Any final design for a collective defined contribution plan structure in the U.K. should not require a capital buffer fund, many retirement experts told the government.
In an effort to help employers make the transition to defined contribution arrangements from defined benefit, the U.K. government in November asked executives at U.K. retirement plans, money managers and consultants to describe an optimal CDC plan design that could be universally adopted by the majority of plan sponsors. The deadline for responding to the government's consultation was Jan. 16.
This type of employer-sponsored plan pools savings and investments, and shares risk across plan participants. CDC plans do not promise a specific benefit, but have a target payout amount.
The aim of the consultation was to find a consensus on plan design so wording to facilitate the offering of CDC plans then could be worked into a pension bill, should the government decide to move forward on crafting enabling legislation.
Under a CDC structure, plan participants' retirement outcomes could be 30% higher than under other DC designs, according to a U.K. Work and Pensions Committee paper published July 11, which cited research by Aon.
One thing that came through in executives' responses was their opposition to a capital buffer that has been integrated into CDC systems in other countries, including the Netherlands. But finding a way to protect the target benefit without such a reserve fund is a concern.
A buffer account is funded by employer contributions and is used to make good on the targeted payout during economic downturns so participants don't see a reduced benefit.
Executives responding to the U.K. consultation request agreed that a CDC design using a classic capital buffer such as in the Netherlands would be detrimental to plan sponsors. Any U.K. design, they said, should leave out the buffer.
Periods of poor performance could deplete the buffer in the short term (as happened in the Netherlands) and result in benefit cuts, experts said. Instead of using the buffer to soften market impact, they said benefit targets should move in line with inflation, which would protect these benefits from being cut at a later date.
Another reason to leave it out is the issue of intergenerational fairness.
"We agree in relation to single-employer plans that no explicit capital buffer should be incorporated. If there was one, it would be intergenerationally unfair, for example, because such a buffer will be built up in the early years for the benefit of those joining later," said Kevin Wesbroom, principal consultant, and Matthew Arends, head of U.K. retirement policy at Aon, both in London, in response to the consultation.
Steven Taylor, London-based partner at Lane Clark & Peacock LLP, said in the firm's response: "The exclusion of capital buffers is a key design feature that we agree with, but has the potential effect of increasing the volatility of target benefits."
"In periods of poor performance, this (lack of a capital buffer) means that future indexation (of pension benefits) effectively takes the role of absorbing shocks, resulting in lower target benefits, and if poor performance is sustained for long periods, accrued benefits could also be cut back," Mr. Taylor said.
The U.K. Association of Consulting Actuaries, in its response, pointed out "the lack of a capital buffer is likely to increase the level of volatility in target benefits. Each year, the target benefits will change based on investment returns achieved and best estimates of the future. There would be no scope to smooth results (by) using part of the capital buffer in bad years and then replenish the buffer in better years." Hugh Nolan, chairman, ACA's defined contribution committee, said in a telephone interview that "there shouldn't be a buffer in a Dutch sense." But, Mr. Nolan said, "there should be a safety margin" in the plan design and "high enough value of expected benefit increases."