Collective defined contribution schemes could become a popular alternative to annuities if their risks can be contained, according to the Pensions Regulator and Financial Conduct Authority.
Speaking at a Work and Pensions Committee hearing this morning, David Fairs, executive director at The Pensions Regulator, said CDC schemes had many advantages over defined contribution schemes and in future could be rolled out to multiple employers and master trusts, hence become the new pension product of choice for many.
CDCs are a half-way house between defined benefit and defined contribution schemes. They allow savers to pool their money into a single fund which pays annual pension income. Pension increases vary depending on the funding level, but the schemes are expected to yield higher pensions for the members than traditional DC annuities.
So far legislation has been established to facilitate CDC schemes for the Royal Mail and other single employers who want to introduce the schemes but not multi-employers.
The committee asked the two regulators if it was a realistic possibility, and what additional risks there would be, if they were to be provided to multiple employers by master trusts.
David Fairs, executive director at The Pensions Regulator, said: “CDC schemes have a great advantage that they pull that longevity risk and they give you a predictable amount of pension for as long as you live. That's one advantage.
"The other is that the investment decisions that are made, particularly in the retirement phase, are being made by trustees who potentially are more open to risk than individuals.
We and DWP are very much thinking of the progression from single employer to multi employer to master trust providing CDCs, but there are different risks that I think we need to think through very carefully before we open the doors to master trusts using those vehicles.Fairs“CDC does deal with those things. The legislation that is in place is there to facilitate CDC schemes for single employers. We then need to look at the steps that we need to take for multi employers, learning from our experience of having authorised single employer CDC schemes.”
He outlined the challenge with defined contribution was that most people do not know how long they are going to live and so there is a concern they may run out of money before they die.
However, Fairs said in actual fact, studies in Australia and America showed the opposite, where quite frequently individuals were so worried they will run out of money that they did not spend enough of their retirement pot.
Fairs said there was a sense that people have turned their backs on annuities over high costs and a feeling of lost control.
“Quite often in surveys you read that what people actually want is predictable income, and I think they probably want predictable income with a degree of flexibility, which is what a CDC scheme is potentially able to offer,” he said.
However, he cautioned the schemes did present different risks with master trusts as a drawdown vehicle, because there is not a guarantee of an income, only an indication of the amount a saver will get.
“We would have to understand that actually the offers that master trusts were making to individuals or to employers were financially sustainable.
An annuity is more of a sort of cast iron guarantee of a payout, so it would be important with CDCs, when they're introduced, that consumers understand the difference between a CDC and an annuity.Pritchard"Obviously if master trusts are competing against each other, you want to know that actually there is a realistic prospect that the pensions they say that they're paying are actually going to be delivered, because ultimately the risk is borne by the members of the CDC scheme if those promises are not delivered.
“So we and DWP are very much thinking of the progression from single employer to multi employer to master trust providing CDCs, but there are different risks that I think we need to think through very carefully before we open the doors to master trusts using those vehicles.”
Regulating CDCs
Sarah Pritchard, executive director of markets at the FCA, said it was important that consumers understand what a CDC is.
She said: “There are many advantages with the CDC for all the reasons in terms of sharing risk and enabling a longer term view on pooled investment and managing the uncertainties around life expectancy and the decisions that individuals have to make, but it is slightly different to an annuity.
“It's a target pension, there is some risk there. An annuity is more of a sort of cast iron guarantee of a payout, so it would be important with CDCs, when they're introduced, that consumers understand the difference between a CDC and an annuity, albeit there were clearly some advantages there for individuals in comparison to the decisions that they need to make themselves on their own DC pensions.”
Pritchard explained the FCA thought it more likely that the first extension of CDC may be to have a look at the operation of CDCs in the master trust environment.
“If the FCA was to regulate CDCs that would require legislative change and for government to determine that there will be use in introducing CDCs in the context of individual personal pensions, which are pensions that we regulate,” she said.
Earlier this year, the government's consultation on rules for CDC schemes was received as a welcome step forward, but experts cautioned that initial demand was likely to be low due to restrictive conditions and high costs.
The Pension Schemes Act 2021 provided the legislative framework required to establish and operate CDC schemes, reviving a concept first proposed in 2015.
sonia.rach@ft.com
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