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Collective defined contribution schemes are soon to be created in the UK, but how do they compare with CDC schemes in other markets?
Regulations for single-employer CDC schemes are set to come into force from August, with Royal Mail so far being the only employer who has said it will offer the new type of scheme. The Pensions Regulator responded last week to a consultation on its proposed code of practice for the authorisation and supervision of CDC schemes.
CDC schemes could offer a middle ground between the current DC and DB systems, the Pensions Policy Institute has said, “providing members with greater certainty about the retirement outcomes they will achieve than would be possible in a DC scheme, while providing greater certainty about costs for employers than a DB scheme”.
Can choice and CDC go together?
In its latest briefing note, the PPI highlighted a number of key differences between the UK pensions landscape and CDC schemes in three other countries where they are already in use: the Netherlands, Canada and Denmark.
For example, UK CDC schemes will exist in the private pensions sector, whereas the same schemes in Canada are state‐sponsored. CDC schemes in Denmark feature in both the state and private pensions, and the same products in the Netherlands are part of the private pension system, meaning the Dutch model of CDC is the closest to the UK, although there are still some differences between the two.
Crucially, participation in UK CDC schemes will be voluntary, whereas participation is mandatory in the other three countries CDC depends on mass and a steady stream of new joiners, arguably making it more suited to mandatory systems.
“This means it is even more important that schemes establish trust, transparency and fairness between different groups of workers, in order to ensure that opt outs and transfers out of the scheme do not threaten the scale and sustainability of the scheme over the long term,” said the PPI.
Intergenerational fairness a key challenge
The institute said one key challenge within CDC scheme design is to ensure risks are fairly distributed between generations. It noted buffers or capital reserves in other countries can be a significant source of intergenerational inequality, as the generations that built up the buffer may be different from the ones that benefit from it. UK schemes will not have buffers, instead using frequent benefit adjustments to rebalance funding ratios on an annual basis.
The PPI said: “While this approach is likely to lead to greater volatility year‐on‐year, it is also likely to mean there is less cross‐subsidy from younger to older members, and therefore less propensity towards intergenerational unfairness.”
When setting valuations and benefit adjustments, the briefing note highlighted the need for clear communication and engagement to ensure members understand the nature of their income entitlement and the possibility that this could be reduced under some circumstances.
While changes in contribution rates can be used to improve funding in international CDC schemes, UK CDC schemes will use only benefit adjustments, with a key focus on ensuring contributions are defined and stable.
What lessons on CDC can the UK learn from other countries?