Skip to main content
Article | Pensions Briefing

What exactly is a collective defined contribution pension?

How CDC pensions can be communicated to members effectively

Defined Contribution
N/A

By Simon Eagle and Shriti Jadav | November 7, 2018

Collective defined contribution (CDC) pensions are looking increasingly likely to come to the UK. In this third of a series of articles on CDC, Simon Eagle and Shriti Jadav look at how CDC schemes can best communicate their pension benefits to members.

Collective defined contribution (CDC) pensions are looking more likely to take root in the UK. The Pensions and Financial Inclusion Minister, Guy Opperman, is becoming increasingly definitive about enabling CDC, and the Department for Work and Pensions’ (DWP) consultation will only ramp things up further. Willis Towers Watson have been designing the UK’s first CDC scheme with Royal Mail, and following previous articles on the concept and employer perspective, Simon Eagle and Shriti Jadav now discuss the challenge of communicating the nature of CDC benefits to scheme members.

CDC would be a new form of pension in the UK.

CDC would be a new form of pension in the UK which comes with advantages over other options for both the employer and employees. For the employer, a CDC scheme could be attractive if they want to pay a fixed rate of contribution rather than sponsor a defined benefit (DB) scheme, but want an arrangement which provides a pension by default, and which is aimed at a higher level than would be expected from individual DC (IDC) annuity purchase. CDC members are provided a pension with variable increases, or decreases, which depend on the funding position of the scheme.  For CDC design to be successful, members will need to understand and accept this variability. Naturally, CDC member communications will need to be carefully crafted to meet these challenges.

What are CDC pensions?

Many UK workers have some familiarity with DB and IDC schemes, and will understand that under:

  • DB – my pension level is guaranteed (by my employer).
  • IDC – I have my own pot of money, and I can decide what to do with it at retirement.  If I decide to buy a pension, the level will depend on the size of my pot and insured annuity terms at retirement.

CDC would work differently:

  • I am paying into a collective pot, from which each member will be paid a pension representing their share of that pot. There are rules for how each pension is worked out in a fair way.
  • I don’t know how big my pension will be, but the scheme should be a good and stable investment for my contributions because the scheme aims to achieve good asset returns and my risks are shared with other members.

For CDC to work, members need to trust that the collective pot is being invested sensibly and shared out fairly.

For CDC to work, members need to trust that the collective pot is being invested sensibly and shared out fairly. So these aspects of the scheme will need to be designed particularly robustly, and then carefully communicated to members.

What will CDC scheme members know about the size of their pension?

CDC benefit statements will need to quote current levels of pensions to members, and also explain the future variability of the pension so that members can sensibly plan their retirement.  As a result, pension statements are likely to be a blend between those received by DB and IDC members.

The statement could show the member’s current level of pension, compared with the previous year’s figure, and explain that it has increased because of a year of accumulation and the increase awarded, or that it has decreased because a cut was required.

For a member who hasn’t yet reached normal retirement age, a second part could show a central estimate of the member’s pension at normal retirement age. The statement should also explain that the eventual pension would depend on the future experience of the scheme, and so future pension increases could be different to the current level of pension increases, and that pensions could be cut. 

Figure 1: Accumulated pension statement

Pension last year                                                      £5,000 pa     
Pension increase this year (3.0%) £150 pa
Pension accumulated this year £300 pa
Pension this year £5,450 pa

There are different ways that this could be illustrated, and we would expect requirements to be set out in CDC regulations.  For DC schemes, SMPI projections are on assumptions which are largely prescribed by the Financial Reporting Council.  However, CDC projections will need to be based on the CDC scheme’s specific design and investment strategy.

What will CDC scheme members ‘own’?

This is a question that is likely to be asked and so CDC communication will need to satisfy it.  In the UK, it is likely that members who have not yet retired will have the right to transfer out of their CDC scheme, for example, if they instead want to use their pension savings flexibly through the IDC freedoms. 

And so, in a sense, what the members ‘own’ before retiring, is the transfer value.  However unlike IDC, this will need to be determined as a share of a collective pot.  The obvious approach is for this to be done in such a way that there is no expected effect of a transfer on other members’ pensions.  In other words, the transfer value would be calculated on the same actuarial basis as the one used to determine the annual pension increases.  By the very nature of a CDC scheme, the total scheme liability value must also equal the asset value, and so a liability value is a share of the assets.  This is different to DB, where transfer values are usually values of the promised benefit, without reference to the level of funding for those.

It can be explained to members that they can transfer out their share of the collective assets before retirement if they wish, and transfer value quotes can be provided.

Trustees of CDC schemes and their advisers will need to give real focus to member communications to ensure that members understand their benefit, the variability and what they "own".

We expect that trustees of CDC schemes and their advisers will need to give real focus to member communications to ensure that members understand their benefit, the variability and what they “own”. However, there are many parallels to be drawn from both DB and IDC member communications which can help in the development of clear CDC member communications so that CDC schemes can run smoothly.

Please look out for the next article in our CDC series.

Related content tags, list of links Article Pensions Briefing Defined Contribution United Kingdom
Contact Us