Preparing for action
Written by Nick Martindale
The introduction of compulsory workplace pensions through the process of auto-enrolment from October of this year marks the start of a radical departure for the UK.
Companies with more than 250 employees will lead the way, with others obliged to enrol staff into workplace schemes at various points before February 2018, in a move that will eventually see contribution rates of 8 per cent of salary, with 4 per cent provided by employees, 3 per cent by employers and 1 per cent by the state.
The new arrangements will have profound implications, not just for individuals, who will have to actively opt out of the scheme if they do not want to take part, but also for trustees and providers. The greatest ramifications, though, will be for employers, who will be expected to set up and run the schemes, including managing any opt-outs.
“For those employers with well established schemes, with a high take-up rate and contribution levels above the minimum requirements, the impact may well be minimal, both in terms of cost and changes to current procedures,” says Capita Hartshead consulting director Sue Curley. “Those employers with large workforces and a low take-up rate will undoubtedly see the greatest impact from a cost perspective, not only for contributions but also the communications processes that will need to be put in place to ensure they meet their employer duties.”
For many employers with existing schemes, the biggest question is whether to modify this or to look at an alternative scheme such as the government’s National Employment Savings Trust (Nest) or one of a number of similar offerings which have been developed to cater for those who have previously declined to join; in doing so creating a two-tier approach for different elements of the workforce.
“These alternatives will include a contract-based scheme approach such as a group personal pension, a MasterTrust or Nest,” says principal consultant Xafinity Consulting
Ian Johns. “The pros of a two-tier approach include cost mitigation with little impact on existing members, while the cons are largely administrative, in having to design, implement and run a new arrangement.”
Fidelity Worldwide Investment director of DC business development Daniel Smith says much will depend on the sector in which the employer operates. “Companies that are competing for talent – such as pharmaceuticals, telecoms and professional services firms – will have a good pension scheme in place and higher take-up rates, and broadly they would like to use that as their vehicle going forward,” he says. “The challenges are more with retail, hospitality and mass manufacturing, where you have a higher volume of lower-paid people with higher job turnover.”
In some cases, employers may not have the choice as to whether to adapt an existing scheme, suggests Mercer head of auto-enrolment Rachel Brougham, as providers may either refuse to take on such low-value and highly administrative business, or charge much higher premiums to do so. “A common solution is that existing members stay where they are and the scheme remains open on a voluntary basis to new people but something is set up alongside that for the auto-enrolment people,” she says.
The arrival of new entrants to the market, though, could shake up the industry, suggests Source Pensions managing director Alastair Burt.
“In the absence of trustees, The Pensions Regulator and the FSA are likely to look to the employer and the scheme’s adviser to monitor the provider’s performance and advise employees,” he says. A number of the new providers are now offering trust-based offerings in response to this need, he adds.
Auto-enrolment is likely to pose a number of challenges for employers, not least the cost of setting up, running and contributing to many more schemes. NOW: Pensions chief executive Morten Nilsson suggests that in the longer term this is likely to lead to a further decline in defined benefit schemes and warns that it could also result in a levelling down of employer contributions for existing members. “Employers are dealing with auto-enrolment in very different ways,” he says. “Some are actually seeing it as a good opportunity to get a good benefit package in place, whereas others cannot afford to look at it in this way.”
BlackRock head of DC consultant relations Paul Gilbody though thinks this ‘race to the bottom’ is unlikely to happen. “Most employers may look to reduce salary increases or take the hit,” he says. “Because the contribution is only 1 per cent and is tax-deductable, it works out at around 0.6 per cent. It’s an extra cost but not as high as some were expecting.” For those companies where some 90 per cent of employees are outside of existing arrangements however, the additional costs could be considerable, he adds.
The full cost implications though, will depend on how many people opt out – a study by the National Association of Pension Funds (NAPF) in October 2011 estimated around one in three would do so – and this is unlikely to become clear until the process gets underway. For now, the focus is more on getting the new regime up and running, and coping with issues around data quality and identifying exactly which employees will be eligible.
“As well as implementing any strategic changes decided on in relation to auto-enrolment, employers will need to make wide-scale amendments to their internal processes and systems, ranging from payroll processes through to how new hires are dealt with when they join,” warns JLT Employee Benefit Solutions director Mark Pemberthy. Trustees will also need to work closely with employers to ensure the new schemes are appropriate, he adds, including making any amendments to rules, literature and operating procedures.
The introduction of large numbers of relatively low-earners who are likely to have little experience or confidence in long-term savings will also create a dilemma in terms of an investment strategy. Johns suggests this is likely to lead to simplification of the market, with individuals offered strategies that are notionally described as ‘cautious’, ‘balanced’ or ‘adventurous’.
“The detail relating to the under-lying asset allocations and fund managers used would be addressed by the scheme fiduciaries,” he says. “Such an approach would allow more workers to engage in their pension provision without having to understand in detail how individual assets or funds perform.”
Effective communication from trustees and employers will also be needed to prevent a situation where individuals feel they have done enough to fund an adequate retirement just by making the minimum contribution of 8 per cent of salary, says Burt, as well as ensuring staff have effective projections and under-stand what this means for them.
“The industry has talked for decades about improving communications,” he says. “This is now the time to insist on decent member-level information, without which the well intentioned concept of auto-enrolment will likely fail. The contributions being stipulated under auto-enrolment should in no way be considered as sufficient; just a good place to start.”
Ultimately, though, the introduction of auto-enrolment is likely to at least begin the process of tackling the ticking timebomb of retirement savings; even if contributions from both employers and employees will need to rise in the longer term, along with the state pension and the retirement age itself.
“Until now, pension saving has been voluntary in the UK but because of inertia only about half of private sector workers are currently saving in a pension,” says NAPF policy adviser Catherine Cunningham. “Auto-enrolment will bring millions of people into pension saving, many for the first time. Without it, they would otherwise face poverty in retirement.”