Time to make a contribution

Why should HR care about pensions? Because events of the past two years have
made it a key recruitment tool, as well as a potential problem area when it
comes to staff retention. In the first of a two-part analysis, Sarah Ball
outlines why HR should be involved

The prediction that pensions would become a huge hot potato for HR to handle
would have seemed like some kind of ridiculous send-up five years ago. Few HR
professionals would have seriously believed that hitherto disinterested
employees might one day threaten direct action – not merely over changes to
their own pension arrangements, but over the rights of future recruits. But
this is precisely what happened at Prudential a few months ago when the news
that it had closed its final salary pensions scheme – more correctly known as a
direct benefit (DB) scheme, as opposed to a defined contribution (DC) or money
purchase scheme – was splashed all over the newspapers.

The press now serves up a daily diet of pension scheme closures, funding
deficits and government reports. Like it or not, pensions have rapidly become
staple boardroom fodder that HR professionals need to get their teeth into. The
cost implications for many employers have been so serious that for some,
dividend policies and credit ratings have even been affected.

But despite all the bad news in the press, which frequently peddles a
simplistic ‘DB good, DC bad’ line, there are currently genuine opportunities
for HR professionals to come up with tailored solutions which match the overall
reward strategy of their particular organisations.

Publishing company Emap, for instance, has just raised the employer
contribution level of its DC scheme for employees with five or more years’
service, bucking the perceived trend of pension benefits reduction. Ralph
Turner, head of group reward, says: "In the media industry it’s hard to
compete over pay, but I convinced the board that pensions was an area where
Emap could differentiate itself. The cost of recruitment is a real issue, and
this new move particularly rewards those who are here for the long haul."

Boardrooms have begun to feel the heat over pensions because the cost of
defined benefit schemes has risen rapidly, principally because pensioners are
living longer. Furthermore, as inflation has reduced, expected future
investment returns have fallen. Schemes that had surpluses until relatively
recently now have deficits due to falls in the stock markets. Government
legislation in response to various pensions scandals has saddled schemes with
ever-higher guarantees to their members, so there is no flexibility when times
get tough. And they certainly are at the moment.

The new accounting standard for pensions – FRS17 – can have a dramatic
impact on the appearance of the bottom-lineprofits of the sponsoring company,
and this may be the catalyst that prompts your financial director to close the
scheme to new members.

Tim Keogh, a European Partner at Mercer HR Consulting, says: "This
won’t solve your financial director’s real problem because you are stuck with
the liabilities you have got."

And Colin Singer, a senior consultant at Watson Wyatt, adds: "This is
where HR needs to step in to make sure the board knows there are a range of
options in addition to DC, such as CARE (career average revalued benefits)
schemes or DB/DC hybrids, and that it considers which will best fit your
overall reward strategy."

The Nationwide building society opted for a CARE scheme two years ago and
employees can choose to top up their pension inside a flexible benefits plan.
Retail giant Tesco also chose a CARE scheme when it extended its pension
provision to its part-time employees. Tesco’s HR director Clare Chapman says:
"Our staff tell us they want flexible work arrangements and a pension that
matches this lifestyle. We designed ‘Pension Builder’ around their needs."

Consulting with staff over pension changes, although not yet a legal
requirement, can avoid bruising battles in the press and improve your return on
investment through greater employee appreciation of the benefits offered. Some
employers, such as aerospace giant BAE and energy company Centrica, have
managed to keep their DB schemes open through employees agreeing to increase

Some unions have begun to factor pensions into pay bargaining. Rob
MacGregor, the national secretary at finance sector union Unifi who works with
the Royal Bank of Scotland, says: "It is our responsibility to remind
staff of how valuable their DB pension is. In the past it had been taken for

This sensitivity worked the other way for Lloyds TSB, which Unifi criticised
in the press last month when it discovered that the new chief executive, Eric
Daniels, would be in a DB scheme despite joining the bank in 2001 – four years
after the scheme was withdrawn for new staff.

A spokeswoman at Lloyds TSB says the bank offers a final salary option at
this level to attract the high calibre of staff it needs. "Some
[directors] do negotiate a package that the remuneration committee must agree
on… we have to continue to look attractive in terms of benefits to attract
people of such calibre," she adds.

