1Introduction
The UK private pensions system
1.There are two main types of private pension in the UK:
a)defined benefit (DB), which promises members a specified regular pension income in retirement paid from a collective fund; and
b)defined contribution (DC), in which employer and employee contributions accumulate in an individual investment pot, which is used by the employee to purchase a pension product on retirement.
Defined benefit pensions
2.In DB schemes, the sponsoring employer takes the ongoing funding risk: if the scheme has insufficient assets to meet its pension promises, the employer must make additional contributions. DB pensions have been in steady decline. Sponsoring employers have found meeting their pension obligations difficult in the context of increased life expectancy, low interest rates and the decline of some traditional industries.1 In 2016, 1.3 million employees were actively contributing to a private sector DB scheme, compared to 3 million a decade previously.2 Many companies have sought to reduce financial risk by closing schemes to the accrual of further pension benefits.3 Alan Rubenstein, former chief executive of the Pension Protection Fund (PPF), which pays reduced pensions in the event sponsoring employers become insolvent, said “we now all recognise that we are moving towards an endgame for defined benefit pensions”.4
Defined contribution pensions
3.Closed DB schemes are typically superseded by DC arrangements, and new private pension schemes are now almost exclusively DC.5 Membership of DC schemes has expanded dramatically in recent years following the introduction of automatic enrolment in 2012. Nearly 10 million employees have been automatically enrolled into pension saving.6 Guy Opperman MP, the Minister for Pensions (the Minister) described this as a “success story on a level and a scale that is beyond anyone’s wildest hope and aspiration”7—an assessment with which we agree.
4.In a DC scheme, the individual saver shoulders the risk that their investment falls in value or doesn’t perform as hoped.8 DC saving is also, in effect, a tax-advantaged individual savings vehicle rather than a pension.9 When an individual decides to start drawing a retirement income they must identify a suitable retirement income product from a range of options. Those include:
- Annuity—an insurance product that offers the individual a guaranteed income, usually for the rest of their life.
- Drawdown—a product that enables the consumer to withdraw some income as cash while leaving the remainder invested in funds.
5.Individuals, many of whom will have been saving passively, can find making an appropriate choice of retirement income product difficult.10 Drawdown options are currently twice as popular as annuities.11 Annuities have offered poor value in recent years given low interest rates. The regular income generated is also dependent on the value of the pot at the point of purchase, which can leave it at the whim of market conditions.12 Drawdown may provide higher total returns and the pot remains invested, meaning it is less dependent on market conditions at a single point in time. But the individual bears ongoing investment risk and could exhaust their pot, particularly if they live longer than they expect (this is known as longevity risk). Research suggests that a high proportion of DC savers aspire to a predictable, regular income in retirement—one survey found that over two-thirds of DC savers counted themselves as either “certainty seekers” or “steady spenders”—without having to manage risk on an individual basis.13
Collective defined contribution pensions
6.The UK pension system is therefore polarised between declining DB schemes underwritten by employers and offering guaranteed regular incomes, and growing numbers of individual DC savings pots subject to risk and uncertainty.14 It is in the context of these challenges that we decided to examine collective defined contribution (CDC) pensions.
7.CDC pensions, which are not yet available in the UK, have received increasing interest as a means of retaining some of the benefits of DB and DC pensions while addressing some of the problems of each. The term CDC has been applied to a variety of existing and theoretical schemes with different characteristics.15 Their shared fundamental features are:
- Collective: the risks that arise in any pension scheme (longevity, investment and inflation risk) are shared collectively among the scheme’s members rather than being borne individually.
- Defined contribution: the respective contributions of employee and employer are defined in advance, with no ongoing liability to pay more to cover deficits.
CDC offers a target benefit rather than a promised benefit. The primary tool for addressing underfunding of the pension target is through reducing the benefits (through lower indexation or cutting pensions in payment) to ensure that the scheme’s assets and liabilities remain aligned. As a result, risk is borne by the scheme’s members without recourse to an external sponsor.16
International context
8.CDC schemes are a major part of the pensions landscape in the Netherlands and Denmark.
