UK: Collective Defined Contribution Schemes: A Fresh Alternative?

The government has given the green light to a new form of defined contribution pension scheme.  At least, it is new to the UK.  "Collective defined contribution" ("CDC") schemes are common in the Netherlands and Denmark but the idea of introducing this type of scheme into the UK has only relatively recently gained traction.  The fact that the Royal Mail wants to put such a scheme in place for its 140,000-strong workforce has provided the impetus for the government to consult on how CDC schemes would operate and be regulated.

CDC schemes are likely to be good news for employers.  Like individual DC schemes, the employer pays fixed contributions and does not bear the risk of any shortfall in expected benefits.  But, all other things being equal, members are expected to get higher pensions with less risk than they would from an individual DC scheme.

A CDC scheme calculates a target level of pension for the member, which is not guaranteed, based on the value of the scheme's assets.  In retirement, the member receives a pension directly from the scheme.  Members are not faced with the choice between buying an annuity or keeping their pot invested and taking income drawdown (although members will be able to take a transfer out of a CDC scheme if they want to do that).

Investing collectively spreads investment and longevity risk across the membership and allows the effect of market movements to be smoothed over time.  The idea is that a CDC scheme can invest more efficiently than an individual member can, in assets that can generate higher returns and have a longer time horizon.  It also means that, whereas, in an individual DC scheme, a dip in the value of a member's pot has a direct impact the amount of the pension, a CDC scheme cushions the member from that effect.

So, you might ask, where is the catch?  For members, an important point to note is that there are no guaranteed pension increases.  Pensions for all members (whether in payment or not) are adjusted (up or down) depending on the investment performance of the scheme's assets.  The government envisages that actuarial valuations will be carried out each year to determine those adjustments.

The possibility of a reduction, rather than an increase, is a feature that will  be unfamiliar to members and will need to be carefully communicated.  More broadly, there are a number of risk warnings the government intends to require members to be given, to make sure they are aware of how a CDC scheme operates.  These include statements to the effect that the projected benefits are not guaranteed, that the pension may be reduced (and the potential scale of variability) and the fact that the risks are borne by the members collectively, rather than the employer.

The government's priority is to bring forward legislation to get the Royal Mail scheme up and running, after which it will then move on to facilitate CDC schemes generally, both for individual employers and groups of associated employers.

Visit us at mayerbrown.com

Mayer Brown is a global legal services provider comprising legal practices that are separate entities (the "Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP and Mayer Brown Europe – Brussels LLP, both limited liability partnerships established in Illinois USA; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales (authorized and regulated by the Solicitors Regulation Authority and registered in England and Wales number OC 303359); Mayer Brown, a SELAS established in France; Mayer Brown JSM, a Hong Kong partnership and its associated entities in Asia; and Tauil & Chequer Advogados, a Brazilian law partnership with which Mayer Brown is associated. "Mayer Brown" and the Mayer Brown logo are the trademarks of the Mayer Brown Practices in their respective jurisdictions.

© Copyright 2019. The Mayer Brown Practices. All rights reserved.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.