Although many employers have voluntary consultations with their staff over
pension scheme changes, whether they should legally be obliged to do so is one
of the proposals in the recent Department of Work and Pensions Green Paper
Simplicity, Security and Choice.

Next week we look at the implications of this issue for HR, along with the
Green Paper by the Treasury and the Inland Revenue, ‘Simplifying the taxation
of pensions: increasing choice and flexibility for all’.

Types of pension scheme design

Defined benefit (DB) or final
salary schemes

Traditionally considered the Rolls-Royce of schemes, these are
still the main type provided by large UK employers. They are typically related
to the employee’s final salary at retirement. The employer promises the
employee a certain proportion of salary at retirement and takes on the risk and
cost of providing it. Contributions from both employer and employees are put
into a fund entirely separate from the employer, and managed by trustees. The
amount of pension paid depends on:

– The number of years served as a member

– Final salary at retirement

– The ‘accrual rate’ (often a 1/60th of final pay for each year
of service). So if the employee does 40 years of service they might get
40/60ths (or 2/3rds) of final pay, the maximum currently allowed.

Employees themselves normally pay contributions to meet part of
the cost – 5 per cent of pay being typical.

Many employers are currently having to put extra into their DB
schemes to plug deficits (and sometimes are seeking extra from employees too).

Career average revalued earnings

These schemes are another form of DB scheme, but are based on
average salary (adjusted for inflation) over the whole career, rather than on
final salary at retirement. The employer still takes on the risk and cost in
the same way as for final salary schemes. CARE schemes are normally slightly
less generous and less costly than final salary ones.

Defined contribution (DC)or money
purchase schemes

DC schemes are the fastest growing type of company scheme in
the UK (and elsewhere). The amount of pension the employee eventually gets
depends on:

– The amount of money paid in by them and their employer

– How well the chosen investment funds perform

– The ‘annuity rate’ at the date of retirement. The annuity
turns the pot of money into an annual pension for life and at present
conversion rates are very poor.

The company can set up its DC scheme under a separate trust,
managed by trustees (as for DB schemes), or can pay into a contract with an
insurance company (see Personal and Stakeholder Pensions below).

Unions often prefer the trust route because it is a
‘collective’ institution, like the unions themselves, and they can sometimes
exert more influence over how trusts are run (by a rep being elected onto the
trustee board).

Hybrid schemes

These combine DB and DC in a variety of ways – for example, a
DB scheme might guarantee some modest level of final pay, but pays out the
value of an underlying DC pot if greater.


Under stakeholder legislation the saver is guaranteed 1 per
cent maximum charges by the provider. These special DC schemes came in during
2001, and in broad terms employers who did not then have an occupational scheme
had to designate a stakeholder provider for their employees.

The specific legislation around this was highly complex, but
the Government’s aim (which has not really been achieved as yet) is to increase
private pension provision for below-average earners.

Stakeholder contributions from both employers and employees are
entirely voluntary, despite union pressure for employer ones to be compulsory.

Personal pensions

Not usually used by employers for their own schemes, these are
individual insurance contracts, and are more or less the same as stakeholder
schemes, but without the cap on the insurer’s charges.

Group personal pensions

This is the version of personal pensions (see above) used by
some employers. The provider bundles the individual personal pensions together
(on enhanced terms normally), and presents them as an employer scheme using
payroll deduction and worksite marketing. Stakeholder pensions run by employers
are also normally grouped in a similar way.

Pensions – How HR can contribute

The cost of defined benefit (DB)
pension schemes is rising fast, and your financial director and chief executive
are probably already exploring the options to contain cost and risk.

Make sure they both factor employee relations issues into their
decisions and alert them to the range of pension schemes.

Take a close look at your pension and retirement policy to see
if it fits with your business and reward strategy, and whether it aids the
recruitment and retention of employees.

Staff are often confused and worried about pensions. Any help
and education you can give them will help them to understand and really value
what you provide. They need to feel good about what you are spending on
pensions, not confused and apathetic.

Pensions need to be viewed as a part of your wider reward
strategy. This means you need to display leadership and ensure consistency over
integrated HR solutions. Because of the interdependency of these activities,
you need to make sure your internal reward, pension and payroll specialists
work together under your guidance within a clear set of guidelines and

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