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Retirement Plans

‘Defined ambition’ plans finding more seats at the table in Europe

Frank Field, a member of Britain’s Parliament, wants feedback.

Collective defined contribution plans are catching on across Europe, following the launch last month of a U.K. review of the defined ambition model and changes to German law earlier this year.

The U.K. government launched an inquiry Nov. 24 into collective defined contribution plans in an effort to address the ongoing cost and challenges of providing a defined benefit plan. Much like in Germany until recently, collective DC plans are not allowed in the U.K. by law.

The government sees defined ambition plans as arrangements that do not promise a certain retirement income. Instead these collective vehicles set out to pay a target or "ambition" amount of income in retirement to plan participants, subject to supportive market conditions.

Some sources said the CDC plans ​ could see success in the U.K., serving as a bridge between defined benefit and defined contribution plans. The key advantage of implementing them for employers, sources said, is that such plans smooth plan participant outcomes through sharing risk. Under a CDC plan, the traditional pension plan's guaranteed benefit based on a participant's ending salary would be replaced by a plan that pools investments across participants and aims to give each a target for retirement income. Dubbed defined ambition in the U.K. as well as in Germany, this model strives to create a more sustainable structure than defined benefit funds. And unlike traditional defined contribution plans, the costs and risks are shared.

Kevin Wesbroom, senior partner at Aon Hewitt in London, said in a telephone interview: "We are aware of two major defined benefit funds that might well want to utilize the CDC model rather than switch to a regular DC.

"Our modeling of CDC outcomes prior to 2015 found that a CDC model could offer a 30% uplift in returns, resulting from risk sharing, over a conventional DC with individual accounts," Mr. Wesbroom said.

But some plan executives and consultants are concerned the model does not solve the problem of cross-subsidization, where younger generations carry the weight for older plan participants.

In 2013, Steve Webb, then-U.K. minister for pensions, floated the idea of collective DC plans. Now, with retirement savings exceptionally high on the Labour Party's agenda, according to Mr. Wesbroom, the idea is getting more attention.

Parliament wants a look

The U.K. Parliament's Work and Pensions Select committee, chaired by Member of Parliament Frank Field, has asked industry participants to contribute views by Jan. 8.

Mr. Field, in an emailed statement, said: "The committee is very interested to see if this model, which works so well in Canada, Denmark and Holland, could be one answer to the U.K.'s retirement saving 'problem.'''

The CDC model, he said, offers an "attractive possibility of retaining some of the best features of company schemes in an age where employers are no longer willing or able to sustain the burden of final salary promises. Instead, employees can club together to pool the risk and potentially enhance the benefits."

Some industry sources remain skeptical about whether a CDC model could truly eliminate the burden of guarantees that employers struggle with in defined benefit arrangements.

Maria Nazarova-Doyle, head of DC investment at consultant JLT Employee Benefits in London, said: "On a theoretical basis, risk-sharing could improve intergenerational fairness. But in practice, in these collective vehicles the money is used to pay for those that retire sooner. This often means that younger participants do not end up with the savings they would have under a pure defined contribution plan in good market conditions."

Darren Philp, director of policy and market engagement at the 2 billion ($2.6 billion) People's Pension, West Sussex, England, said in an interview: "Because you are risk sharing, you have to make it fair to avoid cross-subsidization. The debate is about how we can improve the system to help people manage volatility as they approach retirement."

Still, efforts to ensure intergenerational fairness and smooth outcomes for participants have successfully driven reforms forward in other European countries. The German government acknowledged the defined ambition model could be a step toward a DC system earlier this year, when it passed legislation allowing implementation of collective defined contribution plans.

Previously, Germany only allowed defined benefit funds with final salary guarantees attached, the bulk of which invested in fixed-income assets via insurance companies.

A desire to manage volatility and control participant outcomes was at the heart of the initiative to adopt the defined ambition model in Germany.

Collective risk-sharing is needed from the point of view of the participant, who "may not be educated enough or not (be) comfortable with a high level of involvement in decision-making," said Christof Quiring, head of investment and pension solutions at Fidelity International in Frankfurt.

Volatility reserve fund

With the implementation of the defined ambition model in Germany, plans can create a volatility reserve fund that helps all participants manage volatility of investments. The reserve funds are funded by extra contributions from employees and employers. Money retained in the reserve funds is used in the event of a shortfall to the targeted payout in an economic downturn.

"Since the main legislation was passed, employers and social partners are discussing the details of how much the contribution to this volatility reserve fund should be to ensure adequate returns," Mr. Quiring said. "There are voices that the employer should pay 10% to 15%," into the the reserve fund he said.

U.K.-based sources are skeptical about whether the defined ambition model could be accepted by industry, as it has been in Germany.

According to JLT's Ms. Nazarova-Doyle, investment strategies that offer reserves to manage volatility already exist in the U.K. in the form of "with-profit funds."

"The idea behind these type of funds was that they would return 5%, when in reality they were actually yielding 10%. The remaining return was retained and reinvested by the manager," she said. "But they were not very successful."

It could be a while before the defined ambition model materializes in the U.K. In Germany the reform took around three years to gain momentum and another 12 months for the legislative process to conclude.

However, Mr. Wesbroom said primary legislation in the U.K. already exists, under the Pension Scheme Act of 2015. "While nothing in the Parliament will be happening in the next two years due to Brexit, secondary regulation could be completed outside of the Parliament through the Department for Work and Pensions," Mr. Wesbroom said.