Managers, consultants see bright future for collective plans

A provision expected in next year's U.K. pensions legislation could pave the way for collective defined contribution plans, which look and feel like defined benefit plans but are more employer-friendly and share risk among participants.

But many potholes litter the road, and wide adoption is anything but assured.

The new plans, which pool DC participants into a single plan, rather than individual accounts, could be a boon to global money managers because the plans are expected to use more alternative asset classes than traditional defined contribution plans.

Money management executives and consultants expect the plans to start small, but grow rapidly.

“The whole idea is that (CDC plans) have got more freedom to invest in growth assets,” said Deborah Cooper, London-based partner at Mercer Ltd. “Assuming that CDC works, there is a lot more freedom about investment strategy, investment in growth assets and there would be far longer investment horizons, since money can just keep rolling in” and participants can remain in the plan throughout the decumulation phase.

There is also no target in terms of retirement date or the need to invest in annuity-matching assets, since U.K. employees no longer have to purchase an annuity to fund their retirement.

“We still don't know exactly how it is going to look or be set up — but the best guess is that CDC is going to be a trust-based pension solution,” said Paul Sweeting, London-based European head of the strategy group for J.P. Morgan Asset Management.

“It will be an employer-sponsored arrangement, and as such might be used as a replacement for DB schemes. If a set of reasonably large employers take it on, members will have the DC benefits of making a fixed contribution (and a fixed contribution from the employer), and the DB benefit of intergenerational pots, given members no longer have to buy an annuity.”

One big difference: Rather than all risk sitting with the individual as in traditional DC plans, it is shared by all participants. Therefore, the plans can take more risk, executives said.

The combination of risk sharing and the larger size of the plan could allow plan officials to pursue more risky, and potentially higher returning, asset classes such as real estate, infrastructure and hedge funds.

“Infrastructure and real estate can be difficult to get into and out of — and some hedge funds and private equity funds,” added Mr. Sweeting. “But one advantage with CDC is that is (has the potential to be) big. So it could invest in some more lumpy investments — although maybe not in the first few years.”

Some money manager executives, when talking about the potential for CDC plans, cited the Netherlands, where collective plans began. Sponsors began switching their DB plans to CDC about 10 years ago.

But scale could be a problem in the U.K.

“In the U.K., it is difficult to see how to” achieve scale, said Stephen Bowles, head of defined contribution at Schroders PLC, London. Mr. Bowles said the U.K. government has already ruled out moving existing DB plans to CDC and instead is looking for pure DC plans to adopt the pooled concept.

But one thing CDC does, he said, is improve governance standards, “to place more pressure on suppliers like the investment managers, and to look at different and better types of investment solutions.”

There are other limitations, Mr. Bowles said. Current U.K. regulations on DC plans, which require daily pricing, could discourage plan executives from moving into more illiquid assets. The U.K. needs “a change in the regulation before (DC) can start to access those assets,” Mr. Bowles warned. On top of that, “the timing is particularly poor, I would argue, given the introduction of the charge cap (for DC plans, at 75 basis points) and the changes to annuities. Pension managers are pulling their hair out with (these changes) as it is. In the short- to medium-term, we cannot see many pension managers paying much attention to CDC,” said Mr. Bowles.

Stefan Lundbergh, head of innovation at Cardano, a solvency management firm, who is based in Rotterdam, Netherlands, said the U.K. should avoid basing too much of its CDC plan on the Dutch experience. “I see a big risk ... if the Dutch model is implemented in the U.K. It can be a lot of overpromising and under-delivering,” he said. The key to making it work is to ensure there is “fairness” between the decumulation phase to retirees and the contributory phase, Mr. Lundbergh said.

He cited the problems of benefit cuts in the Netherlands, which were necessary to ensure CDC plans remained at the required funding level of 105%. Dutch financial regulator De Nederlandsche Bank said in April 2013 that 66 of 274 Dutch pension funds sampled had been forced to reduce benefits to restore the plans to the mandated 105% funding level by the end of last year. In May, DNB said 30 of 141 Dutch funds sampled had been forced to cut benefits to reduce funding deficits.

“That we do cut pensions is the key — but the trouble is waiting too long. If the corporate is no longer the sponsor, and the risk is with the members, how do you make sure that the retirees are not getting too much pension paid out, or too little when the scheme is in trouble?” said Mr. Lundbergh. “The longer you wait, the more the young are carrying the risk.”

His advice to the U.K. in designing CDC plans is to look at what the Dutch want to do and how they are trying to improve it. “If that element of fairness is not solved, I'm pretty scared of CDC in the U.K. If it is solved, it can be a very good pensions product.”