As well as introducing new powers for The Pensions Regulator, the Pension Schemes Act 2021 introduced a framework for a completely new type of occupational pension scheme in the UK: collective money purchase/DC schemes, commonly referred to as “CDC” schemes. Similar forms of CDC scheme already exist in the Netherlands, Denmark and Germany, but would be a marked change in how pensions are provided by employers in the UK. Royal Mail is expected to be the pioneer in developing and implementing a CDC scheme.
Whilst much of the detail remains to be confirmed in future regulations, in this Law-Now we’ll take a look at the idea, what these schemes will look like and how they will be funded, authorised and taxed. We would also like to encourage you to take part in the Royal Society for Arts’ CDC survey which is aiming to gather views on what CDC could offer in the UK. You can access the survey by clicking here.
A new idea
The idea behind a CDC scheme is that whilst members are building up benefits the contributions are defined – like a normal DC scheme. However, by pooling assets and liabilities the scheme offers members a target defined benefit which is paid from the scheme when the member retires. This should result in a smoothing of market volatility.
Unlike a standard DB pension scheme the defined benefit is not guaranteed – it is just a target – and members can receive lower benefits if the funding level does not support the target. The key point from an employer’s perspective is that it has no funding obligation other than for the defined contributions and any expenses it agrees to pay. From a member’s perspective, CDC might be simpler than DC – as no choices about investment or retirement provision will need to be made.
Experience in other countries, as well as the history of our own pensions industry, emphasises the importance of two key elements in a CDC scheme: communication and transparency. Members need to understand that the benefit is only a target. They also need to be able to see clearly how benefits are calculated each year, and how they are adjusted year to year to reflect the scheme’s funding level.
One current restriction for CDC schemes is that they need to be an occupational pension scheme in which only connected employers participate – so not a master trust for unconnected employers. Given the costs to set up a new CDC scheme, meet running costs and gain authorisation from TPR it seems likely that multi-employer CDC schemes will need to be permitted in order for CDC to become a success. This would allow groups of unconnected employers to participate in the same CDC scheme, making CDC schemes more accessible to employers with small to medium workforces.
Another area of potential for CDC schemes is as a post retirement vehicle. CDC offers a possible middle ground between a guaranteed annuity, where the guarantee comes at a material cost to the member, and drawdown where the member has to carefully manage their investments and their withdrawals so that they do not run out of money. CDC offers the prospect of higher income than an annuity and a less stressful financial retirement than drawdown, provided members are willing to accept that there are winners and losers when mortality risk is shared and that there are no guarantees.
Authorisation and funding
A CDC scheme must be authorised by TPR before it can be operated. Whilst we don’t have the detail for the authorisation process yet, the key requirements for authorisation are set out in the Act and, unsurprisingly, are similar to the requirements under the DC master trust authorisation regime.
Following an application for authorisation TPR will have six months to make a decision and will need to consider a number of factors including the following requirements:
Fit and proper persons: founders, trustees and those with power to remove and appoint trustees must be fit and proper.
Sound scheme design: trustees will need to prepare a “viability report” and obtain scheme actuary certification.
Financial sustainability: the scheme must have sufficient financial resources to meet the costs of setting up and running the scheme, including being able to run the scheme on for up to 2 years following a “triggering event”.
Adequate systems and processes for communicating with members: as the benefit structure is completely new there is going to be a focus on ensuring that members of CDC schemes understand the target nature of the benefits.
Effective operation: which will need to cover IT systems and risk management processes.
Continuity strategy: a plan for how members’ interests will be looked after if a “triggering event” occurs.
Trustees will need to obtain actuarial valuations at one-year intervals. The big difference between the funding of CDC and DB pension schemes is that, in a CDC scheme, if a valuation shows that it is underfunded, it is the benefits which are to be adjusted. There is no obligation on the employer or the members to top up the funding if the CDC scheme is underfunded, as increases to pensions and other benefits are not guaranteed (but will depend on the funding of the scheme).
In addition to authorising CDC schemes, TPR will gain a range of new powers in relation to them including:
Directing trustees to obtain an actuarial valuation or to adjust benefits in accordance with their scheme rules.
Issuing risk notices to trustees where TPR is concerned that they may breach the authorisation criteria.
Requiring notification of “significant events” affecting the scheme.
The Act contains a list of “triggering events” which result in various consequences for CDC schemes. Examples include the insolvency of an employer, the start of wind-up for the scheme and a notice from TPR that it is withdrawing authorisation.
Where a triggering event occurs, trustees are required to pursue one of the following three continuity options and to produce an implementation strategy to be approved by TPR. In some cases, for example if authorisation is withdrawn, there is no choice and the trustees must follow the first option:
Discharge the liabilities by transferring the value of members’ rights to another scheme (including a DC master trust) or securing those rights with an insurer and then winding-up the scheme.
Resolving the triggering event, in which case the trustees must notify TPR that it is satisfied with that resolution.
Conversion to a closed scheme.
RSA CDC Forum
CMS is a founding member of the Royal Society for Arts’ CDC Forum which is researching support in the market for CDC schemes, including multi-employer schemes and the use of CDC schemes as a post retirement pension vehicle. If the research shows there is sufficient market interest, it will help encourage the government to remove some of the current restrictions.
The Royal Society for Arts’ is currently conducting a survey across the pensions industry, asking participants what they know about CDC pensions, whether it is of any interest to them, and if so in what form. The survey takes 5 to 10 minutes to complete and will close on 31st May 2021. You can access the survey by clicking here.