Collective pension’s conflict with flexibility

Collective defined contribution (CDC) pension schemes was set out in the Queens Speech. Picture: Getty

The proposed creation of collective defined contribution (CDC) pension schemes was set out in the Queen’s Speech, which also included the recent Budget proposals to give savers greater access to their pensions.

But while the latter offers people more freedom with their pension pots, CDCs may have the opposite effect by reducing flexibility for savers and leaving some trapped in underperforming funds.

The idea behind CDCs is, on the face of it, simple. The argument is that pooling member contributions into one huge pension pot creates economies of scale that lower costs and boost returns.

The pot of member contributions is invested in a single, uniform investment strategy and the income paid out at retirement comes directly from the pooled fund (as in final-salary schemes), rather than the individual’s pension pot.

Savers are given a target retirement income, although that level isn’t guaranteed. Instead, the actual amount received is calculated in a similar way to with-profits, where “smoothing” is used to hold back reserves in the good times to bolster payouts when returns aren’t so good.

CDCs are commonplace in the Netherlands and Scandinavia, where they pool member contributions across industry sectors rather than individual organisations. The coalition government hopes they will give workers in the UK a middle ground between final-salary schemes, which are rapidly dying out in the private sector, and defined contribution schemes.

But the timing of the move has been heavily criticised. It comes less than two years after the launch of automatic enrolment, through which some ten million people will be paying into a workplace pension for the first time.

“It will depend on the appetite of other stakeholders, pension providers and employers, who are still addressing auto-enrolment and may want their arrangements to settle before launching in a new direction,” said Glynn Jones, divisional director for group savings and investments at LEBC.

It also follows quickly on the heels of reforms outlined in the Budget aimed at giving savers more freedom with their pension cash from next April.

“The CDC approach offers greater certainty of a more predictable pension in retirement,” said Jones. “However, it does seem at odds with the complete freedom and flexibility announced in the budget.”

That flexibility may not be available to members of CDCs.

Karen Theobald, principal at Buck Consultants in Edinburgh, said: “Since one of the prerequisites for the success of the CDC model is that the member funds are held for as long as possible by the scheme and invested on a collective basis, there is a tension between CDC and the Treasury’s Budget proposals to allow members broader access to their funds in retirement.”

There are concerns too over a recent increase in the number of CDC schemes in the Netherlands cutting payouts for members as they tackle funding shortfalls. Research by Deloitte has revealed that 55 out of 415 Dutch funds reduced their income last year.

Tony Clare, pensions advisory partner at the firm, said: “Many Dutch pensioners have experienced falling pensions and standards of living as a consequence. Once a scheme member retires, the options to rebuild pension savings become more limited.”

And Theobald warned that CDCs may now be outdated.

“In today’s world, where individual flexible retirement strategies are becoming more prevalent, the ability of a CDC scheme to cope and still deliver the expected improved returns over conventional DC schemes will be further tested.”