2020
- collective defined contribution schemes (67)
by
Roderick Ramage, solicitor, www.law-office.co.uk
(first published by
distribution to professional contacts 1 January 2020)
DISCLAIMER
This article is not advice to any
person and may not be taken as a definitive statement of the law in general or
in any particular case. The author does
not accept any responsibility for anything that any person does or does not do
as a result of reading it.
“Measures
will be brought forward to … help people save for later life.” (The Queen’s
Speech 19 December 2019)
“The
main benefits and elements of the [Pension Schemes] Bill [include]
- Creating
a new pension scheme to give greater choice for employers and enable people to
adequately save for retirement and better predict their income in later life,
- Providing
a framework for the establishment, operation and regulation of collective money
purchase schemes (commonly known as collective defined contribution pensions).”
(Queen’s Speech 2019: background briefing notes)
The
probability is that the Pension Schemes Bill 2019, which was lost on the
dissolution of Parliament before the election on 12 December 2019, or something
similar to it, will be introduced during the present parliamentary
session. The bill is expected to provide for collective money
purchase benefits and schemes and the repeal of substantial parts of the
Pension Schemes Act 2015.
“Defined
Ambition” was the term previously used by the government for a new category of
risk sharing pensions to be introduced alongside defined benefit (DB) and
defined contribution (DC) pension schemes.
The new term for the same concept is collective defined contribution
(CDC). The government wrote in 2014 “We
want to encourage risk sharing to provide more certainty and stability in
pensions for individuals than DC pension schemes [and] less variation in costs
for employers than DB pension schemes”.
It introduced provisions for this purpose, in the Pension Schemes Act
2015, which have not been brought into force and are likely to be repealed and
replaced by new provisions for CDC schemes,
The
key to understanding CDC is to describe the present form of DC as
“individual”. Each member of a DC scheme
has his or her individual savings “pot” to provide individual retirement
benefits according to his or her individual means and expectations. In contrast with this, no member of a CDC
scheme has an individual pot, but all
contributions and investment returns are held collectively, as in a DB scheme,
out of which a standardised level or rate of benefits is payable to all
members; but not as DBs, because in a CDC scheme (a) the employer has no
liability whatsoever except for fixed contributions and (b) member’s benefits
(eg a pension of 80ths of salary) can be increased or reduced on
actuarial advice.
For
a more detailed example, see the Royal Mail’s anticipated pension design for
its CDC scheme, published in November 2018, after it and the Communication
Workers Union had agreed it, subject to legislation, at the following link.
https://www.royalmailgroup.com/media/10542/scheme-design-summarybooklet.pdf.
In
short, a CDC pension scheme is not unlike a targeted money purchase scheme, or
even older DB schemes, when there were no sanctions for insufficient funding
and the DBs were no more than ambitions.
The
summary of the government’s response: Delivering CDC pensions schemes, last
updated 18 March 2019, states “Advantages of CDC schemes include that they:
− provide a savings and income in retirement option within one
package that is potentially attractive to people who are uncomfortable making
complex financial decisions at the point of retirement;
− enable the sharing of longevity risk between members,
therefore providing each individual member with an element of longevity
protection without the cost of accessing the insurance market; and
− allow employers to offer their employees a pension scheme,
which offers an income in retirement in the form of a pension from the scheme’s
own assets, but without the risks and balance sheet impact of sponsoring a
defined benefit plan.”
Although
the advantages of spreading risks and possibly negotiating better value terms
for investment management are greater for big schemes than for small, the 2019
Bill contained no provision expressly preventing small schemes from giving CDC
benefits and thereby being able to pay scheme pensions.
the historic reasons for CDC
The
cost of funding and the benefits provided by pension schemes are no different
in principle from the position and momentum of sub-atomic particles in quantum
theory: in both cases neither variable can be measured accurately and
simultaneously with the other. The rule
in quantum physical is known as the Heisenberg uncertainty principle, My description of the rule in pensions is the
finance director/employee friendly principle.
A
DB scheme (whether final salary, average salary or some other measure) is
employee friendly, because one knows throughout what the employee’s pension
will be in relation to his or her pensionable salary and length of pensionable
service on retirement, but it is finance director unfriendly, because the cost
of providing it is unknown and must be guessed on the basis of the scheme
actuary’s scrupulously careful and detailed calculations on a foundation of
sand (assumptions of future interest rates, investment returns, longevity etc).
Conversely,
a DC (money purchase) scheme is finance director friendly, because one knows
throughout what the cost is, what contributions must be paid, but it is
employee unfriendly because no one knows what pension he or she will received
on retirement, the amount of which could be guessed on an actuary’s calculation
as above, except that few employees could afford an actuary and the financial
services legislation, whose purpose is to protect consumers, makes it
impossible for anyone else to guess them, except in the most generalised
terms.
The
stark choice between the two, FD friendly or employee friendly, crystallised on
24 July 2014, when (pursuant to the DPW’s announcement on 27 July 2011, the day
of the judgment in Bridge Trustees v Yates [2011] UKSC 42, that the government
would introduce legislation to reverse the effect of the judgment) the Pensions
Act 2011 s29, which altered the definition of “money purchase” in the Pensions
Schemes Act 1993, came into force, but backdated to 1 January 1997. The finding in Bridge Trustees was that the
payment of pensions out of the scheme’s assets, using a table of factors
provided by the actuary, did not prevent the benefits from being money purchase.
Before
29 June 1992, when s58B (Deficiencies in the assets of a scheme on winding up)
was inserted in the Social Security Pensions Act 1975 by the Social Security
Act 1990, final salary pensions were secure only if there was enough money, and
winding up clauses abated benefits if the assets were insufficient.
In
conclusion, if the Government introduces CDC as expected, it will in effect
reverse its reversal of the Bridge Trustees decision, albeit with more
regulation and provisions that a court cannot find that a CDC scheme is not
money purchase.
END
copyright Roderick Ramage
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