Collective defined contribution (CDC) is “not a magic bullet” in improving member outcomes, the Department for Work and Pensions (DWP) has warned.

Speaking at the PLSA annual conference, DWP head of CDC policy, Julian Barker, said: “The government believes that CDC has an important part to play in the helping pension scheme members get better outcomes than they would otherwise do in standard DC schemes, at a fixed cost to both the member and employer, but it is not magic bullet.

“There have been some issues from CDC schemes abroad, but it is important to remember that is has also been a huge success abroad as well.

"[They] are very highly regarded ... they provide some of the best pension incomes and best results for members anywhere in the world.

"But they have not got things necessarily 100 per cent right so we have done our best to learn our lessons and design CDC in a way that fits the UK environment.”

Also on the panel, Pensions Policy Institute senior policy researcher, Lauren Wilkinson, highlighted how “the UK system and UK CDC legislation is very different to what we are seeing overseas, so we shouldn’t assume the challenges they face overseas will be the same as what we will see here”.

For instance, CDC valuation in the Netherlands relies heavily on buffers and capital reserves, creating issues of intergenerational inequality.

Meanwhile, Denmark has both guaranteed and ancillary benefits that are discretionary, depending on the scheme funding position and Canada has a strong reliance on clear, predefined rules, she explained.

“Most international CDC systems do rely quite heavily on mandatory membership to get the scale and sustainability of those schemes, while in the UK membership will be voluntary, with members being able to opt out,” Wilkinson said.

“That raises questions over whether CDC schemes will be able to be sustainable, but I think the key difference is there is a more of a focus here on establishing trust, knowing that that membership will be voluntary.

"The role of inertia in the success of auto-enrolment should also help to mitigate [the risk of opt-outs],” she added.

The key lessons from the international CDC experience are around “the importance of predefined rules, having a transparent process in how schemes are designed and communicating that to members”, Wilkinson stated.

Barker gave the example of how, with intergenerational transfers, it is inevitable that some people will do better and worse. “But what you need to do is design a system where people can participate and not feel that the system is automatically designed in a way that disadvantages them against other people”.

To help with this, CDC schemes will have to set out in advance how accrual and adjustment rules will work and how adjustment mechanisms will work so that they operate in an “automatic way”.

“This will protect trustees from the pressures they may otherwise be under to try and manipulate the system to the benefit of pensioner members who may be considered more vulnerable than younger members… We have also made sure that when benefits are adjusted each year, they are adjusted in exactly the same way for active, deferred and pensioner members,” he said.

It also tackles the issues around buffers and intergenerational fairness, Barker explained.

He highlighted how CDC schemes will also need to be “completely transparent, publishing what factors they are using and if necessary, why they might be out of kilter with what people expect. We want them to be open to scrutiny”.

CDC schemes will also have to “work really hard on getting communications right”.

“We will be making sure that schemes monitor the effectiveness of their communications and if so, adapt their communications accordingly,” Barker added.

Wilkinson summarised: “It is really positive that so far the UK legislation and regulation really does seem to have learnt from the challenges we have seen overseas and adapting to be stronger and better. But there is still a lot of work to be done to get CDC to a successful point in the UK.”

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