How do Collective Defined Contribution pension schemes work

The launch of the Royal Mail Collective Pension Plan in October 2024 marked the first of a new type of pension scheme in the UK - Collective Defined Contribution (CDC).

Later the same week, the government launched a consultation on multi-employer CDC regulations. This is a crucial next step to unlocking the potential of CDC for more employers, including many housing associations.

What is CDC?

These schemes combine:

• for members, a target pension at retirement and an income for life after retirement, like a defined benefit (DB) scheme; with
• for employers, the cost certainty of a defined contribution (DC) scheme.

Like a DC scheme, benefits are funded by a regular, fixed contribution from employers and employees but, unlike a DC scheme, the investments are managed collectively. Members share risk, enabling CDC schemes to invest in growth assets for much longer than either a typical DB or DC scheme.

LCP analysis indicates expected member outcomes in CDC schemes are up to 50% better than traditional DC arrangements with annuity purchase.

Many employers could benefit from CDC’s potential to provide more attractive benefits to staff without incurring additional cost. However, CDC is particularly attractive to paternalistic employers wishing to provide a high-quality pension to their employees without the risk of future deficit contributions arising, as well as sectors with high levels of co-operation between employers. Therefore, CDC appears ideally suited to the housing sector.

What do the new multi-employer regulations mean?

These are primarily aimed at non-connected employer groups, including industry-wide schemes and commercial operations such as The Pensions Trust. However, they will also cover organisations such as the Church of England, who LCP have been supporting to design a CDC scheme.

While multi-employer CDC schemes will provide many of the same benefits as single employer CDC, their regulation will differ in a few important aspects.

Avoiding cross-subsidy

Risk sharing is an important part of any CDC scheme to allow members to benefit from investment returns for longer. However, it is important that any multi-employer CDC scheme does not include cross-subsidies when determining the amount of benefit ‘built up’ through contributions. Cross-subsidies could occur if the cost of providing benefits for one employer was significantly lower than the cost for others, but the contribution was the same. For example, an employer with an older, more affluent workforce could disproportionately gain if benefits were built up at the same rate as those for an employer with a younger, less affluent workforce.

Therefore, it is proposed an ‘actuarial equivalence test’ will apply for multi-employer CDC schemes. This requires each employer’s contributions to meet the cost of providing benefits for their employees, avoiding the type of cross-subsidies described above.

To protect against these cross-subsidies, multi-employer CDC schemes will typically use age-related accrual rates. This means that younger members would build up more target pension per pound of contribution than older members.

Multi-employer schemes with very disparate employers may need to consider actuarial equivalence in other areas. For example, gender, salary and location can all be strong predictors of life expectancy, and thus the value of benefits offered.

What happens if an employer leaves?

CDC schemes are designed so that no deficits can arise. This means an employer can never be required to fund a deficit in respect of another employer’s members.

If an employer leaves a CDC scheme, no exit debt is payable. Their members are simply treated as deferred pensioners in the scheme. Similarly, on insolvency of an employer, no liability falls on the other participating employers.

Scheme proprietor

Multi-employer CDC schemes will be required to have a ‘scheme proprietor’. This is a central body responsible for the business strategy and commercial activities of the scheme.

The scheme proprietor will be separate from the trustees of the scheme, to allow the trustees to focus on their duties to the members. This structure is designed to protect the interests of both employers and members.

What’s next?

The consultation closed on 19 November. Regulations are expected to be finalised in early 2025, along with the publication of a code of practice from the Pensions Regulator which will allow multi-employer CDC schemes to be approved. We expect them to launch from 2026 onwards.

For many employers these developments have moved CDC up the agenda. The Royal Mail scheme has provided the ‘proof of concept’ and regulation will soon be in place to enable wider groups of employers to access the benefits of CDC.

We believe the housing sector is well-placed to benefit from multi-employer CDC schemes. Many of our clients tell us they want to be able to offer better pensions to their employees but are unable to afford the level of contributions to a DC scheme this would require, and do not have the appetite to build up additional defined benefit risks. A well-designed CDC scheme could bridge this gap. We are excited to support this market to develop in the coming years.

If you would like to explore how CDC could work in practice for you, and the expected benefits it could provide for your members within existing budgets, please get in touch.