Collective defined contribution pension plans could begin to replace DC plans, just as DC plans have replaced the majority of defined benefit plans in recent decades, according to a new paper from the U.S.-based Brookings Institution.
CDC plans, also known as hybrid retirement plans, combine elements of DB and DC plans. They pool contributions from plan members and employers in professionally managed funds. And like traditional DC plans, fund managers target future annual benefit levels, but don’t guarantee these amounts.
“For plan sponsors, CDCs avoid volatile funding costs by accepting fixed employer contributions correcting this drawback of DB plans,” said the paper. “For workers, CDCs pay benefits in the form of periodic retirement income (rather than lump sums), pool longevity risk across participants and provide pooled, professional investing, correcting these weaknesses of most DC plans.”
According to the authors, Brookings Institution senior fellows William Gale, Mark Irwy and David John and research analyst Christopher Pulliam, CDCs allow employers to avoid the cost of funding DB pension-style benefits and plan members benefit from professional investment management and the pooling of individual longevity risks.
“This pooling also enables people to confidently save for an average life expectancy rather than needing to save for an extremely long one,” noted the paper. “In addition, CDC plans’ pooling of investment and longevity risk and lack of guarantee of benefit amounts enables them to provide lifetime retirement income in-house; they have the option but not the necessity of purchasing commercial annuities.”
The report analyzed the performance of CDC plans in a number of countries. It highlighted the success of a number of public and private sector DB pensions in New Brunswick that were considered to be without viability after the financial crisis of 2008/09.
“As a result, several underfunded public and private sector DB plans in Canada moved or are moving to a new shared-risk program somewhat similar to the Netherlands’ defined ambition approach,” said the report. “The Canadian shared-risk model prescribes funding and risk management goals (including financial stress tests and projected funding ratios) with pre-determined cuts or increases in benefit payouts and increases or reductions in employer and employee contributions, as well as changes in asset allocations in response to changes in the plan’s financial condition.”
The authors concluded that transitioning a DC plan into a CDC plan may make sense for organizations eager to provide better retirement benefits than are traditionally offered by a DC plan without the costs associated with a DB plan.
“Looking beyond the conventional, traditional DB and DC plan designs to explore a new, richer and more nuanced array of risk-sharing and pooling strategies is a welcome development that will help identify more optimal allocations of financial risks and retirement benefits.”