The Work and Pensions Select Committee described the adoption of collective defined contribution (CDC) pensions as a 'new Beveridge', a new chapter in delivering pensions. Unlike its defined contribution (DC) counterpart, CDC achieves the proper purpose of a pension: to deliver an income in retirement.Employers offer pensions because they are concerned about the welfare of their employees after they retire, but the present system is problematic. An employer can offer a defined benefit (DB) pension that will give an income in retirement, but the cost and risk in doing so means these are not affordable. Alternatively, a DC savings plan will give the employee a lump sum when they retire, but turning that into a retirement income is costly.CDC allows employers the opportunity to offer staff a retirement income much higher than DC, but without the costs and risks of DB, and it is tried and tested in pensions systems across the world. These systems, in the Netherlands and Denmark for example, are not without their problems, but the UK can learn from their experiences. There is no perfect pension solution, but they are superior to the current UK arrangements.So, how does CDC work? The purpose of a pension is to provide a reliable income in retirement. For any individual, that creates a problem, as they do not know how long they are likely to live for. However, we do know with greater accuracy how long, on average, a group of people will live.There is the need for pensions to find some way of harnessing collective arrangements to allow the sharing of ‘longevity risk’. Such collective arrangements are to be found in the provision of defined benefit (DB) pensions, and in the provision of annuities.When the DB pension system was created, it had some flexibility in the promises it made, and hence had CDC characteristics. However, during the '80s and '90s, the DB promise was hardened. In part, this was a response to organisations asking for ‘pension fund holidays’, and in part it was the unintended consequence of legislation. Ultimately, it made DB pensions unaffordable to private sector employers.Annuities collectivise risk through an insurance contract. The problem is that such contracts are costly; so much so that the government felt the need to introduce pension freedoms. These mean that pension savings do not have to be used to buy a lifetime income, to avoid annuity costs, but can be used as the individual sees fit.This leaves a gap. How can an individual save in a cost-efficient manner, for a predictable income in retirement? That is the gap CDC fills.
David Pitt-Watson (pictured) is a leading thinker and practitioner in the field of responsible investment and business practiceHari Mann is professor of strategy and innovation at Ashridge Executive Education
