Collective defined contribution pension schemes: the future for larger UK employers?

The Pensions Regulator authorised the UK's first collective defined contribution (CDC) scheme – also known as a collective money purchase scheme – the Royal Mail Collective Pension Plan, on 13 April 2023. This development comes shortly after a period of consultation by the Department for Work and Pensions on proposals to extend the CDC legislation to permit  "whole of life" schemes (including master trusts) for non-connected employers and CDC "decumulation only" schemes. Whole of life schemes would provide for members in the saving and retirement phases. "Decumulation only" schemes would provide a retirement income option as an alternative to annuities or drawdown. At the moment, the CDC model is only available to single or connected employers.

Why is CDC important?

When the government announced the consultation on extending CDC, it was as one of four measures intended to "help address the pension inequality gap which has risen since the decline of defined benefit (DB) and the emergence of defined contributions (DC)". 

In short, in a world where adequacy of retirement income is a major concern, particularly for younger employees without any DB (such as final salary) pension provision, CDC offers a third way. The hope is that this new type of scheme could give employers a way of providing employees with a materially better pension outcome than pure DC, without the cost commitment or funding risks of DB. 

When announcing the launch of CDC last August, the former minister for pensions, Guy Opperman, stated: "CDC schemes have the potential to transform the UK pensions landscape. We have seen the positive effect of these schemes in other countries and it is abundantly clear that, when well designed and well run, they have the potential to provide a better retirement outcome for members, and can be resilient to market shocks.  I have no doubt that millions of pension savers will benefit from CDCs in the years to come."

How does it work?

Employers and employees will contribute to a CDC scheme in much the same way as a standard DC scheme, but that is where the similarity ends:

• The contributions paid will be invested and used to target (but not guarantee) a particular benefit at retirement, together with at least Consumer Price Index increases. Employees will not need to make any investment decisions while they are saving, or at or during retirement. The target benefit will also give employees a better idea of the income they might expect to receive when they retire, making it easier for them to plan for the future. 
• Secondly, CDC schemes will pool contributions and investment returns and risk between the members. This means the schemes' trustees can invest in growth assets over the longer term. In contrast, insurers providing annuities to DC savers are required to invest in low-risk assets, and employees retiring from standard DC schemes may be encouraged to de-risk as they approach retirement.

In this way, CDC schemes could be more attractive to employees than a DC scheme. There would be no need for them to take investment decisions and they could have more certainty as to the benefits available on retirement. For employers, that increase in certainty could help them to better manage retirements and succession planning in the workplace. In addition, the greater investment flexibility available to CDC schemes is expected to mean that they will benefit from higher returns and also from opportunities to invest in longer-term assets, such as renewable energy and infrastructure investments.

What are the drawbacks?

Clear and plain-English member communications will be vital. Although CDC schemes will target a particular benefit and increases (for example, the Royal Mail plan targets a career average inflation-linked pension in retirement plus a lump sum), neither the rate of pension nor the pre- or post-retirement increases are guaranteed. This means that, in times of market turmoil, lower or zero increases may be awarded. It also means that in extreme circumstances it may be necessary to reduce benefits, including pensions in payment, to ensure the scheme's solvency and avoid cross subsidy between members.  Members will need to understand that, although benefits are expected to be higher overall than in a DC scheme, the pensions they receive will remain subject to such adjustments. They do not offer the same certainty as annuities or a DB pension.

Who might be interested in CDC?

Until CDC master trusts are available on a commercial basis to non-connected employers, CDC schemes are likely to remain the preserve of larger employers, partly to ensure adequate pooling of risk and partly because they will be expensive to establish.  The standard application fee for authorisation is £77,000 and there would also be legal and actuarial costs in connection with documenting and designing the scheme.

However, large, UK wide employers (particularly those who, like Royal Mail, have at least two thousand employees), who are looking for an option that could combine the best of DC and DB without the DB funding risk, might wish to explore establishing a CDC scheme.

The Pension Regulator's guidance and code of practice provide more detail on the criteria for authorisation of a CDC scheme.

If you would like to discuss this further, please contact Claire Rankin or another member of the Osborne Clarke pensions team.