Select committee hails CDC as 'new Beveridge' for UK pensions

Recommendations in the report include the proposal that CDC should be administered by trusts and overseen by the Pensions Regulator, and that schemes should be required to report annually on their funding position and approach to benefit calculation.

The committee also called on the Department for Work and Pensions to consult on preserving intergenerational fairness in CDC, how transferring out will work, and the possibility of requiring CDC trustees to gain qualifications.

The report follows an agreement in 2017 between Royal Mail and the Communication Workers Union to begin designing a collective scheme, in which members are paid a flexible pension for life, and share investment and longevity risk.

You will not only give people a higher pension, you will give them a more predictable one

David Pitt-Watson, London Business School

The additional risk sharing between generations has led some to claim that CDC can deliver pensions of 30 per cent or more higher, at least when compared with the purchase of a pension for life via an annuity. The Royal Society of Arts, Government Actuary's Department and Aon have all found significant upticks in income, though large swaths of the industry remain unconvinced.

Pointing to these studies, Frank Field, chair of the select committee, said the benefit design could bridge the gap between inadequate defined contribution and defined benefit, which has proved costly for many employers.

“CDC gives companies the option of offering good pensions to their staff without the risk of large long-term pension liabilities on their balance sheets, and gives staff the welcome prospect of a regular income in retirement, managed collectively on behalf of all members,” he said.

Field said the industry was facing a moment of opportunity “to combine decades of individual pension ownership and provision with collective security”, akin to the spirit of the Beveridge Report, which famously influenced the creation of the welfare state.

CDC aims for predictability

Both Royal Mail and the CWU welcomed the report’s release. CDC schemes cannot be run legally until the department makes some changes to legislation, and Pensions Expert understands that the collaboration will not finalise details of the structure until government’s course of action is clear.

David Pitt-Watson, an executive fellow at the London Business School who also leads the RSA's work on CDC, welcomed the tone of the report, which recognises both the potential benefits of CDC and the associated risks that need to be managed.

He said the DWP would have to think carefully about how to ensure that different generations get fair treatment during times of poor investment returns – as befell Dutch CDC schemes following the financial crisis – but argued that the benefits would outweigh the cuts that would have to be applied.

"If you've already got a pension that's 30 per cent higher and someone reduces it by 2 per cent, that's still quite a lot better," he said."The evidence would say that if you can manage that, you will not only give people a higher pension, you will give them a more predictable one."

Michael Johnson, a research fellow at the Centre for Policy Studies, has disputed claims of an uplift provided by defined ambition.

“There is no evidence to support it,” he said. “The sources of uplift are to do with economies of scale and lengthening the investment horizon.”

How would closure affect CDC pensions?

The investment horizon is theoretically longer in a CDC scheme because members do not need to be derisked towards the purchase of a retirement product, while the volatility associated with remaining in risk assets can be smoothed by the cross-subsidy between generations.

However, Johnson said this is dependent on a steady influx of younger members, which cannot be guaranteed for many companies, including Royal Mail.

“We can’t make any assumptions about the size of the workforce remaining static. It’s more than likely to contract in the future,” he said.

While Pitt-Watson conceded that remaining members in a closed CDC scheme may be best served by an annuity purchase, he disputed the assertion that younger generations would ever be immiserated by their subsidy of older savers in a well-regulated environment.

"This isn't something where you're ever paying out more than you think you can afford," he said.

Demand still looks weak

The select committee report argues that as one of a range of options available to savers, CDC schemes are entirely compatible with freedom and choice. But the introduction of freedom and choice may in fact have lessened the demand for such products, according to Maria Nazarova-Doyle, head of DC investment consulting at JLT Employee Benefits.

“There was a potential investment case for these collective schemes when the UK used to have quasi-mandatory annuitisation,” she said. “However, with freedom and choice came multi-asset solutions that allow members to stay invested while drawing down income, which dramatically reduced the investment case for CDC.”

Neither did Nazarova-Doyle predict any substantial appetite from employers for CDC, given that in most cases companies have already abandoned a collective solution in DB, and have put time and resource into DC driven by auto-enrolment.

“Adoption of CDC would in many employers’ minds be a backward step and therefore I struggle to see wide-ranging support from UK businesses for this solution,” she said. “Even the DWP themselves have been quoted previously stating there is no queue of employers outside Caxton House waiting for CDC.”