UK employers with defined benefit (DB) schemes are being urged to move towards collective defined contribution (CDC) over pure DC, should the cost of their current schemes become unmanageable.
Consultancy Aon Hewitt has said employers should start considering the collective savings format in the wake of the abolishment of contracting-out.
In 2016, the UK will move towards a single-tier state pension, which removes the current system of a basic pension, topped-up by a second state pension (S2P).
Currently, employer-sponsored DB schemes are allowed to contract-out of the S2P, reducing their contribution to the government, in return for providing members with a higher pension.
The move to the single-tier removes this option and pushes up the contribution costs to DB schemes for employers by around 3%.
Matthew Arends, a partner at Aon Hewitt, said the increase in cost might make the cost of DB unaffordable for the very few employers still offering the scheme.
“We urge them to start considering CDC now,” he said. “It can be a desirable alternative to implementing a DC arrangement in 2016.”
Aon Hewitt also called on the government to provide more certainty on the timetable for legislative changes required before CDC can be implemented.
The government highlighted CDC as a viable option in pensions minister Steve Webb’s flagship reform – defined ambition, the search for hybrid options between pure DB and DC.
In a consultation on defined ambition, the Department for Work & Pensions (DWP) said the government was inspired by the Dutch and Danish systems, where risk sharing between DC members and employers, such as CDC, is more common.
In a speech to the industry in October, Webb also provided further backing for CDC, saying it was one of the core options he envisaged for the future of UK pensions.
CDC has received support from several sections of the UK pensions industry, across the political spectrum, although there has been some criticism over the legislative requirements.
Opposition party Labour’s representative for pensions, Gregg McClymont, also backed the exploration of CDC last autumn.
Despite the Labour government of 2009 ruling out CDC in a white paper, due to the “legislative burden” involved, McClymont went against this and said the current government was right to explore the collective schemes.
However, working against all positivity regarding defined ambition, and CDC, has been the abolishment of contracting-out.
The government has consistently been under pressure to create the legislative framework for defined ambition and CDC by April 2016, with employers with DB funds expected to close the schemes, and move towards pure DC.
However, realistically, with a general election expected by May 2015, the deadline for the legislative agenda would be the parliamentary session this autumn, where defined ambition and CDC join several other government proposals in-wait.
Aon Hewitt said it expected the publishing of the government’s response to its consultation on defined ambition shortly.
It said it also expected CDC to be enshrined into legislation by 2015, taking effect as contracting-out comes to an end.
However, Arends called on the government to provide certainty on the timetable for implementing CDC, in a bid to avoid employers having no alternative to pure DC.