The Royal Mail Group Ltd. will soon make history in the United Kingdom by becoming the first employer to sponsor an entirely new type of pension plan, called a collective defined contribution scheme.
Under the U.K.’s Pension Schemes Act 2021, which received royal assent in February, collective DC pensions will essentially be a hybrid of defined benefit and DC plans. Employees receive a target retirement income and their yearly pension can vary based on the funded status of the plan. But, like a DB, employees benefit from the collective pot’s longevity and investment-risk pooling. And similar to a traditional DC plan, employers and employees make fixed contributions to the plan. In this model, risk is shared between plan sponsors and members.
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Once the bill is passed, the U.K. will join a small group of countries with such hybrid plans, including the Netherlands, Denmark and most of Canada.
Keep calm (find a compromise) and carry on
The Royal Mail (akin to our Canada Post Corp. national mail service) and the Communication Workers Union, which represents its employees, were the driving force behind the new legislation. The two parties teamed up to lobby the government after a 2017 dispute over the pension and other issues, says Terry Pullinger, deputy general secretary of postal for the union. The Royal Mail declined Benefits Canada’s request for comment.
The U.K.’s mail service was staring down a projected £1-billion funding deficit for its DB plan that was closed to new entrants and wanted to wind it down entirely and move the remaining employees over to its DC scheme. “It prompted the idea in me; I wasn’t satisfied with DC. I absolutely believe that wage in retirement is the only way for people to keep dignity and security in retirement,” says Pullinger. “They were in need of a solution, so out of adversity . . . it gradually made people more open-minded.”
The postal service’s incoming collective DC plan will ave roughly 140,000 members and has been designed with a lump-sum component of 3/80ths of their pensionable pay and a variable wage in retirement component of 1/80th of their pensionable pay. Each year, active plan members will receive an update on their lump-sum payout. When they retire, their wage in retirement could be subject to fluctuations, but Pullinger says the plan is targeting an annual increase of one per cent above inflation. Employees will contribute six per cent per year and the Royal Mail 13.6 per cent.
Strategies from across the pond
Canada’s target benefit pension plans, while largely similar to collective DCs, differ in a few crucial ways, says Rosalind Gilbert, senior actuary and associate partner in retirement solutions at Aon in Canada.
The U.K. government designed collective DCs for single employers with large and/or unionized workforces. But Canadian jurisdictions have been split on who should have access to target benefit plans. The Canadian and Ontario governments only allow for multi-employer target benefit pensions. British Columbia, Alberta, Quebec, New Brunswick and Nova Scotia allow for single-employer arrangements, often with risk-mitigation components such as a provision for adverse deviation and design variations on how benefits are calculated. Saskatchewan allows for a variation on target benefits, called limited liability plans.
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While U.K. legislation will only permit fixed contributions, some Canadian target benefit plans offer the ability to modify contributions within a range. There are tradeoffs for both approaches, Gilbert says. While U.K. employers will always have certainty around their financial commitment, Canadian plan sponsors using a range have “more levers” to pull before cutting benefits in the face of funding issues. She notes that for plan sponsors with unionized workforces, there’s value in having a range of contributions.
“In some jurisdictions in Canada, the legislation isn’t as prescriptive about what can be a target benefit plan . . . so in collective bargaining, it’s always nice to have some give and take if you can [to] put the contributions up a little bit or accept the slight decrease in the bargain. That may make the bargaining process better and it fits fine within the target regime.”
Notably, the two countries have taken different tacks with the thorny topic of intergenerational equity. If a collective DC scheme suffers a funding shortfall, the plan sponsor is required to cut benefits for retirees and active members alike.
Better retirement outcomes
Expected pension levels in collective DC plans are significantly better than traditional pension plans. For a given contribution rate, a collective DC pension is on average 70% higher than buying an insured annuity with an individual DC lump-sum at retirement and 40% higher than what’s provided in a typical DB scheme.
But in Canada, burbling discussions on this topic aren’t in favour of that approach. “If you have retired members in receipt of a pension, does it make sense to cut that 20 per cent and, at the same time, you cut an active member’s target benefit by 20 per cent? That active member has the ability to have that benefit restored, because they have more time,” Gilbert says.
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“What is actually the [right] way to treat the different cohorts? I think in Canada our legislation is flexible enough that that’s more of a design and governance conversation than a legislative conversation.”
Regardless which side of the pond plan sponsors are on, one thing that unites all hybrid plans is the need for member education. “There are question marks about how well understood and appreciated collective DC is,” says Neil Lloyd, Western Canada wealth leader at Mercer Canada. He points to a 2018 State Street Global Advisors survey of people’s trust in their pension systems: plan members in the Netherlands had the lowest trust rating. “I think what has happened in Holland is people have struggled to understand why their benefits keep changing. In a pure DC system . . . you know that if the market goes down, your DC balance goes down. In collective DC, it gets more complex to understand the relationship.”
Will more U.K. plan sponsors embrace collective DCs? It’s an open question. “Those that had already gone from DB to DC probably aren’t going to come back,” says Francois Barker, partner and head of the pensions group at U.K. law firm Eversheds Sutherland Ltd. “The only ones that might look are ex-public sector employers that are still accruing DB, who might look at it as a halfway house, or university education schemes.”
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Though in Canada the main target audience for target benefit plans is DB plan sponsors concerned about the cost of their plan, employers have been slow to adopt the model. In B.C., for example, the province’s Financial Services Authority said in its 2020 annual pensions report that just 36 target benefit plans were registered in the province — an increase of only six since 2017. The reason may be a lack of consistent legislation across the country. As well, Gilbert notes, there’s been an “unfortunate” lack of union support for such plans which created an initial barrier for some employers.
Back in the U.K., Pullinger says the union heard from many naysayers when it started down the collective DC path — and many were fellow trade unionists who’ve fought hard to maintain DB plans.
“I would agree, it’s the gold standard,” he says, but adds that the vast majority of private DB plans in the country are closed to new entrants, leaving many younger workers in individual DC plans and the times ultimately call for working creatively with employers.
He hopes the new plan will inspire other unions and employers. “I do feel we’ve . . . effectively, in respect to pensions, pulled up the ladder on the next generation. I think this is the answer. I like to think: ‘Build it and they will come.’”
Kelsey Rolfe is a freelance journalist.