On the go: Collective defined contribution schemes in the UK are still facing some key challenges that could benefit from further research, such as intergenerational issues and communication policies, according to the Pensions Policy Institute.
In a briefing note published on June 14, PPI’s senior policy researcher Lauren Wilkinson explored insights from countries with established CDC systems in place — the Netherlands, Canada and Denmark — pointing out what ”lessons can be learnt” prior to a full-scale system being put in place in the UK.
Wilkinson stated the differing routes CDC schemes have taken internationally, with the Dutch schemes being reliant on buffers to “satisfy strict rules for certainty of benefits”.
The Danish schemes “split contributions between guaranteed and ancillary benefits”, while Canadian schemes focus on “clearly predefined rules for responsive actions to changes in funding position”.
The UK CDC legislation focuses on “regular and universal adjustments”. From this, Wilkinson predicted that “clear communication of scheme rules with members” will need to be an important component of scheme management, due to the “variable nature of the schemes”.
In order to prepare members for possible fluctuations, Wilkinson recommended “well-communicated, pre-set rules”, seemingly to follow in Canada’s footsteps.
Wilkinson also cited the Dutch CDC reform, expected to come into force in January 2023, as a possible path to follow.
In this case, members are presented with three different scenarios for their pension entitlement: an expected scenario, an optimistic scenario and a pessimistic scenario, in order to enable better understanding among members.
Wilkinson highlighted issues of intergenerational unfairness arising from CDC schemes in the Netherlands, which have opted for a “smooth returns” model to absorb financial shocks and protect members from poor outcomes.
This includes smoothing transfer subsidies from the generations who experience financial markets that generate better returns to those who have had worse returns, thus spreading the wealth so as to omit outliers in cohorts, she explained.
Yet the horizon of smoothing depends in which country the scheme is — with the Dutch scheme starting from 10 years, and 75 or 100 years for Canadian schemes.
Wilkinson noted that “the shorter the horizon, the lower the scheme’s capability of absorbing shocks, but the more stable the scheme’s funding level”.
UK schemes will not use buffers, and therefore cannot have a reserve in times of economic crisis. Wilkinson said this approach will “lead to greater volatility year on year than the Dutch system”.
However, no funding buffers and universal adjustments are likely to mean there is less cross-subsidy between different age groups, meaning there is less scope for a sense of intergenerational unfairness, she added.
For the Netherlands, Canada and Denmark, membership in the CDC schemes is mandatory, while in the UK members have the ability to opt-out or transfer out.
Wilkinson noted that the voluntary nature of membership in the UK could present a potential threat in regard to scale and sustainability.
However, “automatic-enrolment is likely to mitigate this to some extent”, but this feature could present issues when there is economic downturn as more may be opting out.
Pension transfers have to be facilitated in CDC schemes due to the introduction of pension freedoms 2015, but the calculations of cash equivalent transfer values might “present challenges for scheme design”.
Wilkinson advised that schemes would have to “incorporate demand for transfers out into their funding and strategy approaches”.
