Why TPT is exploring CDC

In a world where defined benefit (DB) pensions are increasingly scarce and onerous to run, defined contribution (DC) retirement choices are often difficult for members to understand.

The traditional choice under a DC offering is to take your pension as a lump sum, draw down income over time, or purchase an annuity. Members often struggle with this complex and life-changing decision as well as how those contributions are invested before benefits are paid.

DB schemes are widely recognised as the ‘gold dust’ of private sector pensions as they typically offer members a guaranteed inflation-linked pension for life. However, they are rarely offered due to the financial guarantees that employers are required to provide.

While DC schemes pose less risk for employers, they are not expected to provide members with the same income for life offered under DB schemes.

Is there a solution that leverages the benefits of both? This is where collective defined contribution (CDC) schemes can make a difference, operating as a hybrid solution which can bridge the gap between DB and DC schemes.

What is a Collective Defined Contribution scheme?

There are two distinct types of CDC scheme, whole of life CDC and decumulation CDC. A whole of life CDC scheme covers both the accumulation (building up benefits) and decumulation (paying benefits) phases of a retirement proposition. In these schemes, contributions from employers and members are fixed rates and pooled into a collective fund (like DB). By pooling risk, these schemes are expected to generate higher returns than an individual DC scheme resulting in higher expected benefits.

In contrast, a decumulation-only CDC product is typically chosen by a DC member at retirement. These propositions have the potential to be cheaper than annuities, but still offer members a retirement income for the rest of their life. The key difference between this and annuities is that with a CDC decumulation product, retirees would not receive guaranteed annual increases – they would instead receive a variable rate of income based on investment and life expectancy performance of the scheme.

As it stands, the route forward for the introduction of whole of life CDC is clear and has garnered attention after the first CDC proposition, the Royal Mail Scheme, was approved by The Pensions Regulator earlier this year in April. Further, draft regulations on multi-employer whole of life schemes are widely expected in the coming months as the government has been consulting on how to roll out the implementation of these schemes.

Why CDCs can act as a hybrid mid-ground solution for employers

A whole of life CDC scheme will likely provide better expected outcomes for members compared to DC alternatives for the same cost. This could enable firms to differentiate themselves by offering a CDC scheme to attract and retain talent. 

A CDC scheme is much less burdensome for employers compared with a DB scheme. Firms can still offer their employees a generous pension, but it doesn’t require the open-ended sponsor guarantee. Therefore, CDC could be particularly beneficial to DB employers, as it removes the open-ended commitment. 

Some closed DB schemes may have remained open to new members if the potential cost to employers was less volatile. We envisage the benefits that whole-of-life CDCs bring may encourage employers that have closed DB schemes to make the switch to CDC.

Potential challenges

However, as with all things, there may be a few teething problems with CDCs. One clear temporary challenge at the onset is gauging if there is appetite to achieve sufficient volume of employers and members to make both the pooling and the scheme operation finances viable.

CDC schemes could contribute to intergenerational inequality as members have to pool longevity and investment risk. Younger scheme members may feel they are unfairly subsiding the pensions of older members and effectively penalised for having their contributions invested for longer. Therefore, it is important younger members receive a higher benefit in the CDC scheme structure.

TPT’s CDC journey

To mitigate some of these teething challenges, TPT engaged with several employers about CDC schemes, notably through a series of roundtable discussions we hosted this year.

We are now assessing which sectors CDC fits with best, in terms of member and employer profiles, and we will be engaging with more employers in the new year.

We think communication with both members and employers is key to reassure members that the industry is keen to renumerate members fairly for their pension contributions.

Our focus is on a multi-employer, whole of life CDC proposition, but we are not opposed to providing a decumulation-only CDC proposition in the future. 

Regulations on CDC multi-employer schemes, set to be published in early 2024, will likely provide a bright spot for the nascent industry, through greater regulatory clarity. It is clear that a CDC benefit structure, currently a pipe dream for many schemes and employers, has the potential to become a reality through more thoughtful consideration next year, potentially revamping the retirement coffers of many in the near future.

Andy O’Regan is employer and strategic partnerships director at TPT Retirement Solutions