Will risk-sharing schemes ever take off in the UK?

How CDC works

The concept behind CDC is compelling, at least in theory: members should get a higher benefit than they would do from a conventional DC plan, but an employer’s exposure is capped.  

However, as critics have pointed out:

• CDC schemes need a critical mass of members from day one, which is hard to achieve in the UK;

• the CDC benefit structure is complex and difficult to communicate;

• intergenerational unfairness is difficult to avoid;

• administering a CDC scheme involves significant and costly actuarial, investment management and accounting input.  

Supporters believe the higher benefits provided under a CDC scheme mean the option is still worth pursuing, but the greater focus on governance and restrictions on charges due to the introduction of auto-enrolment, as well as the new Budget flexibilities, means the economies of scale and other advantages may have been overstated.

CDC schemes, for example those in the Netherlands and Canada, have been able to offer economies of scale to members because they are organised at an industry level and participation is often mandatory. 

The response to the question in the title might appear to be ‘no’ - but in fact is a qualified ‘yes’

However, some scale is now being achieved in the UK DC pensions market as a result of auto-enrolment – specifically in the mastertrust environment – and increasing legislative pressure on costs and charges means conventional DC schemes are beginning to offer greater administrative and governance cost-savings, and lower investment fees. 

The other key advantage of CDC over traditional DC schemes has been that members do not have to annuitise at retirement and the investment strategy leading up to retirement does not need to be as conservative. 

These features contribute significantly to improving the pension outcomes members can expect under a CDC scheme. 

Again, however, the new Budget flexibilities mean these advantages will become options in the UK DC pension market too. 

In view of this, the rationale for going down a Dutch-type CDC route in the UK starts to seem less compelling.

Other risk-sharing models

The government’s public consultation ‘Reshaping workplace pensions for future generations’, the precursor to the bill, outlines four other types of shared-risk scheme: a money-back guarantee, capital and investment return guarantee, retirement income insurance and a pension income builder. 

Commentators have questioned whether the benefits offered by capital or investment-return guarantees will outweigh the impact on investment returns. 

They have also argued these types of guarantees encourage ‘reckless conservatism’. The government does not think the market will offer a money-back guarantee, nor retirement income insurance, at least in the short to medium term, and it sees scale as being an issue with the pension income builder model. 

This model also needs an entity willing to stand as guarantee provider, and providers have not, at least publicly, been enthusiastic about the concept. 

In view of the lack of compelling reasons for going down the Dutch-style CDC route and the negative response to the government’s other proposals for risk-sharing, the response to the question in the title might appear to be ‘no’ – but in fact is a qualified ‘yes’.  

The bill is an important first step in facilitating the transition from a traditional defined benefit or DC pensions market to one that can offer something in-between. 

The government’s intention is to provide a less prescriptive legal and regulatory framework that will allow the market to evolve and innovate. 

Assuming it achieves its aim, and as much of the detail is contained in regulations that have not been issued at the date of writing, it seems likely that shared-risk products in some shape or form will start to take off in the UK.

Not least because the target market – both employers and pension savers – have a real need for better retirement saving options.

Nicola Rondel is of counsel at law firm Hogan Lovells