With collective defined contribution (CDC) pensions introduced in the Queen’s Speech, Tom Jackman from the pensions team at our British member firm Sackers, is interviewed about the practical challenges associated with CDC schemes in the UK.

1. CDC pensions--a new pensions A-lister?
Publication Date: 17 June 2014 | Author(s): Tom Jackman Member Firm(s): Sacker & Partners
LLP (Pensions) Countries: Netherlands, United Kingdom
Analysis
Original news
Collective pension schemes to be introduced in UK, LNB News 02/06/2014 22
Daily Telegraph, 2 June 2014: Pensions minister Steve Webb has announced plans to offer Dutch
style collective pension schemes--he has said the plans will be included in the Queen's speech
this Wednesday. Collective pension schemes would allow savers to put cash into collective pots
which Webb says would provide greater value for money.
What exactly is a CDC scheme and how does it differ from other group schemes currently
available in the UK?
A CDC scheme is a bit like an A-list celebrity--it doesn't have an exact definition, but those in the
know will recognise it when they see it.
CDC schemes typically aim to provide a benefit that looks and feels like something from a defined
benefit (DB) scheme (eg a career average 'CARE' style benefit, based on building blocks of
pension for each year of pension saving) but without the absolute benefit promise associated with
a traditional DB scheme. This means that the employer's costs can be fixed, so from the
employer's perspective a CDC scheme need not be any riskier or more expensive than a
traditional defined contribution (DC) scheme.
The risk that there is ultimately not enough money to fund the target benefits is borne by the
members. However, whereas in a conventional DC scheme the funding risk is borne by each
member individually, in a CDC scheme the contributions are invested collectively and the risks are
shared between the members.
The risk sharing is usually achieved by carrying out regular valuations and reducing the target
benefits if the funding position falls below a certain level. The target benefits can be 'topped up'
again if the funding position recovers. Perhaps the most well-known example of this is 'conditional
indexation', where the revaluation of past service benefits can be withheld unless there are
sufficient funds in the scheme.
What does the government seek to achieve by allowing this type of scheme?
The government wants better outcomes for members. Higher retirement incomes mean that
pensioners have more money to put into the economy, pay more tax and are less likely to rely on
means-tested benefits.
With DB pensions seen as unaffordable by most employers, CDC aims to provide the same

2. certainty of cost for the employer as a conventional DC arrangement, but with better outcomes for
members.
What can we learn from other jurisdictions' experience of CDC?
The Dutch model is probably the best developed and is a helpful example because the Dutch
pensions system as a whole is more readily comparable to the UK's than a lot of other
jurisdictions. But even in the Netherlands, CDC is still in its infancy. I think it's too early to draw firm
conclusions about its overall success, but we can learn from the implementation and reception of
CDC in the Netherlands.
Dutch CDC schemes are typically industry-wide and are compulsory for employees. That has
proved controversial. The risk-sharing and level contribution rates means that younger employees
are arguably being forced to subsidise their older colleagues. That may come to make more sense
when members spend their entire working life in a CDC scheme, but for the time being it is
somewhat anomalous and particularly unpopular against the background of economic austerity.
It is also important to keep in mind that the majority of Dutch employers were operating a form of
DB scheme prior to moving to CDC, and the decision to move to CDC rather than traditional DC
was due, in part at least, to significant pressure from the Dutch unions. That is in contrast to the
UK, where the majority of private sector employers have already made the move to DC, and where
the unions are generally less influential.
What are the legal and regulatory obstacles to implementing CDC schemes in the UK?
The UK would need to make a number of technical changes to facilitate CDC. Conditional
indexation is a good example--you would need to disapply some of the existing preservation
legislation (which provides minimum levels of revaluation for the deferred benefits of early leavers
from a pension scheme), but you would also need a new framework to make sure it works properly
and fairly.
It might be a bit of a bumpy ride, but if a particular model for CDC is well-defined, I think that the
government could work with the industry to meet whatever technical challenges it might pose. The
practical challenges may present more significant problems.
What are the practical challenges associated with CDC schemes in the UK?
CDC relies on risk-sharing and economies of scale. So in theory it is at its most effective when lots
of members participate in the same CDC scheme. Put simply, employers need to offer them (on as
large a scale as possible) and members need to join them and stay in them.
If the government is trying to persuade employers to offer CDC now, its timing couldn't be much
worse. The public sector is allegedly committed to CARE for 25 years, while private sector
employers are implementing auto-enrolment (almost exclusively with DC arrangements). It is hard
to imagine that employers will want to fundamentally revisit their pension arrangements again so
soon after auto-enrolment (and communicating auto-enrolment to their workforce) when there is no
obvious benefit for the employer.
If employers do offer CDC, would it be on a sufficiently large scale? Because employer costs are

3. fixed, there is no reason in principle why UK employers shouldn't participate in the sorts of
industry-wide schemes which are common in other European jurisdictions, but again it isn't clear
that UK employers have any incentive to make the shift to bigger schemes.
In theory, the better outcomes expected from CDC schemes should attract members to join them
and perhaps even be a factor in recruitment and retention (thereby providing an incentive for
employers to offer them after all). However, given current levels of public engagement and
understanding, that seems somewhat optimistic.
If CDC schemes are used as auto-enrolment vehicles, getting employees to join is straightforward,
but persuading them to stay in could be more difficult. The concept of reducing benefits is alien to
the UK system with and its protection of 'accrued rights', so reducing benefits below target levels
could prove very controversial. The fear is that members could start to lose faith in CDC if benefit
targets are reduced, even if the reduced targets are far better than what they could expect to get
from an individual DC arrangement. If members leave in large numbers, the risk-sharing could
quickly fall apart.
If the government were truly convinced that CDC offered the best way forward, it could compel
members to stay in the scheme, but that really would be a sea change for UK labour relations
where principles of individual choice and freedom have dominated over the more collectivist,
paternalistic approach still prevalent in much of Europe since the 1980s.
How might the introduction of CDC affect the UK pensions market?
CDC does have the potential to change the landscape quite significantly. If taken up on a large
scale, we could see:
o industry-wide schemes
o different investment strategies to those of individual DC arrangements
o features such as conditional indexation becoming the norm and, most importantly
o better member outcomes at an acceptable cost to employers
But if CDC isn't taken up on a large scale, it could be an obscure backwater which doesn't really
impact on the big picture. Other models already exist in the UK, such as cash balance, which
bridge the gap between DB and DC but these haven't proved popular with employers.
What should pensions lawyers do next?
For now, it's 'wait and see'.
If the government is serious about CDC, the first challenge will be to establish the legal and
regulatory framework. Pensions lawyers, together with actuaries, investment consultants and
others in the industry, would need to have significant input into that process to help ensure that it
will work at the practical level.
Of course, advising clients on CDC schemes could be one of the main areas of work for years to
come if it is taken up on a large scale. But that is an awfully big 'if'.

4. This article was first published on Lexis®Library on 2 June 2014.
Taken from the Ius Laboris Knowledge Base: www.globalhrlaw.com
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