In the slow-moving world of pensions, the week commencing October 7 2024 was a big week.
On the Monday, we saw the launch of the Royal Mail collective defined contribution scheme, and the very next day, the Department of Work and Pensions published their consultation on multi-employer schemes.
For CDC to move beyond an opportunity that is reserved for a relatively small number of very large employers, to a mass market pension design widely available in the UK, this legislation is key.
First, to take a step back: CDC pension schemes have been around in various guises in other parts of the world but, are a new feature in the UK. In essence they are a means of pooling risk between a group of members, in order to deliver more value than an individual investor alone.
Our analysis indicated that a whole-of-life CDC scheme might not only offer 20 per cent more income but also income security for life, relative to a typical defined contribution scheme with an income drawdown strategy in retirement.
Bridging the gap between DC and defined benefit pensions, contributions are fixed and members build up a secure pension, the value of which can fluctuate based on the performance of the scheme.
Similar to a DB pension, actuaries review the scheme and determine the level of pension benefit members accrue. Unlike DB schemes, as the performance soars or tanks, pension benefits are adjusted rather than the cost of contributions.
There are three main types of future CDC schemes covered by the regulations:
- Single-employer CDC – for Royal Mail and other employers large enough, and so minded, to operate a scheme solely for their workforce.
- A sector-specific scheme – in industries that have a large number of similar employers, like areas of transport or the care industry, with a scheme potentially operating on a non-commercial basis.
- Commercial CDC schemes set up to take a wide range of different employers for profit, much like the DC master trusts do today.
All three of these are whole-of-life CDC schemes. Decumulation-only CDC schemes are not yet in scope, but the DWP have asked for input from providers who are interested in offering these. That is likely to be the biggest area of crossover between the workplace pension and the retail savings market.
Multi-employer schemes bring CDC within practical reach of typical companies through the scale benefits of investment purchasing power and lower administration costs, along with the pooling of longevity risk.
This means employers with potentially very different membership characteristics, contribution structures and life expectancies must coexist within the same scheme section. This is essential but brings the potential for deliberate and inadvertent cross-subsidies between employers and groups of members.
Rightly, there is less tolerance for these cross-subsidies compared to those in a single-employer scheme.
The draft legislation acknowledges this challenge and sets a surprisingly high bar for demonstrating fairness in scheme design.
Actuarial equivalence and scheme design
To maintain a sense of fairness, the draft rules require prospective schemes to satisfy a number of tests:
- Benefits must be expected to rise with inflation, so members maintain purchasing power over time (before and after retirement).
- There shouldn’t be cross-subsidies between employers.
- There should either be no cross-subsidy between members, or if there is, each members’ benefits must at least match the value of their contributions.
The principle of actuarial equivalence is intended to eliminate cross-subsidies between employers. But what might those cross-subsidies look like and how can they be prevented?
Life expectancy – a key challenge
How long people can expect to live depends on factors such as sex, health, lifestyle, and affluence. One size does not fit all. Analysis from leading longevity data analysts, Club Vita, indicates that the difference in life expectancy for today’s retirees can be as much as 10 years.
