A collective defined contribution (CDC) scheme would not have had to cut member benefits in response to market volatility in the Covid-19 pandemic, according to research from Aon.

Aon’s research, titled Collective DC in adverse markets, evaluated how the new model of pension scheme would have handled market volatility caused by the crisis in comparison to defined benefit (DB) and defined contribution (DC) schemes.

The provider found that a 25 per cent asset shock to a CDC scheme targeting annual 3 per cent benefit increases to its members would have to scale this back to 2 per cent for the upcoming year in order to remain fully funded.

If assets recovered by 12.5 per cent the following year, members could then be given an improved benefit increase of 2.5 per cent.

This is because the impact of market movements, both positive and negative, is shared across the entire membership of the scheme.

Therefore, although benefits would not need to be cut, the scope for providing future benefit increases would be reduced.

The paper added that, in analysis of how CDC schemes might have performed over the last 90 years, Aon’s research found that member benefits would have been cut once, during the Great Depression.

For comparison, around 25 per cent of DB schemes had seen their funding position strengthen by up to 5 per cent since December 2019.

Approximately half had seen their funding position weaken by up to 5 per cent during this period, while a further 25 per cent had seen their funding position deteriorate by even more.

The research pointed out that, during the Covid-19 pandemic, many DB schemes had seen their liabilities balloon while their sponsor covenant was weakened, leaving member security threatened by short-term cashflow constraints and long-term sponsor viability.

Aon said it was “inevitable” that some of these schemes will fall into the Pension Protection Fund once government support ends, leaving members with a deterioration in the value of their retirement savings.

For DC schemes, Aon found that the impact of market volatility on members’ pots would largely depend on how long they had to repair the market falls and the nature of how their savings were invested.

People retiring in the second and third quarters of 2020, and with greater exposure to growth assets, will probably have retired on less than they were planning for, while the research added that Generation X could be the most impacted as they typically remain fully invested in growth assets and may only be at the start of their lifestyling journey.

“We believe it is this group of savers whose retirement income prospects could be most improved through CDC,” said the report.

Aon head of CDC, Chintan Gandhi, commented: “The nature of a CDC scheme means that members’ target pension increases can be adjusted to reflect positive and negative experience over a period of years. This means that the impact of market movements – in either direction – are shared between members and then smoothed over time.”

Gandhi continued: “We have also considered how a well-designed CDC scheme, targeting inflationary increases to members’ benefits, might have performed more generally. To do this, we have back-tested the impact of past market performance (between 1930 and 31 March 2020) on the benefit adjustment outcomes for members of a hypothetical CDC scheme.

“Our analysis revealed that a well-designed CDC scheme might have seen just one cut in benefits - during the Great Depression of the 1930s. Moreover, even after the market shock following the outbreak of Covid-19, our hypothetical scheme is expected to deliver a modest, positive increase to members’ benefits in 2021.”

Aon head of UK retirement policy, Matthew Arends, said: “The ability of a CDC scheme to adjust target levels of pension increases operates as an efficient way of adjusting members’ benefits to reflect positive and negative experience over time.

“We expect a number of employers will look to the attractive features of CDC for building a more resilient future, for both member and employer outcomes.”

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