I thank noble Lords for tabling these amendments linked to fairness. Concerns about fairness often arise in respect of CDC. I fully understand noble Lords’ interest in this important matter. I share their commitment to ensuring that members of CDC schemes are treated fairly. However, I do not agree that the amendments proposed are necessary to protect members.
Ensuring that members are treated fairly has been a central part of our work on CDC since we began. We have been mindful of the problems that other countries have experienced—for example, in their approach to adjusting benefits—and we have learned from them. Envisaged regulations under Clause 18 will mean that scheme rules will require that there is no difference in treatment between different cohorts or age groups of scheme members when calculating benefits and applying benefit adjustments. If they are not compliant, the scheme will not be authorised.
Noble Lords have previously expressed concern that a significant number of older members might choose to leave a CDC scheme shortly before retirement and that this may pose a risk to younger members. Noble Lords will note that one of the authorisation criteria in Clause 12 relates to the soundness of the scheme design. It is intended to protect members from being enrolled in ill-considered and poorly designed schemes which are unlikely to remain viable over the long term.
It is important that due consideration is given by employers to a scheme’s viability at the design stage, including to how the benefits aspired to will be affected by significant potential events, whether this is a reduction in investment returns or in membership. Envisaged regulations to support the design requirement will aim to ensure that sufficient evidence is provided to satisfy the regulator that appropriate stress testing of the scheme’s design has been undertaken and that a suitable strategy is in place for monitoring and reacting to threats to a scheme’s viability. These are complex matters, so we will consult thoroughly on what the regulations should require in this respect and more widely. We want to ensure that the scheme design is subject to appropriate scrutiny by the regulator at the initial application stage and on an ongoing basis. I am happy to discuss the scheme design requirements in more detail when we reach the relevant clauses.
My noble friend Lady Altmann mentioned cash equivalent transfer values. We propose that a member’s transfer value will be calculated by reference to the present value of the assets currently held that are needed to pay the anticipated pension whenever that is due. That means that, if every member chose to leave at the same time, they would get the present value of their anticipated pension. Nobody would receive anything that was due to anyone else, as the valuation process means that the assets and the cost of all the anticipated pensions should always be in balance. It also means that a member transferring and a member staying always keep the present value of their rights in the scheme and nobody receives anything more than is due to them from the scheme, whether they stay or go.
The noble Lord, Lord Sharkey, asked about the impact of cross-subsidisation on younger members in CDC schemes. Such members may get less value from flat-rate contributions if they decide to transfer out of the scheme before retirement. It is important to remember that pension schemes are long-term saving vehicles, designed to deliver an income in retirement. Our focus is on the long-term benefit of a CDC pension scheme for the scheme members. While CDC benefits are
money purchase benefits, a CDC scheme’s purpose is to provide a variable income for life in retirement for its members and not a transferable cash sum.
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The value of members’ rights in a CDC scheme is derived from reference to the cost of providing a variable income when the member retires. The more distant the date the member is due to draw an income, the smaller the share of the current assets attributable to that member’s pension. We envisage that regulations will require this to be communicated to the membership, so that they understand the implications of a decision to transfer out of the scheme.
The noble Lord, Lord Sharkey, also asked if this would mean benefit cuts for members. Fluctuations in benefit levels are fundamental to CDC scheme design. It is possible that members will see cuts in their pension values in some years, but they should also see increases in others. The Pensions Regulator will look at the way the scheme communicates with members, as part of its authorisation and ongoing supervision. The scheme will need to demonstrate that it clearly communicates the fluctuating nature of benefits to members.
The noble Lord, Lord Vaux, asked how the Pensions Regulator will determine whether the design of the CDC scheme is sound. As I have said, we intend to consult further on these matters when we bring forward secondary legislation for CDC schemes. However, it is intended for the criterion to focus primarily on providing sufficient evidence for the Pensions Regulator to be satisfied that the core foundations of the scheme are sound. For example, are the scheme’s design and rules compliant with legislative requirements? Are the actuarial, investment and other assumptions used in determining its design and proposed benefits comparable to industry norms and existing data; for example, on longevity? How have the assumptions about investment returns been reached and tested against risks, such as a reduction in investment returns or the number of members, or employers’ insolvency?
The noble Baroness, Lady Altmann, asked about the ongoing viability of the scheme and how it will be monitored. Clause 13 provides added protection by requiring that the viability report must be reviewed by trustees and certificated by the scheme actuary at least once a year, with revisions made to the report if appropriate. Furthermore, if the most recent viability report becomes inaccurate or incomplete to any significant extent, the trustees must revise the report and submit a newly certified report to the regulator to consider. This will help ensure that, should it become evident that the scheme’s viability is under threat and intergenerational fairness is at risk, the regulator is alerted and can engage with trustees on the action to be taken.
The noble Baroness, Lady Bowles, asked about ensuring that members are properly informed about the risks of CDC schemes. The possibility of fluctuations of benefits will be made clear and transparent in the key member communications at points throughout their pension scheme’s journey. Regulations under the Bill and powers in the Pension Schemes Act 1993 will require CDC schemes, for instance, to: publish a clear statement on this and on the scheme website, as well as
publishing the scheme rules; provide details of fluctuation risks at the point of joining; emphasise benefit changes in the annual benefit statement for active and deferred members; be clear in the retirement information packs that benefits can change during retirement; and notify members, in advance, of any change to their rate of benefit during retirement. Members and other interested parties will also have access to scheme documentation that must be published on the scheme’s website; for example, the scheme’s annual actuarial valuation.
Finally, how is RMG’s proposed headroom mechanism fairer than a capital buffer? The Royal Mail scheme features an alternative headroom mechanism, designed to reduce the volatility of pension increases and the risk of cuts. It is envisaged that, when the scheme is opened, the level of contributions will include a material amount of headroom funding for future increases. If some headroom remains and the assets are not well behind track, there would not be a pension cut. This is different from a typical capital buffer because the headroom funding is gradually spent on providing increases across all generations who have accumulated benefits under the plan, rather than being an amount that one generation is required to contribute to but which is held back from that generation’s increases to mitigate a later generation’s risk of potential future cuts.
I recognise noble Lords’ concerns—