the schemes that they have been enrolled into and never move.
The default fund will generally be a cautious fund and may not be suitable, particularly for younger savers looking to grow their pension savings across a whole working lifetime. Despite that, the biggest master trust NEST has stated that almost 99% of its savers, representing over half the UK total, are invested in their default fund and are not taking an active role in managing their own investments.
Similarly, the introduction of pension freedoms has removed one of the factors that was militating against retirement saving – the fear that people would be trapped in annuities at poor rates, if the rates were bad at their retirement date. This has led to a precipitous drop in the sales of annuities and a huge influx of new retirees into drawdown products. However, the management of drawing down an income from a fund is a highly complex matter and it means the entire longevity and investment risk is being carried by the individual retiree.
Among the approaches seeking to resolve these issues for workers are the idea of Collective Defined Contribution pensions – “CDCs”. CDCs operate by pooling all contributions from member into a single, professionally managed fund and relieving the member from the responsibility of growing the fund. The fund then undergoes an actuarial valuation each year and adjustments made, both to the promises to the active members and the payments to the retirees in payment. This ensures that the liabilities and assets of the scheme stay in synchronisation.
These types of pensions are already available in other countries, most notably the Netherlands, and are a clever balance between pooling the longevity and investment risk whilst demanding little financial knowledge from the individual employee. It also allows employers to facilitate and encourage pension saving without taking on board the unquantifiable liabilities associated with the old defined benefit schemes.
CDCs would require changes in the law to be permitted in the UK. Pensions Minister Guy Opperman has now committed to introducing this legislation in response to an innovative scheme proposal from Royal Mail Group and the Communication Workers Union (CWU). This proposal is for a CDC scheme to cover all employees and which will be based on a pooled collective fund. This has many benefits for the employees – removing the need for them to actively manage their investments during the accumulation period and guaranteeing them a pay-out from the scheme for their remainder of their life, although that actual payment amount would not be guaranteed as it could rise or fall each year based on the annual actuarial valuation of the scheme.
Whilst many are decrying the lack of initiatives from the Government at this time, given the fact that the Brexit process is taking most of the legislative bandwidth, the Minister is to be congratulated for embracing this scheme and moving forward rapidly with the necessary legislation to accompany it. The fact that much of the legislation will be secondary legislation, which is relatively easy to change, rather than primary attests to Mr Oppenheim’s stated aim of monitoring the progress of the Royal Mail Group scheme closely and making further changes based on how the scheme operates in practice, a welcome flexible approach from the Minister based on an appetite to try new approaches and learn from the experiences.
This is a welcome development in the pensions market and will provide a much needed alternative in the future that obviates some of the downsides associated with pure defined contribution schemes.