Legal upgrade needed for U.K. collective DC plans

A lack of appropriate legislation might halt the adoption of collective defined contribution plans in the U.K.

The CDC structure is a halfway house between defined benefit plans, where risk is shouldered purely by employers, and pure DC plans, where participants take on all of the investment risk. Collective DC plans allow pooling of assets and sharing of risks.

In efforts to allow a CDC model in the U.K., where sponsors now can only offer DB or pure DC plans, the government launched a consultation in November to gauge interest from pension funds. If successful, the proposal would become effective under a new pensions bill next year.

One employer isn't waiting for Parliament. Royal Mail Group, London, this year began developing a CDC plan to replace the £9.6 billion ($12 billion) Royal Mail Pension Plan. That cash balance plan already replaced a frozen DB fund earlier this year.

"Royal Mail and the Communication Workers Union want to see CDC become a reality in the U.K., and we hope the required legislation will be introduced at the earliest opportunity," a Royal Mail Group spokesman said in an email.

Royal Mail officials and the CWU hope their proposed arrangement will give participants a better income throughout their retirement than they would otherwise get through a defined contribution annuity purchase. The plan will be open to all employees at the postal group, according to the spokesman.

Under the design, Royal Mail's contribution to the CDC would be around 13.6%, while an employee will contribute 6%, Royal Mail said. This compares to a contribution amounting to about 30% of salaries that sponsoring employers typically pay into open defined benefit funds.

"We believe that CDC schemes can deliver on these objectives, but without placing volatile and unsustainable liabilities on the employer's balance sheet," the spokesman said.

But sources said that without legislation, sponsors like Royal Mail that are further along in their journey toward a CDC arrangement cannot take the final step.

"The legislation needs to exist for it to work," said Steven Taylor, partner at Lane Clark & Peacock LLP in London. "Existing legislation doesn't work for what Royal Mail is trying to do."

Despite anecdotal evidence of collective DC being considered by some employers, sources said there are very few DB plans in the U.K. that are still open to new participants that could adopt CDC. Many defined benefit plans already have closed their DB plans and moved to pure DC plans, noted Kevin Wesbroom, principal consultant at Aon in London.

There were 661 open defined benefit plans in the U.K. in 2018, compared with 2,126 in 2008, according to the Pensions Universe Risk Profile — known as "The Purple Book" — a joint annual publication by the Pension Protection Fund, London, and The Pensions Regulator.

To be able to leverage scale when pooling risk under a CDC arrangement, pension funds need to be sizable, Mr. Wesbroom said. According to data from The Pensions Regulator and the Pension Protection Fund, London, only 20% of these open funds have the minimum size — in terms of assets and participants — to benefit from the pooling of risks CDC brings.

Lane Clark's Mr. Taylor noted there are other challenges to CDC plan design. "The pension fund can't have a deficit; it is crucial," he said. "If there is a deficit, it is pension increases, and ultimately benefits, that are reduced."

Simon Eagle, consultant at Willis Towers Watson PLC in London who assisted Royal Mail officials with their CDC modeling, sees challenges in getting legislation passed that will serve such a small segment of defined benefit plans. Even if the government introduces the legislation, under the current proposal only defined benefit funds will be able to move to a collective DC plan.

Other plans, such as the DC master trusts, would not be able to benefit from the legislation as it now is written.

While Mr. Eagle thinks there are other corporate defined benefit plan executives watching the developments with the Royal Mail model, he expects "the takeup (by other employers) will be slow."

In order for CDC to really catch on in the U.K., multiemployer plans need access via a separate set of rules, said Mr. Eagle.

"It is hard to see industrywide plans come to the market. (They) would need funding (and the right level of) governance," he said. But master trusts would have the right scale to do CDC, he added.

Other sources think a CDC arrangement has a useful application for the decumulation phase of individual defined contribution plans, too. But separate legislation would be needed to provide for the plans that might want to use it, noted Marian Elliott, managing director, integrated actuarial, at consultant Redington in London.