Industry is divided over Royal Mail's CDC proposal

The proposal, which would also include an element of defined benefit pension provision in the end package and an interim cash balance scheme, brings closer the end of a long-running and bitter dispute over the proposed closure of Royal Mail’s existing DB scheme.

But will the DWP forge ahead with the regulations, and could CDC be the compromise between the expense of DB and the member risk involved in DC?

The push for CDC comes as MPs on the Work and Pensions Select Committee call for evidence on the benefits of defined ambition arrangements. The inquiry has even raised the possibility that failing DB schemes could change their contract to CDC.

There are intergenerational and inter-member exchanges, that’s the whole purpose of risk sharing... whether you view that as fair depends on which side of the trade you’re on

Ralph Frank, Cardano

Royal Mail and the CWU entered into mediation in October after union members voted in favour of strike action.

While the mediator’s report is not legally binding on either side, CWU deputy general secretary Terry Pullinger told members it was “a real pleasure” to be able to update them on the progress of the talks. Royal Mail are also understood to be happy with the pensions proposals.

The report suggests that “Royal Mail and the CWU should commit in principle to the future introduction of a collective defined contribution scheme with a defined benefit element”.

It also recommends the creation of a pensions forum for the postal business and its employees, which would be responsible for lobbying government to set the secondary legislation needed to support CDC.

In the interim period, existing members of the company’s DB plan and members of the DC arrangement with more than five years of continuous service should be enrolled in a cash balance scheme. These arrangements promise a defined lump sum at retirement, effectively guaranteeing a minimum rate of return.

DWP urged to revisit CDC

Primary legislation recognising defined ambition schemes, a term for non-DB shared risk arrangements that includes CDC, was laid in the Pensions Act 2014 by then pensions minister Steve Webb.

However, supporting regulations to govern the management of such schemes were never drafted, with Webb losing his seat in the 2015 general election.

The report's suggestion falls short of the target career average scheme originally proposed by the CWU, referred to as a wage in retirement scheme.

However, Henry Tapper, business development director at consultancy First Actuarial, which helped the union develop the scheme, says he nonetheless hopes the government would press on with writing regulations.

“Sure there are huge issues, but what we know about this is that the Royal Mail like it, the CWU like it and the workers like it… it’s hard to see why the regulator wouldn’t like it,” he says.

Government will not budge yet

Despite pressure building from Royal Mail, the CWU and the Work and Pensions Select Committee to move forward on CDC, the DWP is not disclosing any immediate plans to do so.

“This is a matter for Royal Mail to negotiate with its pension scheme members on, but we are monitoring the situation,” a spokesperson says.

Any government reaction will also be watched keenly by university staff and their union, which has balloted members on industrial action over the proposed closure of the Universities Superannuation Scheme to DB accrual.

Universities UK’s offer of a replacement DC scheme has been called “appalling” by the University and College Union. But if the employer remains equally stubborn to the academics’ preferred choice of a smaller DB benefit, a middle way may have to be found.

Michael Otsuka, a professor of philosophy at the London School of Economics and a pensions officer for the university’s UCU branch, stresses his preference for a DB solution.

But he adds: “Having regulations for CDC provides a cost free way for the government to make it possible, in a way which is not too costly for employers, for employees to reap the benefits involved in risk pooling.”

What does CDC achieve?

A pure CDC arrangement aims to pay a retirement income to members at a target level, but those payments are not guaranteed.

When a scheme’s assets perform better than expectations, the scheme would hold back some excess returns, to smooth any down-rating of pensions brought about by poor asset performance.

By paying pensions from the scheme, members are able to retain some exposure to risk assets and growth in retirement.

Under the proposal for Royal Mail, members would be able to transfer out under freedom and choice in a similar way to cash equivalent transfer values from DB schemes, although they may receive less than 100 per cent of their asset share.

Tapper warns that actuaries would have to be more responsible with their predictions than at the inception of with-profits funds, which were set up to achieve a similar smooth pattern of returns but initially over-promised to members.

Critics of CDC abound

However, others are less optimistic about the proposals. John Lawson, head of retirement solutions policy at insurer Aviva, says: “Unfortunately it all relies on some element of predicting the future and the problem is that nobody can predict the future.”

With-profits funds have now got around this problem by deliberately underpromising throughout the life of the investment, and topping up the member’s fund size at retirement with a terminal bonus, according to Lawson.

The same philosophy applied to CDC pensions might produce a small pension with a large top-up near the end of the member’s life, rendering later life planning extremely difficult.

Proponents of CDC have often argued that the design could generate significantly higher pensions for members, by keeping members invested in risk assets through retirement. Liabilities could be discounted on expected returns, rather than the gilts regime currently used by much of the DB world.

However, Wilse Graveland, head of pensions solutions at Dutch firm Kempen Capital Management, says regulation has evolved around CDC in the Netherlands so that schemes that take more risk in their portfolios must also hold a larger buffer against a deficit opening up.

The generation game

But the fundamental problem the Dutch pensions industry has encountered with CDC is one of intergenerational unfairness.

If a scheme overestimates the amount its assets will return, it must adjust its liabilities, by cutting its pensions promise to some or all members.

“To me that’s a fundamental unfairness, that if you overpromise to one cohort of people you effectively underdeliver to another cohort,” says Lawson.

Ralph Frank, head of UK DC at Cardano, takes a different view: “There are intergenerational and inter-member exchanges, that’s the whole purpose of risk-sharing... whether you view that as fair depends on which side of the trade you’re on.”

Tapper agrees that this transfer is fundamental to risk-sharing, but says a fairer criticism is that in the event of scheme closure, the last generation would be left to pick up the bill for any overestimates.

Is CIDC the answer?

Intergenerational issues have led the Netherlands, a region that is often praised as having one of the best pensions economies in the world, to re-examine its commitment to CDC.

Instead, it is considering collective individual-defined contribution. This works in the same way as CDC, but derisks members approaching retirement along a glide path, as happens in normal DC.

“Everything is collective, only there is a lifecycle in place so that the return for a young person is different than for an older person,” says Graveland.

This retains risk-sharing between generations, but reduces the transfers between generations. Graveland says this does not sacrifice overall returns.

A solution must be found

Whatever the method, support for a new type of pension provision in the UK is significant.

“It’s really exciting,” says Sarah Swift, a pensions partner at law firm Eversheds Sutherland. “It would be a new type of vehicle, which to my mind has a lot going for it, because employers can’t afford DB… and DC just doesn’t give you enough.”

Whether the government succumbs to the pressure or not is a different question. With Brexit taking up the majority of parliamentary time, Swift says: “It would probably be a brave government that takes this forward... brave in the sense of wanting to do something different and creative.”