Shared pain, shared gain: Will risk-sharing get its day in the sun?

Matthew Arends, partner at Aon Hewitt, said risk-sharing schemes could be set up in the UK today, but the option is rarely used.

“The scars of funding final salary DB plans run deep, and employers really do not want to take on any pension risk – and therefore with that mindset the answer is DC,” Arends explained.

Any kind of pension plan design, he said, would have to have fixed employer contribution rates, in order to attract employers.

There is a set of employers who think quality workplace pension provision is part of their mix, like health insurance or a company car

Steve Webb, Royal London

Arends said CDC could come back, if only at a later date: “There is a future for them, for this simple fact, which is that organising your pension savings for a member to deliver a retirement income for the rest of your life is very, very hard.” 

He added: “Now would not seem to be the time but I think as a country we will come back to this at some stage.”

A recently published paper entitled ‘The third way: a hybrid model for pensions’ looks at the experience with risk-sharing in the US state of Wisconsin, where a certain minimum level of benefit is guaranteed, with a variable element sitting on top.

David Villa, member of the State of Wisconsin Investment Board in the US, who is also a member of the 300 Club and authored the paper, argues that risk-sharing creates a win-win situation for employers and employees.

Employers can keep part of the extra value created and will have a workforce more open to reduced salaries in exchange for better pension provision, while employees value the reduction of risk compared to DC and reduction of benefit uncertainty compared with DB.

“By better aligning the interests of the employer and employee, the Wisconsin model creates a virtuous cycle of good governance that leads to better outcomes for both employer and employee, as well as society at large,” he said.

Charles Cowling, director at consultancy JLT Employee Benefits, said: “We have a situation where employers have got fed up with pensions costing them more than they thought they were going to cost, and so pure DC is the easy and obvious answer.”

Cowling added DC does not necessarily deliver a worse benefit than DB, “it’s just that most DC schemes aren’t as generous as DB schemes”.

CDC one option

But CDC schemes could be an option that some employers would consider offering. Speaking in a personal capacity Steve Webb, former pensions minister and now director of policy and external communications at insurer Royal London, said while not all employers would want to introduce hybrid schemes, they should have the option.

The $100,000 question is, if you set up a CDC scheme now, would it automatically by mistake fall into the DB framework and be very expensive to run? In my opinion no, I think you can set up a CDC now under the DC framework

Robin Ellison, Pinsent Masons

“My key point is, risk-sharing and risk-pooling should be part of the menu,” he said. 

“People used to say to me, you know, employers, they’ll never go back, and of course nobody is saying that they would be going back to full-blown DB… but there is a set of employers who think quality workplace pension provision is part of their mix, like health insurance or a company car,” he added. 

Webb said that while the Pension Schemes Act 2015 allows for CDC, there would need to be a bespoke regulatory framework.

For employers who have set up hybrid schemes in the past “it’s been kind of a DIY process”, he said.

“My argument was that if you want more of this, you want to avoid the risk that employers have to have all the DB regulation and all the DC regulation. The regulatory framework was designed in a very binary way.”

The $100,000 question

Robin Ellison, partner at law firm Pinsent Masons, said even though DB regulation would apply to the DB part of a hybrid scheme and DC regulation to the DC part, “in practice nobody seems to interpret it seriously”.

Referring to a meeting of scheme representatives with the previous pensions minister Steve Webb a few years ago, he said: “All of them said if it was available they would very strongly consider establishing a CDC system. I wouldn’t say everybody wants it and it’s not going to be compulsory because it’s just another option.”

Ellison goes as far as saying implementing CDC would be possible today, but added: “The $100,000 question is, if you set up a CDC scheme now, would it automatically by mistake fall into the DB framework and be very expensive to run? In my opinion no, I think you can set up a CDC now under the DC framework.”