CDC pension schemes are go! UK Government gives green light to life-changing pension innovation

23 May 2019

A pioneering pension scheme model that promises improved retirement incomes for millions of workers has cleared its latest hurdle – a consultation response from the Department for Work and Pensions (DWP) – in its journey to primary legislation in the UK.

And what a response it is – it’s not often we get a government paper as positive as this one. It confirms that CDC will be brought into legislation in the UK ‘as soon as parliamentary time allows’. For everyone at First Actuarial, but especially colleagues who have worked with me to propose CDC at the Royal Mail, this is a real cause for celebration.

And let’s not forget the wide range of organisations, 79 to be precise, who contributed detailed responses. These include employers and trade unions as well as pensions businesses. We were delighted to see a number of our responses in the document. If you’re interested, these are in paragraphs 24, 107, 111 and 158.

The vast majority of responses were in favour of CDC and keen to see its introduction in the UK, as the Government press release notes. So much for those commentators who claimed there was limited appetite for CDC. The breadth and depth of responses submitted suggest there’s more public hunger for change than some in the pensions industry might think.

Collective DC – the feelgood story that keeps on giving

In fact the whole story of CDC up to now has been an overwhelmingly positive one – from the enthusiastic report on CDC by the Work and Pensions Select Committee and cross-party support to where we are today, on the threshold of legislation and with the Royal Mail aiming to launch the first UK CDC scheme in 2020.

For those who think the day-to-day business has been ground down under the weight of Brexit, this will come as a pleasant surprise. It’s a move that promises real improvements to ordinary people’s lives. Pensions are not a luxury; ordinary working people need an income in retirement, and they need a guarantee that it will last their entire life.

But what the pensions industry currently provides is nowhere near that. In the private sector, we’ve closed a succession of Defined Benefit (DB) schemes and replaced them with Defined Contribution (DC) arrangements, which are more like saving accounts than pension schemes. They give each individual a pot of money at retirement, with no affordable way of turning it into what people really need – a wage in retirement.

You don’t have to be an ‘entitled millennial’ to see how inter- and intra-generationally unfair that is. Across all age groups, people have steadily lost their confidence in pensions, and for today’s employers the whole issue is a nagging headache.

What is CDC?

CDC is designed to bridge the gap between DC and DB. It is DC, in the sense that pension benefits are based on what fund assets will buy. But it leaves behind the scheme deficits of the DB world, as there are no promised benefits. The beauty of CDC is that it can deliver an income for life without defining the benefits upfront.

It achieves this through collective planning. Individual DC is currently based on single pots of money, which rules out the economies of scale that DB enjoys. Collective DC can pool those individual pots into a much larger, and more efficient grouping of assets. And a stream of incoming contributions can be used to pay outgoing benefits directly. This opens up investment in more volatile assets expected to give better long-term returns. Both of these generate significant savings on investment and disinvestment.

These savings translate into better benefits for scheme members.

CDC schemes can also harness the value of longevity risk-sharing: this is the ‘actuarial magic dust’. Think about individuals relying on their own savings pot. Each person needs to save something like 40 years of income to manage the risk of running out of money. But if thousands of people save together, then all that’s needed is 20 years’ of income per individual, equating to the average life expectancy.

CDC also lifts away the burden of managing investments on an individual basis. This is a responsibility that can come as a nasty surprise when individuals first start saving – and again as they approach retirement.

Introducing CDC at Royal Mail

As the consultation response states, the DWP plans to introduce CDC provisions slowly, starting with the Royal Mail scheme. This is where CDC first emerged as a practical idea here in the UK, with First Actuarial playing an instrumental role. We’ve worked with Royal Mail, the Communication Workers’ Union (CWU) and the DWP on the CDC proposal.

The simplified approach that the Government is taking to allow the Royal Mail CDC scheme to go ahead is the right one, I believe. Let’s get the Royal Mail scheme right and then expand CDC to other organisations.

Terry Pullinger from the CWU is strikingly enthusiastic about CDC. As he states in the response document: “We are very proud and ready to be at the forefront of this historic moment which we believe will make a major contribution to offering future dignity and security in retirement for decent working people.”

To read more about the story of CDC at Royal Mail, read our case study and article, Royal Mail, CWU and First Actuarial – History in the making with CDC pensions.

Where does CDC go from here?

Heartening though the Royal Mail story is, nobody wants CDC to end there. I strongly welcome the flexible structure of the legislation which will accommodate variations in the CDC model as time goes on. Other employers are already interested in CDC, and the Government has pledged to work with interested parties to broaden out the legislation once the Royal Mail scheme is established.

With the likelihood of primary legislation being held up by Brexit, it would be good to see work on the regulations start straight away. In time, I’d like to see an amendment to admit mastertrusts and multi-employer schemes. Mastertrusts would be a great way to allow drawdown from individual-based DC and offer improved pension options to the self-employed.

CDC may be new to the UK, but there are CDC schemes already in operation in other countries. We need to scrutinise existing models to make sure the details fit the UK’s own legal and cultural frameworks. Taxation (not covered in any length in the Government’s response) is a particularly thorny issue that needs to be tackled sooner rather than later.

Let’s get the CDC conversation going

Pensions are a society-wide issue, and this is a key moment in their history, so there’s a strong case for making all generic documents public – and welcoming scrutiny. It’s good to see the response document emphasising the importance of clear communication. Like everyone at First Actuarial, I pride myself on communicating in plain English. As the response document points out, ordinary people are likely to misinterpret the financial term ‘best estimate’ as ‘highest estimate’, for example. We must guard against such misunderstandings.

I would raise one concern. There is a tendency to hold CDC to a higher standard than is the case elsewhere in the pensions world – where bamboozling members is commonplace. That’s not to say we shouldn’t hold ourselves to a high standard in communicating CDC. But for members the most important thing is for their scheme to work!

Moving forward with a positive mindset

It really is brilliant to have got this far. Why do I say this? Well CDC is a great example of actuaries working creatively to find a solution to a big problem. We’ve already seen one trade union, CWU, coming together with an employer, Royal Mail, to take a new innovative approach to pensions. And they’ve now persuaded Government to pass legislation to make it happen.

There’s plenty of work to do to bring CDC to fruition, but everyone at First Actuarial is up for it. And we’re more than happy to help if the Government wants to set up a CDC working group.

Think of CDC as the pension equivalent of a greenfield site, a scheme with none of the legacy problems such as aging systems that we hear so much about. We can start with a blank screen and design schemes that meet the needs of the many not just the few. We need more initiatives like this to rebuild Britain and improve standards of living at every level of society.