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.
