- Collective defined contribution (CDC) schemes might be an alternative to defined benefit schemes
- In a CDC scheme, the actuary is asked what rate of pensions members can reasonably expect to receive
- CDC schemes are widely used in the Netherlands, Denmark and certain parts of Canada
Furthermore, at a collective level trustees acting on behalf of members can have access to investment and actuarial advice and opportunities that would not be available in a cost effective form to individual members acting on their own behalf.
Squaring the circle
CDC is an attempt to square that circle. It offers members access to the benefits of a trust structure where fiduciaries act on their behalf in taking investment decisions and working out the rate at which pensions for life can be paid from the trust assets on the basis of pooled investment and mortality risk. At the same time it makes it clear that employers are responsible only for paying their agreed rate of contributions and are not exposing their business to the future risk of unexpected deficit repair obligations if the assumptions used to calculate the benefits provided from the plan turn out to have been over-optimistic.
A CDC scheme would do this by turning on its head the question it asks of its scheme actuary. Traditional defined benefit schemes ask their actuary what rate of contributions is needed to provide their member population with their promised pensions. The answer drives the employer contribution obligation.
The idea with a CDC scheme would be that the scheme asks its actuary what rate of pensions members can reasonably expect to receive given the rate of contributions promised to the scheme. The answer drives the rate at which pensions are paid. From an employer funding perspective it would remain a DC scheme.
However, its day-to-day operation would probably have more in common with a current DB scheme. In particular, rather than each member investing his own individual retirement account and then using that account to purchase an individual annuity or other retirement product, investment would – as with current defined benefit schemes – be on a collective and centrally-determined basis across the scheme membership. The emerging pensions would be provided from the funds of the scheme rather than through an individual annuity.
This poses challenges: in particular, getting people in the UK accustomed to a new form of pension arrangement where pension amounts are only targets rather than being guaranteed entitlements, and where pensions might reduce once in payment.
Looking abroad
