Occupational Pension Schemes (Collective Money Purchase Schemes) Regulations 2022

Considered in Grand Committee

Moved by

That the Grand Committee do consider the Occupational Pension Schemes (Collective Money Purchase Schemes) Regulations 2022.

My Lords, this statutory instrument will implement the authorisation and supervisory regime for collective money purchase schemes. These are commonly known as collective defined contribution, or CDC, pension schemes. These will be the first schemes of their type in the United Kingdom pensions market. A further statutory instrument, the Occupational Pension Schemes (Collective Money Purchase Schemes) (Modifications and Consequential and Miscellaneous Amendments) Regulations 2022, will be laid shortly to implement further consequential amendments required for existing pensions legislation to accommodate CDC schemes. These further regulations will be laid using the negative procedure.

Before I move on to the detail of this instrument, I will remind noble Lords of the purpose of this new type of pension. The United Kingdom pensions market we see today has been built around defined benefit schemes, where the employer underwrites the pension benefits paid to employees, or defined contribution schemes, where individual members bear all the investment and long-term risks and where there are no employer guarantees regarding what the member might receive at retirement.

CDC schemes provide an alternative approach in which member and employer contributions are pooled and invested with a view to delivering benefits at the level to which the scheme aspires. They offer potential benefits in economies of scale and the opportunity for greater investment in higher-returning assets than are usually associated with defined contribution occupational pension schemes. Their collective nature means that investment and longevity risks are shared across the whole membership, and as these schemes provide an income for pensioner members there is no need for members to make complex financial decisions at the point of retirement. The Government believe that this new type of pension provision will be more sustainable for employees and employers alike, and has the potential to offer better outcomes for pension scheme members.

My Lords, I thank the Minister for her presentation, which was clear and to the point. I would like to raise two issues for consideration.

The first is the possibility of widening the scope for CDCs to smaller companies and how the Government view that. The current legislation has been written very much with Royal Mail in mind but if the CDC scheme goes well, others might want to follow suit, including smaller employers. But they would want to join something bigger; for example, a multi-employer or industry-wide CDC scheme or master trust CDC scheme. Will this require new primary legislation to allow multi-employer schemes, or does the Pension Schemes Act give the DWP sufficient power to do this? If it would require new secondary legislation, how long does the Minister think this might take? Does she share the view that multi-employer schemes are key to unlocking CDC? Not everyone has the resources or scale of the Royal Mail to do it for themselves. Please can she explain the process for multi-employer CDCs?

Secondly, can the Minister say something about retirement-only or decumulation CDCs and the position of the DWP on these? One of the discussions over the new pensions freedoms is that individuals take all the risk of managing a DC pot for themselves, including the longevity risk. In a pooled CDC retirement scheme, this is shared with others, so it is an attractive option for people to join at retirement. What is the scope for these and what is the position of the DWP on this? NEST has hinted that it might be prepared to look at it, but it would be helpful to know whether the Government look on these suggestions favourably. I look forward to the Minister’s response.

My Lords, I refer to my registered interests: I am trustee of the Telefonica pension scheme and the People’s Pension master trust. I thank the Minister for her helpful presentation of the regulations, and the DWP staff who kindly took the time to answer my many queries. My contribution is rather long. The only consolation is that it would have been even longer had I not had that discussion with colleagues.

Collective defined contribution schemes are clearly a welcome addition to the pensions landscape, whereby employees can, in effect, share their investment and longevity risks and remove some complexity from individual decision-making. But with only one employer committed to date, there is a risk that the regulations are bespoke for the Royal Mail scheme but may need adapting for others set up subsequently.

There is considerable uncertainty over the fuller impact of the CDC proposal, which is reflected in the detail of the regulations and the draft code. The code contains a list of matters more likely to satisfy the Pensions Regulator, but some lack a qualitative feel or benchmarks or triggers. Take the example of trustee governance. The draft code says that the regulator is

“more likely to be satisfied”

if there is clarity as to

“who decides in a scenario where both the employer and trustee have an interest”,

but it does not express a view on good practice in such scenarios.

A CDC scheme is set up under an irrevocable trust by an employer. In a single or connected employer scheme, sustainability can be influenced by employer behaviour and changes to corporate control and structure. A regulator’s expectations for the governance framework and the extent of trustee discretion are therefore particularly important. I ask the Minister: is it the intention to set out good practice expectations on the governance framework and the extent of trustee discretion?

