The Work and Pensions Committee has begun an inquiry into collective defined contribution schemes, but experts remain unconvinced of European-style risk-sharing, highlighting intergenerational and moral hazard risks.
Primary legislation for CDC schemes was passed in 2015, during Steve Webb’s tenure as pensions minister. Webb lost his parliamentary seat in that year’s general election, and plans to pursue CDC were shelved just a few months later.
A form of defined ambition schemes, CDC schemes set a target payout based on a long-term, mixed risk investment plan. Unlike defined benefit schemes, the target represents an ambition of the scheme, and is not contractually guaranteed.
The Netherlands, Canada and Denmark have all adopted CDC schemes. CDC has come under the scope of politicians and industry experts in the UK, but schemes are currently unavailable to savers.
People who govern an underfunded DB scheme could engineer a further decline in its funding position just so that they could then convert it to CDC
Matthew Giles, Squire Patton Boggs
Chair of the select committee Frank Field said: “What the select committee is aiming for is to retain some of the best features of company schemes in a different age when employers are no longer willing or able to sustain the burden of final salary promises to employees, who could instead club together and pool the risk themselves.”
CDC would lead to intergenerational transfers
The Netherlands is often viewed as a gold standard for pensions provision by the UK, but the perceived success of CDC in the Netherlands may have been somewhat overstated.
Jens van Egmond, DC manager at fiduciary manager Cardano, said CDC was not implemented in the Netherlands in the way it “is often described in the UK, because it would lead to all sorts of intergenerational transfers that would upset every generation, as everybody would be convinced they are losing out”.
He described such potential issues as “a direct consequence of making promises about risk sharing that cannot be kept”.
Van Egmond said while intergenerational transfers can never be completely eliminated, the strength of De Nederlandsche Bank, the Dutch regulator, provides for an effective system of checks and balances. For example, the regulator has the power to fire trustees. Trustees must also balance member interests or face litigation from members.
Are we past the point of no return?
The inquiry into CDC schemes was a surprise inclusion in the Work and Pensions Committee’s agenda.
Hugh Nolan, president of the Society of Pension Professionals and director at consultancy Spence & Partners, thinks that the UK’s journey from DB to DC schemes is sufficiently far along that “it’s hard to imagine any employer moving back towards taking on more risk themselves”.
The incentives for retaining pure DC schemes, against a push towards a collective approach to risk, also apply to members, according to Nolan. He said they were broadly unwilling to sacrifice autonomy and subsidise others through shared arrangements.
“The idea of members giving up the personal control they have over their own pots, and the freedom of choice they get from that, into some idea of shared risking” is unlikely to gain traction in the UK, he said.
“If people aren’t prepared to accept that there are winners and losers in those sorts of joint contracts, then collective DC is absolutely dead in the water,” he added.
CDC could still replace DB
Matthew Giles, partner at law firm Squire Patton Boggs, attributed the 2015 halt in legislation for DA to a shift in focus towards pension freedoms and a lack of demand among employers.
Giles echoed Nolan’s belief that employers providing DC schemes are unlikely to consider adopting CDC. He said that DB providers, however, may offer a market for CDC.
The committee will examine the conversion of converting “seriously underfunded” DB schemes into CDC.
Field: Members should have first claim on assets
Work and Pensions Committee chair Frank Field wants pension scheme members to have first claim on any assets from bankrupt sponsors, a debate on scrapping limited liability, and hopes to start an independent action group to support trustees.
But Giles was unconvinced, saying converting DB to CDC “is an absolute legal minefield, because that is removing the guarantees that are embedded in legislation. Every set of pension laws in the land from DB schemes will mirror the legislation in saying that you can’t take away accrued rights to DB entitlements”.
He warned that allowing sponsors of underfunded DB schemes to convert this to CDC poses a moral hazard risk.
“People who govern an underfunded DB scheme could engineer a further decline in its funding position just so that they could then convert it to CDC,” he said.
