As Parliament mulls over the possibility of creating a legislative framework for collective defined contribution pensions in the UK, a recent report from conservative think tank the Centre for Policy Studies gave the concept a resounding thumbs down.
A collective defined contribution pension plan, or CDC, “is risky, untested, and undermines the personal pensions freedoms introduced in 2015,” wrote Michael Johnson, a research fellow at the Centre for Policy Studies who was responsible for running the Economic Competitiveness Policy Group under former UK Prime Minister David Cameron.
“The system risks creating irreversible intergenerational injustice by overpaying pensioners at the expense of current and future employees,” wrote Johnson. “It is also unclear whether what is promised to workers is actually deliverable.”
CDCs are a type of retirement saving plan that differs from defined benefit plans in that the employee is not promised a certain retirement income, but instead has a target amount the plan will pay out based on a long-term, mixed-risk investment plan. They aim to pay out an adequate level of index-linked pension for life, but do not offer a contractual guarantee. They differ from defined contribution plans in that they do not produce an individual pension pot, which a worker then has to decide how to invest, but instead invest savings in a larger “collective” pot, and then provide an income during retirement.
The plans are common in the Netherlands, Canada, and Denmark, but have only recently been allowed in the UK. They were authorized by legislation in 2015 in the UK, but regulations to make it possible have not yet been enacted, and Parliament is currently holding an inquiry into the matter.
However, according to the report, CDCs that have been tried in other countries have either been considered a failure, or the particular circumstances were not applicable to the UK.
But rather than just shoot down the idea of a CDC, Johnson offers an alternative, which he said should be as personal as a bank account.
“There is no need for any entirely separate workplace-dedicated savings architecture,” Johnson wrote. “Each employee could have his own personalized savings pot, capable of accommodating both his own and his employer’s contributions.”
Under the concept, Johnson wrote, during the period of accumulation, individual defined contribution pots would be invested in diversified, low-cost default funds to provide economies of scale. After reaching private pension age, which he said should be 60 not 55, employees and retirees would be defaulted into approximately 15 or 20 years of income drawdown, with the remainder invested in low-cost default funds. Then later on in retirement, longevity risk would be pooled by default, in the form of a lifetime annuity, beginning at an age between 75 and 80.
“The default funds could be in the form of with-profits funds, which share many of a CDC scheme’s attributes and underlying performance drivers,” said Johnson.
He said this arrangement would preserve individual property rights, extend the investment horizon and harness economies of scale through investment pooling, and could be accommodated within today’s legislative framework. He added that the funds would not provide guarantees, would include regulated consumer protections including a default fund charge cap, and would be overseen by a strong, independent, governance body.
“The DWP [Department for Work and Pensions] is sensibly demurring on proceeding with CDC schemes,” wrote Johnson. “The evidence all points to an obvious conclusion—CDC schemes in the UK are superfluous.”