On benefits, calculations and adjustments, the regulator expects the trustees to make their legal advice available to the actuary. Can the actuary rely on the trustees’ legal advice when issuing a viability certificate? A certificate requires certain tests to be met: two gateway tests at authorisation and two live running tests after the scheme has begun operating. The first gateway is met if the estimate of the projected average annual increase in the first 10 years of benefits on a central estimate is no less than the estimated projected annual increase in the CPI. But why is that test is set on a central estimate basis with no element of prudence built into achieving the projected increase?

The other tests are intended to limit the amount of cross-subsidisation between members and the risk of excessive cross-subsidy. As the Minister herself said, fairness between groups of members—in particular, the fair treatment of younger members—is of considerable importance. On the information available, it is difficult to assess whether the proposed gateway and ongoing tests provide a confident measure of whether a scheme’s design is sound and fair, and whether they would be appropriate for all CDC schemes. Given their importance, could the code of practice or any guidance to supplement that code set out more clearly why these tests for controlling cross-subsidies will be fit for purpose in all authorised schemes?

A CDC scheme can have more than one section. For example, where an employer wants to pay different rates of contribution for particular employees, new employees or future accruals, or offer non-CDC benefits, they have to set up a separate section. However, in my view, separate sections can carry the potential for one section to weaken the viability of another—or even precipitate closure; for example, by reducing the size of the scheme membership and/or stemming the flow of new members. I think I understand that the potential to impact on the soundness of another section would not form part of the assessment for the authorisation of a new section; such an impact would be dealt with through the “significant or triggering event” process for those other sections. However, given that CDC schemes need to be sustainable over very long periods, and companies can change ownership or be restructured over shorter periods, that could be a regulatory weakness. If it is considered appropriate, can the Pensions Regulator defer the authorisation of a new section on the grounds of its impact on the sustainability of another section? What consideration is being given to permitting variation in the benefit characteristics in a CDC scheme without the need for opening a new section?

To be financially sustainable, a scheme must have reserves to meet the costs of dealing with a triggering event and implementing a continuity option. These requirements seem less robust than those required of master trusts. Reserves do not have to be ring-fenced and the employer is not explicitly required to contribute. No doubt the Minister will argue that a CDC scheme cannot take in member contributions or funds prior to authorisation and the financial sustainability criterion being met. This, therefore, implies that an employer such as Royal Mail must provide some financial resources for a scheme to be authorised.

There are some “buts”, however. It is not clear in what circumstances the regulator could require an employer to contribute to the reserves. The financial reserves required will change over time, as a scheme grows and becomes more complex, so what suits authorisation may not suit ongoing supervision.

Trustees have to identify other ways of meeting these scheme costs where they are not relying on the employer, such as building reserves from member charges or a service provider contracted on a fixed-cost arrangement, even if a triggering event occurs. The code does not require a pot of money or assets to be ring-fenced; the trustees can rely on other means, such as enforceable guarantees. But the strength of those guarantees or other means may depend on the strength of the employer. The employer covenant, trustee access and enforceability in insolvency will then all come into play and have to be monitored, but regulatory failure happens, even with the best of intentions and the most applied regulators. Yes, there is a prohibition on increasing member charges during a triggering event, but I ask the Minister—as I have in the past and no doubt will in the future—what happens if the reserves are not sufficient to meet the costs flowing from a triggering event.

Under a CDC scheme’s rules, the employer can retain the right to wind up or close a scheme, or add sections, but there is no requirement to contribute to reserves, where their decisions increase the likelihood of a triggering event in a particular section. I ask the Minister: would the regulator have the power to direct an employer to contribute to the reserves where an employer decision leads to a triggering event, if it is considered appropriate?

Where continuity option 3 to run as a closed scheme is implemented, there has to be a question about how long that position is sustainable. It is unclear when the regulator would consider it to be unsustainable, so I ask the Minister whether it is intended to set hard triggers that would flag to the regulator to consider directing trustees to wind up.

I am drawing slowly to a conclusion. The wind-up of a scheme and decollectivisation of benefits to individual discharge amounts will pose some challenges, and this will be a novel area. In my view, the regulations and draft code lack flesh on the process to manage members out of CDC. There needs to be a high level of confidence in and understanding of the calculation of members’ final discharge amounts. Communications to and support for individual members will be challenging, yet there is no explicit provision for defaulting members into guidance nor requirement for targeted support for pensioners defaulted into income drawdown. Is it anticipated that such matters will be covered in the code?

Under the regulations, no pensions or benefits must be paid by the scheme during the wind-up period, but Regulation 29(7) says: