Collective defined contribution (CDC) schemes will deliver retirement income on average 70 per cent higher than annuities bought through traditional DC saving, and 40 per cent higher than typical DB structures, according to a new guide from Willis Towers Watson.
The consultancy, which references the work it has done on the Royal Mail scheme, says increased exposure to higher growth asset classes, facilitated through risk sharing, means funds can grow 15 per cent more during accumulation, and can deliver 50 per cent more in retirement than annuities which are required by law to be backed by secure, low-return assets.
Legislation facilitating the controversial new structure for pension schemes is included in the Pension Schemes Bill and is set to become an option from next year.
Willis Towers Watson says the 70 per cent CDC pension ‘boost’ vs individual DC annuity statistic is higher than statistics from some other organisations ‘in part because the new analysis is based on a new design of CDC for the UK, and in part because the analysis is forward-looking’. The projected pension levels are for a CDC plan opening now and use current annuity pricing which is relatively expensive by historic standards. The calculations also include a comparison of CDC with DB pension levels, which show a 40 per cent increase in equivalent outcomes.
The consultancy’s modelling references a base income is given with no further increases and ‘headroom’ funding for pension increases. In the Royal Mail this headroom funding is initially sufficient to give increases of CPI+1 per cent, and absorbs most asset/liability valuation movements, says Willis Towers Watson.
CDC structures have received much criticism in the media for being like with-profits funds which take from one group and give to another. One criticism often levelled at CDC is that older members benefit from sharing risk with younger members. But supporters of CDC argue that both younger and older members gain from a trade-off that sees them likely to benefit more from increased exposure to growth assets for longer than they might lose from seeing the collective fund pay out more to support retired members when markets are down.
There is no single form of CDC scheme – under the Royal Mail structure older members pay the same contributions as younger members and accrue the same level of benefits. This structure has been determined by the sponsor.
But other CDC structures could include those with different accrual rates to reflect the fact that a younger member’s contribution will benefit more from compound growth by the time they retire, meaning they would be entitled to a higher income than an older member contributing the same account.
A third approach is to accrue a DC individual pot and then convert that into a CDC pension. This could be a structure used by master trusts as a decumulation strategy, which could reduce risk for retirees, avoiding the worse effects of sequencing risk where markets fall in early years.
Willis Towers Watson senior director and head of UK CDC Simon Eagle says: “With CDC, even if there is a 20 per cent fall in the markets, this means we might give a 1 per cent lower increase that year. You wouldn’t have to cut further because that 1 per cent cut would also mean income was lower for the next 19 years.
Eagle says: “We’ve seen increased interest in CDC since the Government tabled the Pension Schemes Bill at the start of the year. CDC is on track to become an option from next year, and so it is now a more distinct consideration for employers. To help the industry get to grips with this innovation we have published a guide to answer the 15 most commonly-asked questions.
“Initially, employers will only be able to access CDC if they provide it through their own trust. For CDC to become prevalent in the UK we would need further regulation from the Government enabling CDC master trusts, so that an employer’s scale is no longer a constraint. In today’s flexible world of work, industry master trusts could be an especially effective way of providing CDC pensions, as members could continue to accumulate retirement contributions in the same scheme when changing employer.”