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Collective DC plans - the Queen’s speech heralds more pension reform

4 June 2014

The Queen's speech heralds more pension reform with the introduction of Dutch style Collective DC plans.

But what are they and how could they work?

2014 was already due to go down in history as the year of the Great Pension Reforms but this is not enough for the Pensions Minister, Steve Webb, who has always had an ambitious agenda for pension change. Collective DC plans may be a possible answer to the problem of UK pension provision but there are many hurdles to overcome. They follow on from the DWP Consultation paper, November 2013, on reshaping workplace pensions for future generations. Interestingly this proposal also has support from Labour and the TUC. This is perhaps not surprising as the aim of Collective DC is to smooth out the peaks and troughs of investment risk, obtain cost savings and better returns through pooling and size, and provide a 'targeted' pension on retirement which, it has been suggested by Steve Webb, could be as much as 30% higher than current retirement incomes for some workers. However, this is hard to judge as there is no track record for this type of plan in the UK.

What are they?

Collective DC plans aim to be money purchase arrangements. Nothing is guaranteed. The employer would only pay an agreed fixed level of contributions to the plan for its members. A target pension would be provided on retirement but it is just that - a target pension payable from the plan, not a fixed pension to which a worker has a legal entitlement. Similarly pension increases for pensioners and revaluation for early leavers would not be guaranteed, or automatically payable, each year. They could be reduced or just not given. What is paid would depend on the plan's current funding position. This would vary according to its assets, liabilities, membership profile and what actuarial assumptions are used. As such Collective DC has many similarities to with profits arrangements, and these fell out of favour some time ago.

A Collective DC plan needs a large group of members, with the minimum being approximately 1000, to work. The idea is that such plans would be set up by the larger employer and/or trade associations as master trusts under a mutual type arrangement, rather than by more commercial providers. Good governance would be key. This will have to be carefully managed as recent events with the Cooperative Society have shown.

How could they work? What are the legal complexities?

Great care will need to be taken in setting up a Collective DC plan. Long awaited Regulations, flowing from the Supreme Court's decision in the Bridge Trustees case, due to become law in July 2014, clarify what a money purchase benefit is. They are drafted in a purist way, so anything that is not plainly a DC benefit is treated, for all purposes (funding and benefit terms, like revaluation and pension increases), as DB. Given this, a target pension benefit from a Collective DC plan could easily be regarded as a DB benefit and this would drive a coach and horses through the idea that Collective DC plans are purely DC plans. Given how long it has taken for the Government to decide what a DC benefit is, it's hard not to be concerned about how difficult it might be to provide a statutory definition of a Collective DC plan and in particular one which excludes the risk of Collective DC plans being treated as DB plans.

Another problem to navigate is the European funding rules contained in the IORP Directives. They apply to DB plans but what is a DB plan is broadly defined. One concern is that a Collective DC plan, by its nature, has to operate with biometric risks ie there has to be cross generational cross subsidy, with the young subsidising the old, for the plan to work. This may be sufficient for the ECJ, for example, to decide that, for funding purposes, a Collective DC plan has to be treated as a DB plan. The Dutch Collective DC plans are, in fact, treated as DB plans under the IORP Directives and funded as such. This is however because some DB plan benefits were transferred into the Dutch Collective DC plans some time ago and these transferred in benefits were given guarantees in the Collective DC plans.

Collective DC plans also potentially cause compliance problems with the Equality Act 2010, so this will have to be ironed out. This is perhaps inevitable given the cross subsidies between the younger and the older workers, and the healthy and the less healthy workers. However, the Equality Act derives from EU legislation and so it will be interesting to see how far it can be changed and still comply with the basic EU requirements.

Given all of this, it will be no easy task legally to introduce Collective DC plans into UK law.

How should it be explained to workers and members?

We think clear communication about Collective DC plans, with workers and members, will be essential. This should be legally vetted, given the potential legal pitfalls with such plans.

It will be difficult to explain to workers, and, we suspect, employers, exactly what a Collective DC plan is and we can expect there to be numerous variations on a theme, rather than each plan being identical in terms of what it offers.

Additionally, we now have the new legal concept of a worker having Reasonable Expectations about their pension arrangements, which can create legally enforceable rights against an employer in certain circumstances. It is fairly easy to see how a 'target' pension benefit, referred to year on year, could give rise to a definite expectation that this is the benefit the worker will receive and will continue to receive on and after retirement. We understand this aspect of Collective DC plans causes a problem in Canada, another country which has adopted Collective DC plans.

How do Collective DC plans fit in with current trends?

Because of how Collective DC plans have to operate, it is likely that the worker will only be permitted in very limited circumstances to be able to take his benefits out of the plan. This obviously goes against the idea of 'pot follows member' if a worker changes jobs, unless the new employer participates in the same Collective DC plan. It also goes against the principle underlying the new pension freedoms provided by the 2014 budget that members can and should, at retirement, take responsibility for their own retirement income.

It will be interesting to see how enthusiastically UK employers embrace the idea of Collective DC plans. Is it all just too much extra cost and change and risk? Are Collective DC plans just too sophisticated or too much of a sleight of hand for our workers?

Paternalism was the main reason employers set up pension arrangements for their workers in the past. With the ongoing decline of DB plans, due to affordability and complexity, and the problems that mainstream DC plans have, with the worker bearing all the pension risks, it is worth exploring further how Collective DC plans could operate successfully. They do offer a halfway house between the two types of pension provision. The challenge for Collective DC plans is to take the best of what they can from both types of offerings, rather than the worst of both, but this may be hard to achieve in practice. Ironically, the Dutch are now becoming attracted to our purist type of DC plan, with each individual worker having their own DC pot and for some, this will always have its advantages.

This all goes to show how hard it is to get pensions policy and reform right. There will inevitably be further tinkering and major reform over the years and with any type of pension plan with elements of 'pay as you go', there is also the beginnings of a potential Ponzi scheme.

For more information, please contact Michael Jones on +44 (0)20 7203 8917 or michael.jones@crsblaw.com