This has the potential to open CDC schemes to a much wider audience. To be successful, CDC needs scale. Without multi-employer arrangements, they will likely only be available to the largest employers. Additionally, this is a new type of arrangement in the UK. The startup costs are therefore likely to be high – which will be prohibitive for many.

However, running a multi-employer CDC scheme comes with a new set of challenges compared with single-employer arrangements. In this article, we’ll focus on one key challenge – setting an appropriate accrual rate. In other words, how contributions are converted into target pension amounts.

Creating scale

There are currently no established multi-employer CDC schemes in the UK or a defined blueprint for how they should be designed. So, we’re still just theorising at this stage. But let’s assume, for the purpose of this article, that in a multi-employer CDC scheme, all members irrespective of employer would be pooled together, with a central fund for all the scheme’s assets. This would be the easiest way to create scale and bring the benefits of CDC. We also assume that the main design features of a multi-employer CDC scheme would be the same as a single-employer CDC scheme.

Contributions are made by the employer and employee, and paid into a central fund. For these contributions, members accrue a target pension – an income payable from retirement age until death. But how will schemes convert contributions into accrued target pension?

Fixed accrual

One of the simplest methods is to use fixed accrual as a percentage of salary e.g., 1/80th. This is how most legacy defined benefit (DB) schemes worked. Here, members accrued a fixed percentage of their salary each year as a pension benefit, irrespective of age. However, the reality of this approach is that younger members are subsidising older members due to the difference in the value of £1 accrued by a 20-year-old today versus £1 accrued by a 55-year-old at the same time. The £1 accrued by the 55-year-old is worth more because they are closer to receiving their pension (less discounting). There are other factors, such as differences in life expectancy, but the main factor is time to retirement. For this reason, I can’t see a multi-employer CDC scheme using fixed accrual. So, what’s the alternative?

Actuarial equivalent factors

The alternative would be converting pension contributions based on actuarial equivalent factors – think commutation factors in DB world with best-estimate assumptions. These factors would be age-dependent, so the 20-year-old would accrue more pension for the same contributions compared with the 55-year-old, to reflect the difference in the actuarial value. If done on this basis, the transfer value just after the pension was accrued would be equal to the contributions made (assuming assumptions are consistent, which I think they should be). This seems fair. As an example, the chart below shows the age-dependent accrual rates calculated in our CDC simulator where contribution rates remain fixed. This method has the added benefit of providing an incentive for younger members, which could be used to encourage pension savings at an earlier age.

Source: abrdn CDC simulator[1]

Another benefit of this method is that it would accommodate different levels of contributions across different employers. Some employers may want to contribute more, and this would be reflected in higher pension accrual for those employees.

From this, you might conclude that actuarial equivalent accrual means any new accrual into a multi-employer scheme would not change the scheme’s funding position. In fact, the answer depends on the pension increase assumption used in the accrual calculation.

Pension increase assumptions – option 1

I believe there are two options for pension increase assumptions. The simplest is to price accrual based on a central long-term pension increase target for the scheme, for example, the Consumer Prices Index (CPI). The conversion factors would then reflect the cost of providing a pension assuming CPI increases each year.

However, this could potentially be unfair, depending on the current position of the CDC scheme. For example, a strong investment performance for many years would be reflected in higher pension increases in a CDC scheme.

Let’s say the last awarded pension increase was CPI + 3%. This means the scheme is sufficiently funded to continue to award CPI + 3% each year in the future. If a new member joins the scheme and starts accruing pension, their accrued pension will also be expected to increase by CPI + 3% per year, irrespective of the conversion terms. However, if the conversion terms only assume CPI increases, the member will be getting a very good deal. The opposite is also true. In some scenarios, the pension increase expectation could be materially lower than what is assumed in the conversion factors.

One positive feature of always using the central long-term pension increase target for pricing new accrual is that a sufficient new accrual each year will help anchor the funding position back to this central target. If the scheme is overfunded on the central target (because pension increases are up at CPI + 3%, for example), the new accrual will be ‘cheap’ and bring down the funding position. The opposite is also true, helping improve the funding level if the CDC scheme is in a worse position where pension increases are currently less than CPI.

Pension increase assumptions – option 2

A fairer approach could be to update the conversion factors over time so that they always reflect the current pension increase awarded in the CDC scheme. This would mean that any new accrual does not impact the scheme’s funding position. It would also provide a truer actuarial equivalence conversion for members.

However, the downside of this approach is the uncertainty in the conversion factors year-on-year, leaving members unsure as to how much pension they will accrue. Very low CDC pension increases today mean they will accrue much more pension each year but with the expectation of low annual increases. Conversely, very high CDC pension increases mean the member will accrue a much lower pension each year but with the expectation of high annual increases. Over their retirement, the path of annual income could look markedly different in each of these scenarios. This is akin to the difference between buying a flat annuity and an index-linked annuity.

Comparing two approaches

To illustrate the difference between the two approaches, the charts below illustrate the dispersion of pension increases awarded in our CDC simulator. As expected, the results show that pricing new accruals based on the central target (3% in this case) helps anchor the pension increase for the whole scheme. If you instead assume the conversion factors for new accrual always reflect the current pension increase level, then the pension increase has more opportunity to drift materially from any central target.

Source for Figures 2 & 3: abrdn CDC simulator[1]

One solution to this issue is to have a cap and floor on the annual pension increase awarded in the CDC scheme. The recent DWP consultation specifically asked for views on this. For example, if increases are capped at CPI + 2%, and the scheme’s funding position exceeds this level, then an additional one-off increase would be provided on all accrued target pensions. This would bring the funding level back in line with a CPI + 2% future increase level.

This means new accrual would never need to be priced beyond CPI + 2%. The opposite could also work – a floor of 0%, with an explicit one-off pension cut beyond this level, is already part of the single-employer CDC legislation.

Final thoughts

The topic may seem complicated, but attention to detail will help ensure that multi-employer CDC schemes are fair to all members.

A focus on fairness will be important for multi-employer CDC – even if it results in a more complex scheme design requiring careful management and communication strategies for employers and members. With the right design, however, multi-employer CDC schemes could potentially change the future of pension provision, moving the UK private sector back to pension arrangements where, by default, members have the security of an income for life in retirement.