EMPLOYER ACTION CODE: MONITOR
Based on responses to its recent consultation on so-called collective defined contribution (CDC) plans, the U.K. government intends to proceed with legislation to allow employers to introduce tax-qualified CDC plans “as soon as Parliamentary time allows.”
In the proposed CDC design, fixed rates of employer and/or employee contributions are paid to a collective pension fund, which in turn provides members with pension benefits, the amounts of which depend mainly on the asset returns and member longevity. Employers have no financial responsibility to contribute beyond their fixed contribution. Unlike a traditional defined contribution plan, there are no individual member accounts. However, the professional investment management of a CDC fund and risk-pooling between members should support more consistent exposure to return-seeking assets so that the plan can aim to generate higher member pensions than from insured annuity purchase via a traditional DC plan. The pooling of longevity experience means that, unlike under DC drawdown, retirement income should be more evenly spread over an individual’s retirement no matter how long he or she lives.
Similar pension designs have been introduced in recent years in Belgium, parts of Canada, Denmark, Germany and Japan and are also currently being investigated in other countries.
Features of the proposed CDC plans include:
- CDC plans would provide pensions for a member’s retired life, as well as a contingent spouse’s pensions. There would be no guaranteed benefits.
- Initially, only single or associated employers could establish their own CDC plans; however, the government intends to legislate "in a way that can quickly accommodate other models of CDC,” including master trusts or other multiemployer solutions and potentially decumulation-only vehicles so that DC pots can be used to buy a CDC pension as an alternative to drawdown or annuities.
- CDC would be an option for employer provision of pensions only for future service. No changes would be allowed to accrued pension benefits (except possibly if members choose to transfer-in past service benefits from another plan).
- CDC plans would not rely on employer covenant, and so would not be eligible for the Pension Protection Fund.
- Members' pension increase (or decrease) levels would vary each year based on annual actuarial valuations.
- Unlike Dutch CDC plans, the annual valuations would usually be carried out on a “best estimate” basis, with no deliberate prudence or optimism in the assumptions; however, risk capital buffers would not be banned.
- The annual pension adjustment (increase or decrease) would need to be applied uniformly across the entire membership (active, deferred and pensioner members).
- Employers would require individual authorization by the Pensions Regulator before they can open a CDC plan. The application would include actuarial projections of benefit levels.
Our Client Briefings provide a fuller discussion of the CDC plan proposals (here) and the government’s consultation response (here).
The legislative process is expected to start in mid-2019, to enable the introduction of plans from 2020. The Royal Mail (140,000 U.K. employees), with the agreement of the Communication Workers Union, has publicly committed to provide a CDC plan if the legislation in enacted. Employers should evaluate the suitability of CDC for their situation (including potential accounting treatment), based on the combination of defined contribution risk characteristics from the employer’s perspective and potentially superior benefit forms and outcomes for members. Among U.K. companies surveyed by Willis Towers Watson, one in eight expect that their organizations will adopt a CDC design by 2025. More polling information is available here.