Draft CDC regulations hampered by poor definitions, industry warns

In a CDC scheme, contribution rates for employers and employees are set in advance, and members pool investment and longevity risk. These pension funds provide income in retirement, though the rate of increase varies and pension reductions are possible in certain circumstances.

In his foreword to the Department for Work and Pensions consultation, which closed on Tuesday, pensions minister Guy Opperman explained that CDC schemes have long been seen “as a third way between traditional final salary schemes that are guaranteed by employers, and individual defined contribution schemes where investment and longevity risks are born by the individual members”. 

Collective money purchase schemes will still not be available to the majority of the population. We encourage DWP to continue their good work by enabling collective money purchase schemes for multi-employer schemes and as an alternative option at retirement for all individuals

Fred Emden, SPP

CDC schemes have greater potential than DC to invest in illiquid assets such as infrastructure, and “recent studies have shown that a well-designed and well-run CDC scheme can also be resilient to sudden changes in market conditions, such as we have seen during the current pandemic”, he continued.

At present, the government is focusing purely on CDC schemes set up for single employers or connected employers, a fact Tim Middleton, director of policy and external affairs at the Pensions Management Institute, told Pensions Expert would mean initial demand for these schemes would be limited.

In its response, the PLSA questioned whether there will be much enthusiasm for CDC among the potential candidates in scope.

“We have previously commented that it is not clear that there is demand from employers to provide such schemes, particularly as many have already invested heavily in high-quality individual DC provision,” it said.

It added, however, that “some of our master trust and multi-employer scheme members are keen to see the next phase of collective money purchase regulations, which the minister has indicated will cover industry-wide schemes, multi-employer schemes for unconnected employers, and the development of collective money purchase schemes for decumulation purposes only”.

This is an opinion shared by the Society of Pension Professionals. Fred Emden, the trade body’s chief executive, wrote in its consultation response: “Collective money purchase schemes will still not be available to the majority of the population. We encourage DWP to continue their good work by enabling collective money purchase schemes for multi-employer schemes and as an alternative option at retirement for all individuals.”

Vague definitions could create ‘back door’ for unscrupulous employers

Though broadly supportive of the regulations, industry respondents highlighted a number of areas where greater clarity will be needed in the regulations if the CDC rollout is to be a success.

The PLSA highlighted feedback from its members criticising the fact that maximum application fees for prospective CDC schemes are twice the expected level, which it argued could slow the growth of the sector.

It also raised concerns about the definition to qualify as a CDC scheme in the first place, which it said “appears at first glance to be quite loose” and would require a “careful and attentive authorisation review”.

“For example, some DB schemes have scheme rules that enable them to reduce benefits when the scheme is in deficit and an unscrupulous sponsoring employer may be tempted to do so by self-declaring their pension to be a collective money purchase scheme,” it said. 

“If the scheme was no longer receiving contributions, technically authorisation might not be required. Thus a ‘back door’ could be opened to avoidance of section 75, TPR moral hazard powers, and the reduction of member benefits without recourse.”

What is ‘soundness’?

Both the PLSA and the SPP criticised the loose definition of “soundness” with respect to scheme design.

In its consultation, the DWP acknowledged that what constitutes “sound” could be open to interpretation, and set out a list of indicators to which a scheme actuary would have to have regard before certifying a CDC scheme as such.

The DWP explained that these indicators fall into three categories: those considered at initial application and during live running; “gateway tests” considered at application only; and those considered at subsequent annual reviews, known as “live running” tests.

Where these indicators are not met, the actuary should not certify the CDC scheme and should bring the failures to the attention of trustees. 

No such indicators exist for determining whether a CDC scheme should be wound up rather than closed to future accrual, as the DWP said it wanted to avoid “inappropriate or overly sensitive triggers that would require a scheme to wind up where it is still able to provide better or comparable benefit levels compared with what might be secured elsewhere, even if those benefits are significantly less than those originally aspired to”.

The PLSA, however, called for the definition of “soundness” to be refined, as currently it is open to interpretation, a “vaguery” the SPP said would confuse both actuaries and trustees.

CDC regulations ‘asking too much’ of actuaries

In its response, the SPP argued that the proposed regulations are “asking too much” of actuaries, whose work should instead be “entirely actuarial in nature”.

For example, in their existing form, regulations governing CDC schemes will require that actuaries “have regard to whether the scheme rules meet certain legislative requirements regarding the calculation of benefits”, which the SPP pointed out is “a legal matter”, and the actuary “will have to rely on advice from the scheme’s lawyers”. 

The draft regulations also require the actuary to consider whether certain matters have been “accurately communicated” to members, despite member communication being “a specialist area” with which an actuary might not be all that familiar; while requirements around “accuracy” might compel the inclusion of information “not conducive to member understanding”, the SPP added.