We have noticed an uptick in interest in collective defined contribution or ( CDC) pension schemes in recent months, perhaps in part because the ongoing "war for talent" means offering something more than a basic DC scheme could be a real differentiator for employers.
The government has also indicated that multi-employer CDC schemes will be permitted in due course, which may result in a CDC option being offered by master trust providers in time.
What is a CDC scheme and why might it be a good thing to offer?
CDC schemes are occupational pension schemes in which the funds available to provide benefits are derived from investment return on employer and member contributions, and in which the contributions payable are at a defined rate. The scheme would aim to provide benefits to members at a specified level, but if for example poor investment return meant a lower level of funding in the scheme, benefits could be cut back. There would be no recourse to employers for more funding (as is the case for defined benefit schemes). If benefits are reduced in one year, they could be reinstated to their normal level in a subsequent year if the scheme's funding level recovers. It could also be possible for the scheme to provide a higher rate of benefits in "good" years, although there would be no guarantees that this would happen.
The assets of a CDC scheme would be pooled and invested by the trustee, without the members needing to select investment options, and enabling the trustee to take advantage of economies of scale and potentially lower investment fees.
The key advantages of this sort of arrangement are certainty for the employer, who will never have to pay more than their pre-agreed contribution rate, just like in a traditional DC scheme, and a degree of certainty for the member. As noted above, if the scheme is underfunded, it is the members who will pay for this by reduction to their benefits, but the scheme is designed to "smooth" outcomes. This should avoid the situation where a cohort of members are significantly worse off due to the timing of their retirement or an investment switch.
What is the downside?
There are complexities in running a scheme of this type. In particular, the trustee will be heavily reliant on the actuary modelling the scheme's assets, investment returns and cashflows accurately so that outcomes can be "smoothed" and the scheme can pay intended benefits to the greatest extent possible.
For this reason, legislation governing the creation of CDC schemes, set out in the Pension Schemes Act 2021, requires any CDC scheme being set up to become authorised by the Pensions Regulator. The Regulator has now published a draft Code of Practice covering the processes to be followed by schemes applying for authorisation. Under this process any new CDC scheme will be required to demonstrate that it is run by people with appropriate skills and experience and that systems and processes are adequate, for example. As with any authorisation process, there will be a fee payable to the Regulator and also costs associated with ensuring and demonstrating compliance.
Looking forward
At present, the legislation, as reflected in the draft Code, is that a CDC scheme cannot be set up for non-associated employers – ie employers who are not in the same corporate group. This would prevent master trusts from adding CDC as a benefit structure, but we understand that it is proposed this will change in the coming year. This will allow even quite small employers to offer CDC to their employees, and an opportunity to differentiate themselves from competing employers in the market. Whether employers take up the opportunity remains to be seen, but we expect to see more employers and scheme providers considering with their advisers whether CDC might be suitable for them.
