Collective DC plans a new part of U.K. retirement matrix
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March 08, 2021 12:00 AM

Collective DC plans a new part of U.K. retirement matrix

New approach shares investment, longevity risks to boost benefits

Paulina Pielichata
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    Simon Eagle
    Simon Eagle said utility and industrial companies are especially interested in the new law.

    Collective defined contribution plans could soon see a widespread rollout in the U.K. as employers move away from defined benefit plans but still seek secure retirement outcomes for employees, consultants said.

    Following the final enactment of the Pension Schemes Act 2021 on Feb. 11, collective DC plans, where employees share investment and longevity risk, can be established by plan sponsors for the first time in the U.K.

    Under these new arrangements, retirement income is secured by the pooling of plan participants' assets and investments, in contrast to DB funds where the sponsoring employer bears all the risk. At the same time, the employer contribution is fixed.

    Sources said the law opens up an avenue for single-employer DB plan sponsors to set up a new arrangement that uses unpaid retirement benefits from participants in the pooled plans that die younger to subsidize payments for those that live longer. Unlike in traditional DC plans, where participants can outlive their savings, the bigger pool of assets in CDC plans can help to spread the costs and risks over a longer period of time.

    While CDC plans are similar to an insured DC annuity or DB fund in that they pay out benefits as annual income for life, they are cheaper for employers as they don't provide a guarantee to participants as to how much they will receive each year. Under CDC plans, the amount paid out adjusts for as long as participants live, with benefits reducing if people are living longer and increasing if they die younger than expected. An actuary works out the distribution of these benefits among plan participants. Actuaries and lawyers are also needed to set up the plans, consultants said.

    "We're seeing interest in opening CDC schemes from a number of organizations which want to provide collective retirement income at a fixed cost, via the new CDC legislation," said Simon Eagle, senior director at Willis Towers Watson PLC in London, adding that the firm has been commissioned by clients to work on potential CDC designs.

    Mr. Eagle noted that the interest comes mainly from employers in the utilities or industrial sectors that feel that annual retirement income is the best retirement arrangement for their employees but for which DB is or would be too expensive.

    Other consultants added that a CDC plan could be a midway option between DB and DC by allowing corporations to remove the uncertainty of future deficit recovery programs and varying contributions, while providing reliable lifelong income in retirement to participants at a predictable cost. In traditional DC plans, individuals can only rely on his or her own savings to last a lifetime.

    CDC arrangements are most likely to be adopted by large employers with large workforces that will be stable over the course of the next 20 years, according to consultants.

    That's because plan sponsors are going to need scale to activate the benefits of CDC because the model requires large assets to keep costs low, said Steven Taylor, partner at consultant Lane Clark and Peacock LLP.

    David Pitt-Watson, executive fellow at the London Business School in London said: "Most people want to offer best value for money for employees and, in every study comparing (CDC) with individual savings or annuities, on average, you get a better retirement income if you use CDC."

    Mr. Eagle said that insured annuities are very expensive because under insurance regulations the insurance company must invest in very low-returning assets to support the annuity, while CDC can target higher asset returns to help meet the retirement income payments.

    Robin Ellison, head of strategic development for pensions at law firm Pinsent Masons LLP in London, said that CDC plans are needed in the U.K. because pure DC plans have not been delivering on their expectations in fluctuating markets, because there is little investment and mortality risk sharing, and because benefits offered are lower than those available under CDC for the same contributions.

    Other consultants added that sponsors of defined benefit plans are interested in the CDC model because studies show that market downturns would not result in severe cuts to benefits compared to DB funds.

    A study published in September by Willis Towers Watson PLC showed that CDC income can on average be 70% higher compared to that provided by an annuity purchased by a DC plan participant at retirement, and 40% higher than the benefit in a typical DB plan. Mr. Eagle said that the DB benefit is lower because a DB fund is typically invested in assets with lower expected returns to reduce volatility in the DB funding level.

    Bloomberg

    A Royal Mail Plc trolley on a street outside a residential address in London.

    Royal Mail model

    Royal Mail Group Ltd. is looking to start its CDC plan, known as the Collective Pension Plan, in the second half of the next financial year. Its launch will depend on further details being worked out with the government, including how the plan will be accepting contributions and when it may be granted authorization from The Pensions Regulator, the postal service company said in a news release on its website on Feb. 11.

    Royal Mail rejected a pure DC model to replace its £10 billion defined benefit plan because of high pricing in the insurance market for annuities, opting instead for a plan design with an annual lifelong retirement income and with variable benefit increases at a fixed cost, according to WTW, which advised the plan trustees.

    Royal Mail's workforce currently has the choice to accrue DC income or cash balance benefits, but these employees will move to the new CDC plan when it launches and more than 140,000 people will go immediately into this new plan.

    The U.K. Department for Work and Pensions has made clear it wants to work with other employers considering a CDC model that does not look like the one proposed by Royal Mail, LCP's Mr. Taylor said.

    Multiemployer CDC plans

    Still, CDC could be expensive to set up for small employers, said Matthew Arends, partner and head of U.K. retirement policy at Aon PLC in London, who added that his firm has been receiving questions from small employers about options to join a multiemployer CDC plan. Mr. Arends added that small employers are interested in whether they can access or set up industrywide plans or when CDC can be part of master trusts' fund choices.

    The new law actively permits the government to open up CDC arrangements to multiemployer plans with secondary regulation through the DWP rather than requiring new legislation.

    Currently, multiemployer DC plans, known as master trusts, run DC assets in individual retirement accounts with target retirement dates. At retirement, plan participants choose to receive their benefit as cash, annuities or via an investment drawdown option.

    "We have had employers interested in understanding CDC benefit structures and what it might mean for them, motivated by seeing developments of the Royal Mail scheme and the passage of the act," Mr. Arends said, predicting that interest will grow closer to the Royal Mail plan launch.

    Still, LCP's Mr. Taylor said that the DWP has yet to clarify if plan sponsors that wish to enroll plan participants from different employers into one CDC plan could use Royal Mail's plan design, or whether they need to wait for more detailed regulations expected later this year.

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