Why Royal Mail’s new pension scheme could be a game-changer

“It’s a massive moment,” says Paul Waters of Hymans Robertson, who reckons the trailblazing move by Royal Mail will catch on. Other large corporate clients are watching very closely to see whether CDC could work for them too, he says.

Others are similarly persuaded. Chintan Gandhi at Aon, which did some of the preliminary research for Royal Mail, says CDC will come to be seen as “one of the greatest innovations in UK pensions in generations”.

Rubbish, reckons John Ralfe, an independent pensions consultant and a frequent commentator in these pages. “It’s the biggest damp squib you can possibly imagine.” He detects no serious intent from anyone to follow the lead of the parcels company. “It’s all about providing work for under-employed consultants,” he says.

Ouch. Not for the first time in the esoteric world of pensions, the experts are divided. And it will be a long time — a century should be just about enough — to know for certain who is right.

The basic principle behind CDC does seem persuasive. Savers in bog-standard employer-sponsored DC schemes start to de-risk their pots from their mid-50s and often buy an annuity with the pot when they retire in their mid-60s. If they live into their 80s, they spend 30 years condemned to receive the fruits of low-risk but low-return assets.

Individually, this may be sensible. Collectively, it is madness. CDC, in essence, socialises investment risk among different workers and different generations. Schemes stay invested in riskier assets and so generate higher returns. Smoothing means no particular cohort misses out just because they happen to be unlucky in the timing of a bear market, say.

It’s all underpinned by the equity risk premium. Shares compensate patient investors for the higher risk they are shouldering with higher returns in the long run. It’s a force that has worked for more than a century across dozens of markets. Shares on average outgun bonds by 3 per cent or more in real terms each year. Simply put, CDC harnesses this potent force for much longer than DC.

Nothing is guaranteed, however. CDC scheme members are given a target retirement income number but this is adjusted every year and could be cut after a protracted or deep stock market slump. This actually happened with some Dutch CDC schemes after the financial crisis of 2007-09.

Backtesting of its CDC model by Aon suggested that only once in the past 90 years, immediately after the Wall Street Crash of 1929, would trustees actually have to take the extreme step of cutting pensions in payment. Most crashes could be weathered merely by reducing the pace of benefit increases.

Ralfe is not convinced. The intergenerational risk-sharing that supposedly underpins CDC is a myth, he says. Under UK rules, the trustees are not allowed to “store up” above-average investment gains in the good years to build a buffer and so soften the blow in the bad years.

The potential policy prize of significantly bigger pensions is too important to be ignored. The claimed benefits of CDC dwarf most wheezes for boosting retirement incomes — not least this government’s drive to prod schemes into greater investment in UK infrastructure and private equity, or the London Stock Exchange’s lobbying to push them into London-listed shares.

It is deeply seductive, too. Hard-pressed workers are in no mood to up their retirement saving just now. How much easier it would be if only more jam tomorrow could be generated without any extra sacrifice of jam today.

The government has had to play a part. CDC was illegal until 2021. Two sets of legislation have been introduced to get this far and the Department for Work and Pensions this week said it was consulting on a further boost — enabling multi-employer schemes to adopt CDC.

That would open up CDC as an option for millions of smaller employers that do not have the scale to do it individually. Andy O’Regan, client director at the Leeds-based master trust TPT Retirement Solutions, which operates schemes for 2,500 employers and 450,000 employees, says he is seeing “great interest” in CDC from clients sponsoring both guaranteed defined benefit (DB) schemes and DC schemes. The Church of England is so far the only major employer to go public in saying that CDC might play a part in its future plans.

The big question is how many employers will really want the hassle and cost of adopting CDC. A superior pension scheme would be a fabulous employee benefit but tends to be under-appreciated by staff. HR bosses will have to be persuaded that CDC would really help in attracting and retaining staff — and that requires a persuasively superior track record which the new system won’t have for years, or perhaps ever.

Two other observations are worth making. The first is that if the CDC narrative gains traction, it will draw attention to just what a poor choice annuities are, just as the insurance industry is starting to sell more of them again on the back of higher interest rates. A new report from Willis Towers Watson claims that members of schemes that introduce a CDC option at retirement would be 40 per cent better off.

The second is that if these eye-catching claims for the superior performance of CDC pensions are even remotely correct, then employers — and ministers — were guilty of a terrible dereliction of duty when they failed to introduce them 25 years ago, when DB schemes were shuttered in their thousands.

Patrick Hosking is Financial Editor of The Times