Out-Law News | 04 Jun 2014 | 10:09 am | 2 min. read
The government is expected to announce a new Pensions Bill as part of the Queen's Speech legislative programme for the next parliamentary session. That Bill would provide for the introduction of collective defined contribution (CDC) schemes, in which individual pension contributions are pooled to form a single 'mega-fund' for investment purposes, amongst other reforms.
This type of pension scheme is not yet permitted in the UK but has been popular in other European countries, including Denmark and the Netherlands. However Deloitte, the professional services firm, said that the fact that 55 out of 415 such funds in the Netherlands actually reduced pensions in payment last year showed that this type of scheme was not without its drawbacks.
"Contributions to some Dutch funds tend to increase during economic downturns as their trustees prefer this solution to cutting benefits to deal with deficits," Tony Clare of Deloitte said. "The result can be that employers' pension costs increase and employees' take home pay reduces just at the time when people and business can least afford it."
"Young employees often perceive their contributions as a tax. Employees and employers pay level premiums to Dutch funds but as the costs of benefits are much higher for older employees, younger employees effectively subsidise the pensions of older workers. Dutch-style collective pensions are certainly an option, but great care needs to be taken in their design and communication," he said.
This weekend, the Sunday Telegraph reported that CDC pensions could be introduced in the UK "as early as 2016". Measures announced as part of the Queen's Speech would also introduce a legal right to independent advice for workers nearing retirement on how best to use their savings and give them more freedom to use their pension savings as they wish, as announced by the Chancellor of the Exchequer during March's Budget speech.
In a collective pension, employers and employees pay a fixed contribution but the pension risk is shared between members of the scheme. They have been particularly successful in the Netherlands, where such schemes pay benefits to members directly from the collective fund in proportion to that person's contributions rather than requiring the member to convert his or her individual contributions into an annuity.
By contrast, in a traditional DC scheme the final value of the pension fund a member receives depends on the performance of that member's individual contributions, meaning that it is that employee who bears the full risk of the pension losing value. The vast majority of the nine million people that the government expects to begin saving more towards their retirement or saving for the first time under automatic enrolment will be enrolled into DC schemes. Until now, DC savers have generally purchased an annuity from an insurance company that will convert the pension fund, or part of the pension fund, into a regular pension income.
CDC schemes were one of a number of proposals set out in a consultation paper on the future of workplace pensions issued by the Department for Work and Pensions (DWP) in November 2013. They would be classed as 'defined ambition' (DA) schemes for the purposes of governance, disclosure and funding requirements set by the pensions legislation and related regulation.
Pensions expert Robin Ellison of Pinsent Masons, the law firm behind Out-Law.com, said that although CDC schemes had some "idiosyncratic risks", there was "no such thing as a perfect pension system".
"Much depends on proper governance and trusteeship, although the risks are diminished by removing the profit motive," he said. "Most CDC schemes are run on the basis of non-profit-making trusts."
"There is always the suspicion that the trustees do not recognise falls in the market as longer-term, and therefore the current generation of pensioners may abstract excess benefits at the cost of the next generation of contributors. But that risk can work both ways. It will be up to employers and employees to decide whether they wish to adopt the mechanism, and in the early years the take-up may be modest. But anything which allows greater choice must be welcome and should lead to the strengthening of the sector," he said.