Collective defined contribution (CDC) pension schemes are a relatively new (in the UK at least) product which aims to offer a middle ground between traditional defined benefit (DB) schemes, which provide a guaranteed pension underwritten by the employer but at a high cost to the employer, and conventional defined contribution (DC) schemes, where investment and other risks are borne by the member.
CDC schemes work by offering members a fixed pension on retirement, akin to a DB scheme. They also provide for fixed employer contributions to the scheme such that if investment returns are lower than predicted and the scheme is underfunded, members’ pensions will be reduced rather than the employer being required to make up any funding shortfall required to pay the target benefit in full.
Like Master Trusts, CDC schemes must be authorised by The Pensions Regulator prior to operating within the market. Although CDC schemes were first legislated for by the Pension Schemes Act 2021, the current rules only allow schemes which relate to a single or connected employers, and at the time of writing only one such scheme (i.e., the Royal Mail scheme) has been established. This is in part because a CDC scheme needs a large enough number of members to make the investment in scheme infrastructure worthwhile, while also generating enough funds to allow the investment and longevity risks to be properly pooled and diversified.
However, it was always envisaged that the rules would be amended to allow unconnected multi-employer schemes and the Government has just published draft regulations and a consultation paper to enable schemes for unconnected employers to apply for authorisation, which will open the space to commercial providers such as TPT Retirement Solutions which is currently designing a new multi-employer CDC scheme, with plans to complete authorisation by the end of 2026.
The proposed regulations borrow significantly from the existing regulations for multi-employer master trusts, which means that much of the thinking about how to establish such a scheme will have already been completed.
CDC schemes offer a number of benefits:
- a pension arrangement that offers increased financial certainty and a more generous pension to members upon retirement could be a valuable recruitment tool for employers;
- employers pay a fixed contribution to the scheme – once they have paid their contributions, they are done;
- a sufficiently large pool of assets for investment will enable trustees to invest in longer-term illiquid assets. This could enable a higher rate of return and, in the long term, reduce the contributions required from scheme sponsors;
- CDC schemes could be a way of moving away from DB schemes (for those employers still offering them) without placing all the risk on the members. As an extra benefit this may help to limit the extent to which a move from away from DB increases generational unfairness between younger members who are more likely to be members of conventional DC schemes only, and older members may still have some DB benefits; and
- the Government has also announced that it will consult on a separate framework for “retirement only” CDC offerings, where members can pool their DC pots at retirement for a collective income thus expanding the scope of the arrangements to a larger pool of people.
There may be an opportunity to redirect scheme surpluses from DB pension schemes into new CDC schemes following the Government’s plans to reform the rules around accessing surpluses in DB pension schemes (see our recent blog post here). This, compounded with the Government’s existing commitments to reform pension regulations to free up investment in private markets, could provide a unique political tail wind behind moves towards the widespread uptake of CDC schemes.
Existing operators of multi-employer schemes would be excellently placed to leverage their existing knowledge and investment into scheme management and investment infrastructure to create a ‘first to market’ CDC offering.
Having advised Sixth Street on their first to market multi-employer scheme Clara-Pensions in 2023, Freshfields is uniquely placed to discuss how the move towards CDC schemes could impact sponsors of all sizes.
