One of the big news stories of the past few months has been the agreement between the Communication Workers’ Union and Royal Mail to work towards establishing a collective defined contribution scheme for all employees, while closing the current defined benefit scheme to future accrual.
The agreement came a day after consultation closed on the Work & Pensions Committee enquiry into CDC schemes.
The evidence given to that enquiry highlighted some key challenges to the introduction of CDC, most notably the lack of industry consensus on its viability and the difficult current political environment, with Brexit occupying an inordinate amount of the government’s time.
Indeed, Guy Opperman’s assertion that the government is “minded to assist” while not wanting to give any cast-iron guarantees, suggests it is far from a done deal.
Contribution rates in CDC schemes are defined for both members and the employer. Investment and longevity risks are pooled, with a non-guaranteed pension paid out on retirement. Pension increases can be restricted or, in extreme cases, benefits can be reduced if the pooled investments underperform.
So, if CDC is the perceived solution, what is the problem it is trying to solve and why is the pension industry so divided? The challenge is that there are a number of different factors in play with no simple one-size-fits-all solution.
Contributions need to come up
Defined benefit schemes are proving increasingly unaffordable and employers need a way out.
While CDC removes the burden of a pension deficit from an employer’s balance sheet, the high contribution rates required to support defined (albeit non-guaranteed) benefits still make it an expensive option.
The transition from DB to DC has been in full swing for several years, with DC scheme membership now exceeding DB. DC offers employers the double benefit of reduced cost and less responsibility.
Savers want freedoms
One of the main benefits of CDC is it pays a “wage for life”. But is that the primary concern of today’s worker?
The Pandora’s box of pension freedoms has been opened and it is showing no sign of closing again. DB to DC transfers rose to £20.8 billion in 2017 from £7.9 billion in 2016, and the Retirement Outcomes Review highlighted the amount of money being withdrawn from DC pots, albeit by what is a relatively small and unrepresentative cohort.
While pension scammers and unscrupulous advisers have played their part, this is not the behaviour of a workforce for whom a wage for life is the only priority.
CDC is designed for people who work for the same employer for a long time. The benefits of pooled investment and mortality risk really kick in when belonging to a scheme over the long term. But the rise of the self-employed (now 15 per cent of the workforce), the gig economy and the regular job-hopping prevalent in the modern world mean a job for life is a thing of the past.
Education, communication and engagement
The average employee doesn’t understand or engage with their relatively simple DC pension – auto-enrolment has used this inertia to its advantage.
CDC schemes are complicated, and employee communication would need to be handled extremely well by both employers and trustees for members to have a chance of truly understanding the non-guaranteed nature of their retirement benefits.
The risk is that employees may feel let down by their employer if their benefits end up not being what they expect.
Employers will not flock to CDC
The longer CDC legislation remains on the back burner, the more DC will become ingrained in the employer derisking, cost-reduction psyche.
And without a union twisting their arm, how many employers would choose a more expensive, untested option anyway?
So has the CDC ship sailed? The mastertrust tanker is already ploughing full steam ahead through the waters of auto-enrolment.
The pension freedoms flotilla is growing by the day. Meanwhile, CDC is still in the dry dock. With a fair wind, it will set sail shortly. If it does, it seems unlikely that many employers will jump on board.
*This article first appeared in Pensions Expert on 20th June 2018.