Collective defined contribution has been causing a stir among employers and group schemes? What do advisers need to know about this new type of pension?
Last month’s Queen’s Speech rubber-stamped the introduction of collective defined contribution (CDC) plans. This type of defined contribution pension basically pools risk in large defined contribution schemes set up to pool a particular group of employers.
The schemes are so large (usually with thousands of members) that the scheme benefits from economies of scale.
In addition, the size of the CDCs often mean members can access investments they would be unable to do so on an individual basis and so have the opportunity for higher returns. Performance is based on the members and investment choices.
A European hit
CDCs have been popular in European countries, most notably the Netherlands where they cover entire industries. So with IFAs increasingly advising employers on the auto-enrolment revolution, what do they need to be aware of when it comes to CDCs?
Intelligent Pensions marketing director Andrew Pennie explains: "CDCs can be used to pool risk and drive cost efficiencies, and they have been popular in some European countries.
"Certainty of cost will be attractive to employers and the ‘group’ concept could be beneficial to encourage participation, particularly for smaller employers who are struggling with auto-enrolment and lower paid earners."
However, questions remain over the long-term stability of such a venture and ultimately how it will benefit savers and schemes, particularly after the retirement freedoms granted in the Budget.
Aegon UK regulatory strategy manager Kate Smith says: "The scheme does have its merits. The collective buying power would offer benefits through economies of scale and could provide higher investment returns than personal pensions.
"But the move does not reflect trends in UK society. The Aegon Global Retirement Readiness Report 2014 revealed that only one in three UK workers expect to have a fixed retirement date, so the constraints of a CDC scheme would severely damage the retirement plans of the remaining 71%.
"The new legislation will allow employers and providers to set up CDCs from 2016. But it is unlikely that the industry will be so fleet of foot as they continue to focus on delivering choice and new ways for customers to engage in saving for retirement.
"Only the very largest employers – those who continue to run defined benefit schemes – are likely to be interested."
An issue for Pennie is how employers may respond to these changes given the fact that auto-enrolment is in full swing.
He warns: "Many employers may well accuse the government of putting the cart before the horse when it comes to CDC schemes as this initiative should have been announced before auto-enrolment began.
"Many employers for whom CDC could be appropriate have already gone through a painful and costly auto-enrolment process."
Elsewhere, Hargreaves Lansdown head of pensions research Tom McPhail agrees: "The timing could not be worse. Large employers have already gone through auto-enrolment. They don’t want to go back now and redo the whole exercise as a defined ambition (DA) scheme.
"In addition, the Chancellor’s new pension freedoms announced in the Budget are pulling pensions in precisely the opposite direction."
So what about potential downsides of the way a CDC scheme operates? It does not take a great leap to suggest there may be concerns if they perform in a similar way to with-profits funds.
Pennie explains: "Benefits are not guaranteed and there is a sense of ‘with-profits’ about the scheme – increasing income when the scheme does well and reducing income if the scheme does not perform, as happened for many Dutch CDC schemes after the last economic downturn.
"As we know, with-profits has become a much lambasted and archaic means of investing, and it was heavily criticised for not delivering transparency and value. CDC schemes will face similar challenges in these key areas and must improve on previous efforts."
He continues: "The big downside of CDCs is the lack of sophistication and ability to tailor benefits to an individual’s bespoke circumstances.
"It is interesting that some Dutch commentators are now speaking out in favour of the UK’s individual pension scheme approach rather than their CDC scheme approach."
McPhail adds: "Unlike in a defined contribution plan, where a member with poor life expectancy can get an enhanced annuity, in a CDC scheme they simply end up cross-subsidising the healthier (and often wealthier) members."
Meanwhile, the way CDCs operate could be seen to undermine auto-enrolment and the push for people to engage with pension saving – potentially not a good thing for advisers and their clients.
McPhail warns: "CDC schemes discourage personal engagement in retirement planning. They perpetuate a dependency culture and expectation among the members that someone else is taking responsibility for their retirement.
"It is better by far to encourage them to engage with their retirement provision and ensure that they are saving enough."
However, pensions minister Steve Webb personally sought to allay some of these fears at the launch of the recent Scottish Widows Retirement Report.
As reported in Retirement Planner’s sister title Professional Adviser, Webb said: "I can see the point that says collective DC keeping people locked in doesn’t fit very well with budget freedoms. But we don’t envisage any constraint on DA schemes access in line with budget freedoms.
"The reason I’m kind of relaxed about that is that if I’ve been in a CDC scheme through my working life and they’ve done a good job, then fine, I’ll take a bit of cash.
"But what do I want to do with the rest of the money? Well, if I want to invest it in a good value-for-money scheme that I trust, why wouldn’t I leave it where it is?
"Yes, the DA scheme will have to plan ahead for freedoms. But I don’t think that fundamentally impacts it."
Another issue as to whether these schemes do reach their full potential is down to political will.
Pennie concludes: "As ever with pensions, there would be winners and losers with CDC schemes. As such, it will be interesting to see how these schemes are implemented.
"Undoubtedly, this will take time, but will they be able to design schemes so that those who need or want increased sophistication and flexibility are able to do so?
"Steve Webb is the driving force behind CDC schemes and there is no doubt the CDC initiative will take years to implement.
"Unfortunately, Webb is unlikely to be in government after the next election and one wonders how this initiative will develop without his passion and involvement."
Tracking real performance
Diversified return team
The equivalent of £1.7m every day
Janus Henderson Global Dividend index