The number of companies making radical changes to their final salary pension schemes in the past few months makes pretty depressing reading. In December 2005, Rentokil became the first FTSE 100 company to close down its final salary scheme for all staff. Meanwhile, other firms, including Scottish Power and the AA, have closed down their schemes for new starters, and put in place alternative arrangements.
Final salary pensions – for so long a mainstay of employee reward schemes – are becoming increasingly unsustainable as schemes struggle with large deficits, prompting chief executives and finance directors to take the tough decision to pull the plug. But what does this mean for employee reward as a whole? Must those companies that have ditched final salary schemes redress the balance by offering some other kind of benefit?
Reactions are mixed. Take motoring services group the AA, which closed down its final salary scheme to all new starters last September, after closing it to new managers only two years previously. While existing staff can retain the final salary arrangements, newcomers are being offered a career average scheme.
The AA says it does not feel it is necessary to adjust its reward package to reflect these changes. “We haven’t made any changes to benefits and pay for new starters to compensate for the closure of the final salary pension scheme,” says Martin Sawkins, HR director at the AA. “It isn’t an issue for us, as we believe what we are offering is very competitive in our marketplace.”
Sawkins adds that many of its staff are call centre operators, and in that sector a final salary pension scheme is very rare. Similarly, its competitors for breakdown services tend to offer money purchase arrangements, which the AA says are less competitive than its new career average scheme. In short, it doesn’t believe the closure of the final salary scheme will in any way affect its ability to recruit new staff. Nor does it believe there is resentment between existing staff with final salary pensions and newcomers with the career average scheme.
“The level of awareness about pension performance has grown among employees generally in past few years. People increasingly realise that final salary schemes are difficult for companies to maintain,” says Sawkins. “Whenever we make changes to terms and conditions at the AA, it is usually for new staff rather than for existing staff.
“People know they are employed under different terms and conditions and they are used to this,” he adds.
This certainly was not the experience of industry regulator, the Financial Services Authority (FSA), which has restructured its reward offering as a result of these changes to pensions.
Before the FSA was formally established by an Act of Parliament in 2000, it was made up of a combination of 10 different organisations. When they came together, it involved the transfer of 1,700 staff under the Transfer of Undertakings (Protection of Employment) regulations, all with final salary pension schemes. FSA managers decided to close the final salary scheme for newcomers and replace it with a money purchase scheme.
Ringing the changes
Two years ago, the FSA decided to make changes to its reward structure, as it was concerned about the effect of the different arrangements on staff.
“We were worried about the equity issues between those staff on final salary and those on money purchase arrangements,” says Jonathan Chapman, head of organisational development and reward at the FSA. “The problem was that we were spending two-thirds of our reward budget on one-third of our staff, because contributions for the final salary scheme were so much higher.”
After a nine-month consultation with staff, the organisation decided to introduce two different pay scales, so that the pay scale for staff on the final salary scheme was 8% lower than those on the money purchase scheme. “Adjusting pay allowed us to take control of our pension deficit and to develop a fairer deal for employees,” says Chapman.
The FSA is one of a host of employers shifting the emphasis away from pensions towards so-called ‘total reward’ schemes.
Total reward recognises both the tangible elements of reward (such as pay, benefits, bonuses) and the less tangible elements (such as learning and development opportunities, work quality, work-life balance and leadership quality) – all of which hopefully contribute towards employee engagement.
The FSA says that the approach has proved popular with staff and that its reward rating has gone up nine points in staff surveys in the past two years.
There is no straight, causal link between the demise of pensions and the rise in popularity of total reward among employers. But changes to pension arrangements will have a knock-on effect on reward strategy for many organisations.
Simon Barron, managing consultant, reward, at consultancy The Hay Group, says: “If employers are making major strategic decisions about pensions provision, it makes a lot of sense to review their entire reward package at the same time. They may be able to use some elements of this to compensate for the changes.”
Company pensions are by no means a thing of the past, but their profile is certainly changing, as are employees’ expectations.
Sawkins says: “Today’s employees don’t expect to stay with the same employer for 30 or 40 years, and they expect to make some personal provision for their retirement. Employees want reward packages that are flexible enough to suit their circumstances and will place more or less emphasis on pension according to what stage in their life they are at.”
Closing final salary pension schemes may cause alarm in the short term, but a well-communicated total reward policy could soften the blow and protect the long-term interests of an organisation.