What does the collective defined contribution (CDC) code of practice include?

Need to know:

  • The Pensions Regulator has published a new code of practice for employers that would like to introduce collective defined contribution (CDC) pension schemes.
  • The code lays out the detailed and extensive process employers will need to go through to receive authorisation.
  • It is early days for CDC in the UK, but Royal Mail has blazed a trail for other UK employers to follow. At this stage, CDC is really most likely to be of interest to large employers, perhaps ones where there is heavy unionisation.

The Pensions Regulator (TPR) has published a new code of practice for employers that want to introduce collective defined contribution (CDC) pension schemes.

Popular in the Netherlands, CDC is widely seen as a compromise between the generous, old-style defined benefit (DB) pension schemes and the modern defined contribution (DC) schemes, which typically have lower contribution rates and in which individuals shoulder their own investment risk.

They were championed by Guy Opperman, who recently resigned as minister for pensions. Opperman said in June 2022: “Collective defined contribution pension schemes have the potential to transform the UK pensions landscape and deliver better retirement outcomes for millions of pension savers.”

CDC schemes could give employers a competitive edge, says Hari Mann, co-chair of the RSA’s CDC Forum. “I think we are at a point where we are seeing more employers thinking about how they can enhance employee benefits, especially when it is difficult to increase salaries at this point in the economic cycle, particularly when the regulatory guidance says ‘Don’t increase salaries, you will fuel inflation.’ How do you then improve employee benefits in other ways?”

In a CDC scheme, members share investment risk, as well as the financial risks associated with living unexpectedly long lives. Contribution rates are fixed for employers. The pensions paid to members will depend on how well funded the scheme is, which will be determined by investment performance. Chintan Gandhi, partner and head of CDC at Aon, says: “Typically, CDC pensions are likely to be considerably higher than DC pensions.”

A conservative estimate of the uplift would be 30 to 40%, says Mann, who has analysed numerous research papers on the subject.

In the past, most people assumed there would be limited interest in CDC among UK employers, because so many had already closed their DB schemes and opened new DC schemes. However, Royal Mail’s decision to introduce a CDC pension scheme for its workforce has changed the conversation.

Royal Mail agreed with its union, the Communications Workers Union, that CDC pensions would meet their mutual objective to provide employees with sustainable, affordable and secure retirement arrangements.

The Pensions Regulator’s code of practice

Introducing a new type of pension scheme required UK government legislation. The latest step in this process is TPR’s new code of practice, which was issued on 1 August 2022. The code of practice sets out the process for UK employers that want to apply for authorisation of a CDC pension scheme. Employers must go through the authorisation process if they want to launch a CDC scheme. So, what are the main points for them to bear in mind?

To be authorised, a CDC scheme must meet six key authorisation criteria. The people who run the scheme must be deemed fit and proper. That means being honest and having knowledge appropriate to their role, among other qualities.

The scheme must have IT systems in place, and robust governance processes.

Those running the scheme must be able to communicate with members so that they understand the risks and benefits of the scheme; this is so important in the context of CDC, where benefits can be cut if investments underperform.

The scheme must have a continuity strategy, in case the employer runs into financial difficulties. It must also have sufficient financial resources to operate.

Finally, it should be able to demonstrate a sound design, with a viability report containing evidence from external professional advisers.

Other considerations

Only the serious need apply for authorisation. When submitting an application, a standard fee of £77,000 must be paid to TPR.

Katy Harries, associate director at law firm Sackers, says: “At this stage, CDC is really most likely to be of interest to large employers, perhaps ones where there is heavy unionisation. They may still have open DB schemes. It will be interesting to see whether demand for CDC will come from employers or from unions.”

It is still very early days for CDC in the UK. “I imagine there will be a lot of waiting and seeing what happens with Royal Mail,” says Harries. “Unless [an employer is] the size of Royal Mail, why would [it] be a market leader on this? CDC is expensive and unknown for everyone, and a huge amount of work must go into underpinning it.”

The word in the industry is that several other large employers are having serious conversations with their advisers about introducing CDC. Some of the bigger pension consultancies have also appointed heads of CDC, with supporting specialist teams, showing that they anticipate future demand.

Master trust pension schemes may also look to incorporate some form of CDC into their investment design. However, as yet, no legal basis exists for them to do so.

Gandhi says: “Any employer [that] is seriously considering introducing a CDC pension scheme should start by consulting their advisers and TPR.”

The RSA’s CDC Forum could point a large employer in the right direction, suggests Mann, who adds: “The place to go to is current scheme actuaries, because most of them are talking about this right now.”