Pensions: Are the goalposts about to move?

The Department for Work and Pensions is asking employers for their views on possible changes to pensions, auto-enrolment and personal accounts. Alex Rush analyses the consultation paper and the likely outcomes.

Much has been written about automatic enrolment and the format of the pensions reforms that are due to come into effect from October 2012. Some of the proposed reforms are likely to be modified as a result of the latest Department for Work and Pensions (DWP) consultation paper released on 24 September 2009.

Here we examine some key points of the consultation, and identify some of the possible benefits and risks to employers of participating in the centralised money purchase pension scheme, known as personal accounts, that is being set up by the government.

The consultation

The DWP consultation has suggested some significant modifications to the way in which the pension reforms, notably automatic enrolment and compulsory contributions, will be implemented. Some of the key modifications are:

• From 1 October 2012 there will be a staging process, which means that automatic enrolment will be phased in gradually in stages over three years.
• Each employer will have a staging date, with large employers being phased in to automatic enrolment at earlier dates, followed by mid-sized, small and micro employers later.
• The aim of the reforms is that employers will be required to contribute at least 3% of each employee’s qualifying earnings.
• These contribution requirements will also be phased in gradually. On reaching their staging date, employers, other than employers providing a defined benefit (DB) scheme, will be required to contribute 1% until 1 October 2015 at which point the minimum contribution will be 2% rising to 3% from 1 October 2016 onwards.

For employers that run DB schemes (including hybrid schemes), automatic enrolment will not bite until October 2015, provided that their scheme is open to all their employees.

As this is a consultation, these suggested changes are not set in stone. However it is clear that the DWP is envisaging a slower introduction of the reforms, fearing that a ‘big bang’ introduction on day one could result in chaos.

For some employers, the requirement to automatically enrol their employees into a qualifying scheme could be as far off as 2015. For those that do have to start on or soon after 1 October 2012, the initial level of contributions will remain at 1% until 2015.

Should employers take action now?

Well in advance of reaching their staging date, employers will need to consider carefully whether their current retirement benefits structure (if any) will comply with the requirements of the pension reforms.

Employers that already provide a pension scheme to their employees need to decide what to do with their current schemes. Should they maintain their scheme and modify it to ensure it is a qualifying scheme under with the Pensions Act 2008? Should they change to a different scheme, perhaps personal accounts? Or should they opt for a combination of these?

There is no silver bullet; the answers will depend on many factors such as the size of the employer, the nature and complexity of its current pension arrangements, its budget and its employees’ requirements. Many chapters could be filled with the pros and cons of the personal accounts system for employers currently participating in the myriad species of occupational and private pension schemes. But I want to focus broadly on employers that already participate in some form of money purchase scheme.

Employers with money purchase schemes

By enrolling staff into personal accounts, employers can be sure that they are complying with the requirement to automatically enrol their employees into a qualifying scheme without the expense of designing and establishing a new one themselves. Employers and employees may stand to benefit from lower charges than a typical money purchase scheme.

However, employers will not be able to transfer any of their employees’ existing benefits under an existing scheme to personal accounts. If they want to participate in personal accounts, employers will need to retain, wind up or make some other arrangement for that scheme. Any such action will need to be carried out carefully – for example, ensuring statutory notice requirements are adhered to.

Defined contributions snapshot 2009 Average employee contribution to a defined contribution scheme:  3.5% of salary Average employee contribution in charity sector:  2.4% of salary Average employee contribution in financial services sector:  2.6% of salary Average total (employer and employee) contribution:  9.7% of salary Average combined pension pot in leisure and travel (lowest by sector):  7% of salary Average combined pot in financial services sector (highest by sector):  11% of salary Average employer contribution across all sectors:  6.2% of salary Source: Aon Consulting, 2009

Private providers such as insurance companies may be better placed to provide alternative, reform compliant packages which allow transfers-in from existing schemes. Such packages may have additional features such as outsourced administration to ease the regulatory burden on the employer, and a bigger range of investment options for members to choose from. However, at this stage, it is uncertain how such products will compare with personal accounts.

Where the employer does choose to participate in personal accounts, a key risk will lie in the administrative cost involved. For example, employers will need to ensure that their payroll systems integrate with the scheme so that contributions are made in respect of their employees accurately and promptly. This may be aggravated by the inevitable teething problems that a new and relatively untested nationwide system is likely to encounter; something employers will have absolutely no control over.

There will also be the risk connected with ensuring that employees are adequately informed about any changes to their benefits and rights under the new system, for example, the right to opt out of the scheme. Linked to this issue is the risk that employee relations may deteriorate. For example, if the employer decides to contribute the minimum amount, personal accounts may provide staff with far weaker benefits than they received previously. Even if the employer maintains a similar level of benefits in the personal accounts system, its employees may have concerns about the unknown service levels and perhaps the more limited investment options available to them.

For many employers, the latest DWP consultation is likely to offer some extra thinking time to determine how exactly they will adapt to comply with their new duties on workplace pensions. Compliance will mean a certain degree of cost and administrative burden for employers, but by seeking advice and taking time to consider their compliance strategy now, employers may be able to curb the potential for substantial cost and upheaval to their businesses.

Alex Rush, pensions associate, Stephenson Harwood