More unions eye CDC as possible negotiation outcome

The idea of exploring the potential of collective defined contribution, the pensions system Royal Mail and the Communication Workers Union agreed to develop in a dispute resolution, was rejected by university staff in March, despite their trade union having agreed to the proposal.

But with last week’s announcement that the benefit design is now under government consultation and legislation promised for December 2019, other trade unions are now eyeing CDC as a possible alternative to pure defined contribution when closure of defined benefit schemes is unavoidable.

It’s a potential win-win, because certainly from the employer’s point of view it’s no different from DC

Neil Walsh, Prospect

Minister for pensions and financial inclusion Guy Opperman argued that with one out of every 190 people in the UK working for Royal Mail, and confidence that others would follow suit, “it matters so much that we ensure that we give you a proper future”.

Members of Prospect have recently passed a motion requiring their trade union to investigate the merits and drawbacks of CDC, while policy officers at Unite the Union and GMB say they see CDC as offering inherently better protection.

Union support could mean CDC becomes a significant part of the UK pensions landscape, despite the government’s own consultation admitting that few employers are interested in setting up new schemes.

CDC could improve DC outcomes

CDC schemes involve fixed contributions from members and employers, and would be defined as money purchase benefits under the government’s proposals, which experts said would mitigate the risk of employers being asked for more cash in the future.

They also aim to pay an income for life through the same collective insurance principle as DB schemes or annuities, although the level of income is not fixed.

With private sector DB provision “falling off a cliff edge”, Prospect pensions officer Neil Walsh said members had asked the union to investigate whether CDC could offer any extra protection against poverty in retirement.

“It’s a potential win-win, because certainly from the employer’s point of view it’s no different from DC,” he said. Prospect’s study had been scheduled for early 2019, but Walsh said the government’s legislative timetable could push this back.

A sceptic when ‘defined ambition’ was originally tabled by former pensions minister Steve Webb, Walsh did add that the union’s primary focus will be on increasing employer contributions – which may be more difficult if it demands the setup of a new scheme as well.

Unions will not roll over on DB demands

Neither will unions let employers downgrade from DB to CDC, which by design offers less protections for members, without a fight.

“Our policy is to keep defined benefit schemes open for existing members and new members in all circumstances. We’re of the opinion that DB schemes are affordable and continue to be affordable,” said George Georgiou, national pensions organiser for the GMB.

“If we are not going to keep a DB scheme open then we will look at DC schemes, and CDC by definition does provide greater security,” he continued. Georgiou dismissed criticism of cross-subsidies in CDC as missing the point of a collective insurance solution.

Unite has also couched its support for CDC in criticism of the state of play in DB. A spokesperson said the best estimate actuarial methodology envisaged by the government combined with economies of scale mean “CDC scheme’s will have the ability to invest a higher proportion of members’ funds for longer periods in return-seeking assets and should allow a targeted member outcome to be delivered”.

“The irony is that this was once the investment approach of defined benefit schemes,” the spokesperson added.

Royal Mail is yet to publish plans for its CDC scheme. But early indications are that the government, which has been in contact with shadow pensions minister Jack Dromey on the development of CDC, has support across the political spectrum.

CWU deputy general secretary Terry Pullinger said wages in retirement are needed “if ordinary working people are going to have dignity in retirement”, while Tory peer and executive chair of the Resolution Foundation David Willetts said CDC reduces the risk of exposure to “the ups and downs of investments” and “the uncertainty of how long each of us will live”.

Master trusts see potential

The government’s own consultation admits that few employers have shown interest in developing similar schemes so far, and experts say only the most paternalistic would upgrade their existing DC schemes.

But the benefit design may prove attractive to large providers in the DC sector, offering a third way between what are perceived to be poor-value annuities and drawdown products that offer no protection against living too long.

Despite savers consistently saying in surveys that they favour guaranteed income, in practice they have favoured cash and drawdown since the introduction of freedom and choice in 2015.

Darren Philp, head of policy at master trust Smart Pension, said that while pot sizes are currently small in master trusts, members could find CDC useful if it is communicated to them in language they understand.

“Master trusts will certainly be looking at this going forward; we certainly will be at Smart,” he said.

With-profits still haunts industry

However, Philp said a key challenge would be ensuring strong governance, given the accusations of “over-promising and under-delivering” associated with the similar concept of with-profits funds launched in the 90s.

The positive of this approach is that it ensures any outperformance or underperformance should be shared equitably among the membership

Tom Selby, AJ Bell

It is these governance issues that have some in the pensions industry deeply concerned about the development of CDC.

“The [consultation] is very broad brush, with no ‘detailed nuts and bolts’. Coupled with the need for primary legislation, if CDC happens at all, it won’t happen anytime soon,” said John Ralfe, independent pensions consultant.

“The [Department for Work and Pensions] rightly highlights the structural cross-subsidy from younger to older members in the Royal Mail proposal – part of the younger members’ pension savings is effectively used to pay the pensions of older members,” he continued. “Even if this flaw is explained very carefully to Royal Mail employees the DWP still leaves itself open to future mis-selling claims.”

DWP sidesteps Dutch pitfalls

The DWP consultation has taken steps to address this. Launching the consultation, Opperman stressed the importance of members understanding that CDC benefits are not guaranteed.

The government’s consultation makes clear that investment underperformance will be countered by an immediate reduction in benefit promises to all members, rather than by a financial buffer.

Funding surpluses, as employed by Dutch CDC schemes, reduce the likelihood of cutting pensions in payment, but rebuilding buffers after the financial crisis led to accusations of intergenerational unfairness.

“With the financial crisis they had to service those buffers and the impact of that affected younger people more than older people,” a DWP spokesperson explained.

The spokesperson said market shocks could often be absorbed by tweaking inflation protection in one year for all members, rather than cutting benefits.

“The immediate impact of changes are in almost all circumstances going to be relatively small,” they said.

Key challenge is communication

Tom Selby, senior analyst at platform provider AJ Bell, said the government’s proposed approach showed that the potential for backlash over intergenerational unfairness was at the front of ministers’ minds.

“The positive of this approach is that it ensures any outperformance or underperformance should be shared equitably among the membership,” he said. “Clearly the downside is that a level of predictability in delivering retirement outcomes will be lost if members potentially face revaluations both while saving and in retirement.”

The complexity of this ‘soft promise’ leaves “one very big problem to be resolved”, according to Chris Wagstaff, head of pensions and investment education at Columbia Threadneedle Investments: “How to communicate to members the rather complicated mechanics of benefit increases and reductions inherent in CDC”.

If that can be overcome, he said CDC could reduce “many of the various risks people face in individual DC plans, both in accumulation and decumulation post freedom and choice”.