Going Dutch: What is a collective pension scheme?
- 4 June 2014
- From the section Business
Once, personal pensions were simple. You paid money in every month, and you knew how much cash you would receive once you retired.
But this "defined benefit" model now provides gold-plating only for the lucky few.
Many more people now pay into a scheme based on "defined contribution" (DC).
That means you know exactly how much you are paying in.
But you do not know for sure how much you will get out - i.e. how big your pension will be.
As a result, the government wants to allow Dutch-style "collective" defined contribution schemes, known as CDCs.
Such schemes are designed to give people more certainty over their retirement incomes. It is claimed they can also increase the value of pay-outs by around a third.
What does a collective scheme do?
The best way to think of a collective scheme is to see it as being halfway between a defined benefit scheme and a defined contribution scheme.
From an employer's perspective, there is no risk, as he or she will pay out the same amount every month. That makes it look like a defined contribution scheme.
But from an employee's point of view, there is a target for what he or she will receive on retirement.
For example, the target might be 30% of their salary, after they retire. That makes it look like a defined benefit scheme.
Why are they called "collective" schemes?
Conventional pension schemes involve hundreds, or even thousands, of employees. But in collective schemes, tens of thousands of employees get together in a single pension plan.
A collective scheme might therefore involve workers across an industry - such as shop workers, or taxi drivers - rather than a single company.
Do they provide better returns?
They can do. Their larger scale means their costs are lower. Unlike conventional DC schemes, they do not have to account for each employee's individual pension pot.
They are also able to invest in longer-term assets, such as transport projects or mortgages.
For accounting reasons, other pension schemes rely more on the bond markets, which are stable, but can provide lower returns.
But unlike a defined benefit scheme, these returns are not guaranteed. For example, in 2012, a quarter of the schemes in the Netherlands cut pensions by an average of 1.9%, to restore their finances.
Is it true they can provide a pension which is 30% larger?
David Pitt Watson, the chairman of Hermes Focus Asset Management, has said returns on CDCs can be "up to 39% " higher than DC schemes.
A study of CDCs between 1955 and 2011 by consultants Aon Hewitt compared them with defined contribution schemes.
It concluded that those retiring on the average DC scheme received 21% of their previous salaries. Those on a CDC scheme received 28% of salary, out-performing the DC schemes by 25%.
But the study also showed that CDCs did not provide superior returns in every year.
Between 1994 and 2004, the reverse was true. However, the study argued that CDC projections are much less volatile. "The pension journey is more stable and contains fewer surprises," it said.
Some pensions experts, including Tom McPhail at Hargreaves Lansdown, say they doubt that such returns are actually achievable.
So what are the disadvantages of CDCs?
•There is no guarantee that workers retiring will actually receive the target proportion of their salaries.
•Workers using defined contribution schemes will get new freedoms to use their pension pots as they like from April 2015. It is not clear whether CDC members will get the same freedom.
•DC workplace pension charges will be capped from April at 0.75% a year. It is unclear whether such a cap will be imposed on CDC schemes.
Could CDC schemes work in the UK?
Critics argue that the Netherlands has a very different social structure from the UK, so collective schemes might prove difficult to run here.
They would need serious co-operation between different employers, to sign up hundreds of thousands of employees.
And following the government's auto-enrolment initiative, all but the smallest companies are already signed up to pension schemes.
The TUC is an enthusiastic supporter of CDC schemes. But it believes employers will need substantial incentives to start them off.
Several Dutch pension funds have said they would be happy to launch schemes in the UK.
Is it true the Dutch actually want pensions more like the British?
The youth wings of three Dutch political parties have come together to push for pension reforms in Holland. But there is no widespread revolt against CDCs.
Pensioners in Holland enjoy much bigger pensions than those in the UK, but that is partly because of higher contribution rates.
Dutch workers contribute between 21% and 25% of their pre-tax pay to their pensions. In the UK, we contribute 9.4%.
Who runs a CDC scheme?
The schemes are run by a group of actuaries. Rather like "with-profit" schemes, the actuaries declare the pension pay-out rate for every year.
They can decide to cross-subsidise the generations, by cutting or increasing payouts for workers in a particular age range.