- The Pension Schemes Act 2021 (the PSA 2021) establishes the legal framework for collective defined contribution (CDC) schemes. More detail will be forthcoming in secondary legislation and regulatory guidance.
- CDC schemes are shared risk schemes in which risks are shared between all of the members of the scheme.
- CDC schemes do not carry additional risks for employers – employers’ liabilities under CDC schemes are limited to the contributions they make in respect of members (as in a traditional defined contribution (DC) scheme).
- The first CDC scheme is likely to be the one established by the Royal Mail. At this stage, it isn’t clear whether any other employers will follow. One key factor will be whether regulations are made that allow unassociated multi-employer mastertrusts to provide CDC schemes.
What are collective defined contribution schemes?
The PSA 2021 establishes the framework for a new kind of pension scheme – the collective defined contribution (CDC) scheme.
CDC schemes share the most important features of individual DC schemes – like DC schemes, the benefits of each member will depend on:
- how much money is in the member’s fund (which will depend on the amount of contributions made in respect of that member and the investment performance of the fund); and
- the expected cost of providing the pension benefit (which will depend on when the member takes a pension, life expectancies, etc.)
The key difference in a CDC scheme is that while a member of a DC scheme has to bear all the risks of providing the pension themselves – particularly around investment and longevity – in a CDC scheme these risks are pooled. The promise of CDC is that by sharing those risks, members would receive a substantially greater income in retirement than they would from a CDC scheme. This approach has received some support from modelling carried out by some of the UK’s actuarial consultancies.
Crucially, the risks are shared among the members but not with the employers. The liability of employers to contribute to a CDC scheme is therefore limited (broadly to the regular contributions they agree to make in respect of each employee). Employers participating in CDC schemes will, therefore, not have any unexpected deficits to manage in the future or have to deal with fluctuating pension costs.
The drive to get CDC legislation into the PSA 2021 came from Royal Mail and its employees (through their union, the CWU): establishing a CDC scheme was the solution to an industrial dispute between them. Both Royal Mail and the CWU have been keen to establish the agreed scheme. We can therefore expect at least one CDC scheme to be up and running in around a year.
Although the PSA 2021 establishes the framework for CDC schemes, a lot of detail still needs to be filled in through secondary legislation. One aspect that will be closely watched is whether regulations will permit unassociated multi-employer mastertrusts to provide CDC schemes.
What does this mean for trustees?
For trustees of existing schemes, CDC schemes will not have a major immediate impact – the legislation is specific to the new separate CDC schemes.
In the longer term though, trustees of schemes with members still accruing DB benefits may find employers looking at CDC as an alternative provision. And for trustees of DC schemes, if CDC schemes deliver on their promise, the pensions they deliver will be highly relevant to what good outcomes look like.
What does this mean for employers?
Employers with open DB schemes may want to consider whether a CDC scheme would be an attractive alternative (and whether all employees could be offered membership). There is likely to be less interest from employers who currently only offer DC benefits but, again, if CDC schemes are successful they may form part of what a good benefits package looks like.
At present, the PSA 2021 only allows a single employer or a connected group of employers to participate in a particular CDC scheme. This means that, initially at least, there is likely to be a minimum size of employer for whom setting up a CDC scheme will be feasible. Going forward, the success of CDC may well depend on whether smaller employers are able to participate in CDC schemes provided by mastertrusts and other pension providers.