Royal Mail ready to launch first U.K. collective DC plan

The Royal Mail Group Ltd. is getting closer to the launch of its long-awaited collective defined contribution plan, which will be U.K.'s first such plan, as the government unveiled a final set of CDC requirements on July 19.

Sponsors of defined benefit funds in the U.K. such as Royal Mail, which have been grappling with the increasing costs of running a pension fund will soon be able to switch to a more affordable alternative.

That alternative is a CDC plan, a bridge between a DB fund and a pure DC plan, in which lifelong income is secured by pooling participant assets and investments in both accumulation and decumulation phases of the retirement journey, with participants bearing the investment and longevity risks instead of the plan sponsor.

"Our goal was to create a plan that was affordable, sustainable and secure for the members and for the business," said Angela Gough, London-based head of corporate pensions at Royal Mail.

The government expects CDC plans such as Royal Mail's to be cheaper for employers because they won't require sponsors to guarantee how much participants will receive each year.

The benefits paid out in CDC plans will instead be influenced by asset returns and could be reduced or increased depending on plan participants living longer or shorter than expected, Ms. Gough said.

Single-employer and connected industrywide multiemployer pension fund sponsors could implement new CDC plans in the U.K. soon, now that the government unveiled the final set of CDC regulations.

The Royal Mail's situation is unique because its CDC plan design — first developed in 2018 to replace its DB fund by plan executives in conjunction with The Communication Workers Union representing Royal Mail employees — was already endorsed by the U.K. government as one that could be replicated by other plan sponsors.

Royal Mail is expecting to launch its plan in 2022, once the U.K. draft regulation is incorporated into the U.K. law and it receives authorization from the regulator.

The new regulations, which outline the requirements and are expected to be adopted into the law in the fall, were a missing piece for Royal Mail to move closer to overhauling its retirement arrangements. The passage of the Pension Schemes Act 2021 earlier this year already provided a legal framework for CDC plans to operate.

"We are expecting that the authorization regime will be fairly similar to the (DC) master trusts' (one). We have already had conversations with The Pensions Regulator (about) what they need from us. We know they are already thinking about it," Ms. Gough said, adding that the company is already starting preparatory work on the application "so hopefully it won't be a very drawn-out process."

Ms. Gough said Royal Mail did not change its plan design in the past three years. Other avenues such as outsourcing to an insurance company or to a DC or a DB master trust — options that have increased and evolved in the U.K. market since 2018 — still wouldn't offer the features that Royal Mail sought. "We genuinely believe that CDC is the best fit," Ms. Gough said, because plan participants will not have to make complicated choices at retirement and because there is potential for higher investment returns in both accumulation and decumulation phases compared with DC plans.

"CDC allows members to pool longevity risk, which is really powerful," she said, adding that CDC plans can help achieve an income for life without having to opt for a more conservative investment strategy or without paying a premium to an insurance company.

"One of the really powerful (aspects) of CDC is obviously that the members don't have to derisk as quickly. So, the (new) asset allocation broadly is that the scheme will be held in return-seeking portfolio for longer," she said.

Ms. Gough added that DC master trusts don't "automatically provide a wage in retirement."

Royal Mail also couldn't have designed a DB plan with the same level of benefits affordable to the company because the costs of continuing to run the DB fund, which was frozen in 2018, would "dramatically" increase over the years, she said. "Going back to March 2018, the Royal Mail Pension Plan closed to the accrual of career salary benefit and that happened because if it remained open in its previous form, annual contributions by Royal Mail would have risen to unaffordable levels," she said. Simultaneously, in 2018, a cash balance fund replaced the £10 billion ($13.9 billion) pension fund as a transitional arrangement, which currently offers participants a cash lump sum at a 19.6% rate of pensionable pay. Royal Mail also operates a pure defined contribution plan with a 10% employer contribution rate.

The Collective Pension Plan, as the Royal Mail's CDC plan will be known when it launches in 2022, will replace both plans.

When the decision to freeze the DB plan was made, annual cash contributions were forecast to increase from about £400 million a year to about £1.3 billion a year.

Royal Mail's CDC plan will feature income in a retirement element and a cash balance element that provides a lump sum. In the new CDC plan, Royal Mail will contribute 13.6% of pensionable pay into the new plan and participants will pay 6%. Participants will build a CDC retirement income of 1/80th of their pensionable pay for every year of work, Ms. Gough said. The lump sum element will be set at 3/80th of pensionable pay.

Depending on the period when participants accrue benefits in the new plan, the retirement outcome could go down or up due to the investment performance and longevity, she said. But she said: "The basic amount (that participants) build up is the same for the same service and the same salary."

Before the new plan launches, Ms. Gough said Royal Mail will appoint a trustee board that will set asset allocation and launch an official procurement for money managers that will run assets.

When the new plan launches, Ms. Gough said Royal Mail's current pure DC participants will migrate to the new CDC plan alongside former DB participants currently accruing benefits in the cash balance fund.

"Everybody within our cash balance arrangement will automatically join the plan and within our defined contribution, everyone with a year of service with a certain contribution rate will join as well,'' she said, adding that Royal Mail expects about 120,000 to automatically join the collective pension plan.

For participants with less than one year of service or those who want to opt out of the CDC plan, Royal Mail will still set up a "nursery scheme," she said. The vehicle will be a new pure DC arrangement. But employees with shorter service will still automatically join the collective DC plan after a year of service.

In preparation to launch the new CDC plan, Royal Mail extensively communicated with employees about what the new arrangement will look like. An ongoing communication with plan participants is one of the requirements of receiving authorization from the U.K. regulator to run such a plan in the U.K.

Royal Mail employees were told that if returns of the plan's assets over the years suffer or if participants live longer than expected, retirement benefits could be reduced.

Conversely, if assets more than cover the accrued benefits, incomes will rise, Ms. Gough said. An assessment will be made annually.

But Royal Mail will also spread the decreases over multiple years if benefits must be cut because participants are living longer or returns stumble. Ms. Gough said if an income payment decrease of more than 5% had to be applied, the plan would spread the decrease over a maximum of three years to ensure that the cuts aren't too drastic.

Ms. Gough added that the smoothing can help tackle the intergenerational fairness aspect of running of a CDC plan so younger participants don't subsidize benefits of older participants. "We don't want to a build a problem for future members where they are paying additional contributions or they are having lower benefits to subsidize benefits that were already built up," she said.