Going Dutch isn't a free lunch
June 05, 2014
Proposed as the answer to the UK’s pensions challenges, collective defined contribution (CDC) provides a middle ground (of sorts) between defined benefit (DB) and individual defined contribution (DC) plans with the promise of economies of scale and fairer sharing of risk.
Although common in the Netherlands, we need to be cautious about adopting wholesale the Dutch system for UK workers. The Netherlands has a more collective approach to pension provision, and employers have been able to use this to roll previous DB schemes into the new CDC environment. Under Dutch regulation, it is possible to alter past benefit promises and this has proved attractive to employers. No less than 45% of the AEX25 has moved to CDC, giving it immediate scale. UK legislation simply will not allow this type of unilateral move.
The CDC system with large collective funds should provide better outcomes for savers through economies of scale and a more diversified investment strategy. However, the Dutch system hasn’t been properly tested yet and the early results show that the majority of CDCs are still loss-making two years after their introduction. Of the 500 or so Dutch plans, over 10% reduced benefits in 2013 and 29 did so again last year.
To work, CDC schemes must deal with the twin challenges of ever increasing longevity and variability of investment terms. A key challenge is how to split this cost should the CDC benefits prove to be more expensive than planned.
This introduces the risk of intergenerational unfairness in the CDC approach, and the Dutch experience shows that for collective schemes to be successful they need to be seen to operate fairly between generations. However, any type of collective scheme that transfers potential shortfalls to younger members will be viewed with suspicion. When Dutch benefit plans cut pension benefits earlier this year, these cuts were applied to existing pensioners - a political hot potato in the UK.
It is claimed CDC has the potential to deliver positive results, but we need to question whether it will gain employer support or actually even get off the ground. Moreover, CDC does not seem to sit well with the new pension flexibility promise from April next year.
Like conventional DC, CDC does not protect individuals from the investment or longevity risks in providing retirement income. It merely splits the bill in a different way between individuals.
Ultimately to get good retirement outcomes, there is no substitute for adequate pension savings. The challenge remains to encourage employees to save sufficiently for retirement. It is not clear that CDC achieves this aim.
Will CDC follow the story of Defined Ambition and end up dead on arrival?