Government begins CDC pension consultation

The Department for Work and Pensions (DWP) is consulting on proposals for collective defined contribution (CDC) pension schemes, first outlined at Budget 2018, which allow contributions to be pooled and invested to give members a target benefit level

Royal Mail has established the first such scheme in the UK and the work and pensions select committee has urged the government to consider this option in the light of the risks of underfunding of pensions by companies and individuals.

The consultation seeks to set out DWP’s thinking about CDC pension schemes, and the legislative and regulatory regime that would be needed to support any such scheme. It does not include draft legislation.

DWP says its proposed framework would closely mirror Royal Mail’s initiative and the company will be releasing more details of scheme design during the consultation phase for discussion.

In a CDC scheme, financial contributions are invested in a collective fund. In outline, a particular member’s pension is calculated by estimating how much money is needed to provide the target level of benefits to each member.

if the assets available are higher or lower than the estimated money required to meet target benefits for all members, then the scheme will make corresponding adjustments to the current payment of benefits to each pensioner member and the prospective pensions payable to active and deferred members.  In addition, the future target level of benefits is adjusted so that the total value of benefits is equal to the total value of assets.

The collective nature of a CDC scheme, and the way it adjusts the level of pensions and prospective pensions, should mean that the overall membership will enjoy an element of cushioning from volatility as investment risk is adjusted for over time and longevity risk is pooled across the membership. Because the fund is administered and managed on a collective basis, there is also no need for members to make choices about the investment of funds or the ways of converting that fund into an income stream in retirement.

Communication

In the consultation, DWP points out that an important principle of CDC schemes is that the benefit level offered can only ever be a target or an estimate. It is not guaranteed by the employer and members will need to recognise from the outset that the benefit levels aspired to may not be achieved and that the level at which pensions are paid or prospectively payable may go down, while the rate at which benefits are uprated each year will be subject to a degree of uncertainty.

While legislation will need to be clear that there is no obligation on employers to meet shortfalls in funding, the way CDC schemes work will pose ‘a significant member communication challenge’, DWP underlines.

The consultation also highlights the issues around cross-subsidisation, which are a feature of CDC schemes, saying it is important that attention is given to the way in which the potential for differential impact on different generations or groups of members is communicated to the membership.

Money purchase

As part of discussions with Royal Mail about setting up a CDC, the government has already concluded that the Pensions Schemes Act 2015 cannot be amended to allow for such schemes, and fresh primary and secondary legislation is needed to deliver an appropriate legislative and regulatory framework.

These new provisions will make clear that CDC benefits are a type of money purchase benefit, to provide clarity for members and establishing employers of CDC schemes, as well as providing for the necessary supporting regulatory framework.

The initial framework is intended to facilitate provision by single or associated private sector employers who wish to consider alternative pension provision options following appropriate consultation with their workforce and trade unions where relevant. The legislation will therefore initially restrict CDC benefit provision to such schemes.

Where appropriate, detailed provisions related to valuation, adjustment of benefits, transfers, wind up, disclosure and other technical requirements will be provided through secondary legislation. DWP says this will allow greater flexibility to adapt the legislation as needed as these schemes become more established in the UK or if issues emerge once the initial tranche of schemes are in operation.

As a consequence of CDC benefits being a type of money purchase benefit, the Pension Protection Fund would not be expected to pay compensation in respect of CDC benefits should the employer become insolvent.

CDC schemes are required to be occupational trust-based pension schemes with their main place of administration in the UK. They will also need to be registered with HMRC for tax purposes, and be authorised by The Pensions Regulator (TPR) before they can receive contributions.

 CDC schemes would need to undertake annual actuarial valuations in order to determine whether benefit adjustments up or down are required, and specify principles that will apply to those valuations.

DWP says given the complexity of CDC schemes compared to individual defined contribution schemes, they will be required to appoint a scheme actuary. Changes to tax legislation may be needed for CDC schemes to receive equivalent tax treatment as existing registered pension schemes. Following this consultation, the government will consider whether further legislation is needed for tax purposes and how best to fit CDC schemes into the current Finance Act 2004 framework, for example for the purposes of testing benefits against the individual’s annual and lifetime allowance.

DWP says the government is keen to bring forward legislation to facilitate the setting up of this form of CDC scheme ‘as soon as Parliamentary time allows’.

The consultation closes on 16 January 2019.

Delivering collective defined contribution pension schemes is here

Report by Pat Sweet

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