Charge cap could be a barrier to CDC, experts fear

CDC schemes attempt to ‘bridge the gap’ between traditional defined benefit and DC schemes. For a fixed contribution rate, a CDC pension scheme has a target but not guaranteed amount the pension will pay out, which could even be cut.

Speaking in the House of Lords on February 24, Deborah Stedman-Scott, minister for work and pensions, confirmed the government’s intention “to implement an annual CDC charge cap set at 0.75 per cent of the value of the whole CDC fund, or an equivalent combination charge”.  

The average administrative charges are around £100 per member per year, but for smaller CDC schemes administrative charges three times that are not uncommon

Stefan Lundbergh, Cardano

Ros Altmann, a former pensions minister, also backed lower charges, saying the collective nature of CDC means costs “should be much lower per member than an individual DC scheme”.

The cap will mirror a limit on the costs that can be incurred by DC members saving into their scheme’s default fund. Modern master trusts now levy fees well below this cap, but have only recently acquired the scale to implement sophisticated investment strategies.

Experts speaking to Pensions Expert said the extra demands on a CDC scheme to deliver predictable income for members may make this charge cap a serious frustration in the short and medium term.

‘Legislative meddling’ must stop

Hugh Nolan, a director at Spence & Partners, condemned the decision: “This is a badly judged amendment by the Lords. A CDC scheme will be more expensive to run than a traditional DC scheme, but the expectation is that member outcomes would be better, even after allowing for the extra costs.”

He said the added complexities of running a CDC scheme, which would pool investments to pay pensions but also require administrators to be able to calculate an equitable share for withdrawal under freedom and choice, would increase costs.

As these administration fees also count towards the cap, CDC schemes would be “less able to take full advantage of market opportunities to benefit members”, compared with DC, Mr Nolan said. 

“This will be particularly challenging at the start of new CDC schemes, when the additional overhead costs will be spread over a relatively low level of accumulated funds. This is therefore a serious barrier to anyone wanting to set up a CDC scheme,” he added, cautioning against “legislative meddling” by badly informed politicians.

“This intervention demonstrates that our politicians have not learned the lessons from their destruction of DB schemes, though that is perhaps less surprising given that they still have theirs in force.”

Royal Mail still on track

Matthew Arends, head of retirement policy at Aon, agreed: “It is quite likely that in their early stages [with still rapidly growing asset sizes] compliance with the charge cap may be more problematic. In our consultation response to the Department for Work and Pensions, we did point this out and ask for an easement for ‘young’ CDC schemes, but it remains to be seen whether this is implemented in the relevant regulations.”

A key driver of progress on CDC legislation has been the demands made by Royal Mail and its trade unions. After a protracted industrial dispute over the closure of the now-privatised service’s decision to close its DB scheme, the two sides agreed to lobby the government for the creation of CDC.

Other employers’ appetite to follow suit has been distinctly lacking, but Royal Mail claims its own scheme is close to becoming reality, with the cap posing no hindrance.

A spokesperson said: “The proposal for a cap will have no impact on our wish to introduce a CDC pension scheme as soon as the legislative and regulatory framework allows.”

As yet no employer has opted to follow Royal Mail. Simon Eagle, senior director and head of CDC at Willis Towers Watson, stressed: “We need further regulations from the government to allow the introduction of CDC multi-employer schemes and master trusts.”

Clampdown on charges inspires confidence

Some experts said the principle behind the extension of the charge cap for DC, in force since April 2015, is sound.

John Reeve, director at Cosan Consulting, said: “One of the key issues with CDC is going to be building confidence. With this in mind, it is difficult to see how the regulators could contemplate anything different to a similar cap to auto-enrolment arrangements.”

He expected downward pressure on both charge caps, citing lower fees seen in Dutch CDC schemes.

However, Stefan Lundbergh, director of insights at Cardano, explained that the percentage fees seen in the Netherlands are somewhat dependent on pot size, as seen with some UK master trusts.

“For most CDC schemes, the investment charges are in the range of 0.4 to 0.5 per cent; somewhat higher for the largest schemes since they implement more complex investment strategies. The average administrative charges are around £100 per member per year, but for smaller CDC schemes administrative charges three times that are not uncommon,” he said.

Administration costs could be significant in CDC, in stark contrast with Baroness Altmann’s statements in parliament.

Penny Cogher, a partner at Irwin Mitchell, warns: “CDC are much more complex schemes to run than standard DC schemes – very specialist advice is needed, as well as highly experienced trustees. This is all expensive.”