Earlier this week independent pensions consultant Hamish Wilson told Pension Funds Insider that a new structure of collective defined contribution (CDC) could increase members' pension pots by between 35-45%.

According to Wilson, a CDC system which will allow trustees to more freely allocate benefits depending on how the scheme performs would be more beneficial for both employers and employees. 

"Sponsors have to have the fundamental right to change the contribution level whenever they need to. Trustees can, and must be able to, change benefits when needed," he said.

Managing director at the firm which carries his name, Hamish Wilson, has argued before that a CDC system could be the way forward for the private pensions sector.

In March this year he called for an independent commission to report on what conditions are necessary in the private sector to allow the freedom to design pensions with access to risk sharing, including CDC approaches. Wilson argued that in order give effective choice to the private sector, the industry should press Government to examine as a matter of urgency ways of providing risk sharing in private sector pensions. This would also help close the gap between public and private sector pension provision.

"Of particular interest to the private sector is leveraging the defined contribution (DC) approach while at the same time maximizing the benefits of 'collectivism' for the benefit of all. CDC, unlike Hutton's proposals, does not discriminate between the economically active or inactive in relation to indexation. More importantly, it caps all costs and achieves considerably greater benefits and cost efficiencies compared to the only current realistic alternative for the private sector i.e. 'raw DC'. It can result in, on average, 35 to 45% higher benefits than currently possible under the 'raw DC' approach with considerably less volatility."

Talking to Pension Funds Insider Wilson also said that it was crucial in the private sector to get rid of 'guarantees'. He explained all parties had been guilty of "falsely giving the impression" to members that binding guarantees regarding the level of payouts existed - which in turn had led to unrest and also played a role in the downfall of defined benefit (DB) schemes.

"Communication is key," he said, "we should all change the way we communicate. No more guarantees, or even implying there is one."

Under CDC, pooling members' investments would allow risk to be shared between them. It would potentially provide more security of retirement income. The sponsor would carry no risk and could not be forced to increase members' contributions. The scheme's liabilities would always be equated to the scheme's assets by changing the level of indexation or revaluing members' pensions. This would eliminate the possibility of a funding deficit.

The concept is gaining more momentum and big players have shown interest in the model such as future market entrant APG, the Dutch pension provider.

What sets Wilson's ideas aside from others is the fact that he believes it is better if employees do not pay member contributions. "It would only lead to a feeling of 'ownership' towards the scheme and a feeling of rights towards a minimal return. This would lead to anger if the scheme had to pay out less in times of economical hardship," he explains.

Annuities would also no longer be necessary under this model, in fact, it should be made very unattractive and benefits should be paid directly from the fund. "Insurance companies only take money. What do you think it costs to transfer your money?" he asked.

Time will, according to his theory, ensure that the funds will increase in value when no buy outs take place. This is also the main reason for the 35-45% improvement in benefits. Other reasons for the higher payouts would come from the economies of scale savings on administration costs, pooling and fund management charges. Risk sharing would be purely between members.

One ingredient, however, is still needed for the scheme model to work; good trustees. The question 'who appoints them' would still need to be answered. "A good mix would be essential and it would need to be decided who appoints them, for that I have no answer yet," Wilson said. The trustees would ultimately be the ones to ensure members are getting fair pensions, after all. The need for more and better skilled independent trustees would therefore increase if CDC came into existence.

Wilson says: "Everybody needs to cooperate. We are doing it for the future, for our children. This is no regular DC scheme but a much more sustainable system."

The consultant is of the opinion that the UK pensions landscape is currently too restricted for the private sector. He asked why a company could not decide for itself which scheme it wanted as long as it was "fair and efficient with good governance".

"Sponsors do not want to waste time on pensions but get back to their businesses," Wilson said. "A good pension plan means guaranteed succession and new blood, which is what the sponsor wants. On top of that he gets cost certainty."

"We would all achieve the ultimate freedom; we would get value for money, more transparency and security would increase."

Wilson mentioned the PPF as the ultimate example of a CDC scheme already in existence. "If the PPF runs out of money they can lower the retirement benefits to scheme members, there is no guarantee."

The PPF would, however, no longer be needed if a comprehensive CDC plan came into the market. "We would all be in it together. Size does matter – safety comes in numbers but this system would still be able to provide for small employees."

First published 30/06/2011

azeevalkink@wilmington.co.uk