- The Netherlands: has around 260 CDC pension schemes, including 183 company pension funds, 58 industry-wide funds and 9 occupational funds.17 Dutch pension schemes are characterised as CDC in that the contribution rate is fixed and the benefit is variable. Participation is effectively mandatory, meaning that around 95% of employees are members. Schemes are regulated by the Dutch central bank (De Nederlandsche Bank) which requires schemes to adopt a recovery plan (involving benefit reduction or deferral of indexation) if funding drops below 105% of target benefits.18
- Denmark: has a statutory pension fund, ATP (Arbejdsmarkedets Tillægspension, or “labour market supplementary pension”), which was created in 1964 to provide an earnings-related CDC-style pension to supplement the state pension.19 Employers and employees make flat-rate contributions to ATP on a 2-to-1 ratio.20 Enrolment is compulsory for all employees in Denmark. The ATP and state pension combined provide 80% of the total retirement income of Danish pensioners.21 Employees are also typically enrolled in quasi-mandatory sector-wide pension arrangements.
The two countries are widely recognised as having among the best pension systems in the world.22
2 ONS Occupational Pension Schemes Survey 2016, table 3
3 Written evidence from KPMG (CDC0016). The proportion of private-sector DB schemes that are closed to future accrual increased from 12% in 2006 to 39% in 2017. See PPF Purple Book fig 3.2 Distribution of schemes by scheme status and year, p11
6 TPR Automatic enrolment declaration of compliance: monthly report June 2018
10 Written evidence from B&CE Ltd (CDC0041) and Unite the Union (CDC0006). The reports published as part of our Pension Freedom and Choice inquiry contained recommendations aimed at ensuring that DC savers are equipped to make well-informed choices and are well served by the pensions marketplace.
11 Financial Conduct Authority (FCA), Retirement Outcomes Review Interim Report, July 2017, para 1.7
12 TUC blog (30 Oct 2017) “Workers must be protected from pension roulette, says TUC”; TUC blog (14 Nov 2017) “Pensions: the retirement lottery”
13 Aon (Dec 2014) In a brave new pensions world what will DC members really want? Aon DC Member survey. Cited in written evidence from Royal Mail Group (CDC0033) Also written evidence from TUC (CDC0019) and Unite the Union (CDC0006).
16 Vews differ as to whether CDC can be classed as a form of “defined ambition” scheme [eg KPMG CDC0016], in that it aims to pay out a target benefit but with no guarantee, or whether the two terms are mutually exclusive: The Pension Schemes 2015 Act categorises “defined ambition” as synonymous with “shared risk” schemes which share risk between members, sponsoring employers and potentially third parties. For the purposes of this report, and in line with the 2015 Act, the term “defined ambition” is not applied to CDC, as CDC involves risk-sharing among scheme members only.
17 De Nederlandsche Bank pensions statistics accessed June 2018
18 Pension reforms in the Netherlands this millennium; from DB via CDC to DC? Presentation by Bastiaan Starink (Tilburg University, Netspar and PwC) to Pensions Workshop at Cass Business School, 9 April 2018
19 InDepth: collective DC in action, David Rowley, PensionsExpert 3 April 2012
20 ATP contribution rates 2016–2018 from virk.dk website, accessed June 2018
21 “Around ATP Livslang Pension,” atp.dk website, accessed June 2018
22 The most prominent global ranking of national pension systems, the Melbourne Mercer Global Pension Index, has placed Denmark and the Netherlands first and second in the last three editions (2015 to 2017). Both countries scored an ‘A’ grade in 2015 and 2016, meaning a “first class and robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity.” Denmark and the Netherlands also rank 2nd and 4th in the 2016 Allianz Pension Sustainability Index.
Published: 16 July 2018