At the start of the year, the slow train of pensions reform reached another stage on the way towards its final destination after the government announced the final employer duties timetable. Businesses of all sizes now know when they must comply with the legislation and can start preparing for one of the most radical shake-ups of pension provision for 50 years.
Employers with more than 120,000 staff are the first in the frame and from 1 October 2012 they must comply with Employer Duties legislation as laid out in January this year. Companies with 50,000 to 199,000 employees follow just one month later but it will take until 2016 for the new rules to be rolled out to all employers with more than 50 members of staff.
At the same time, the government unveiled the National Employment Savings Trust (Nest) which replaces Personal Accounts as the default workplace scheme for all qualifying employees, and since then it has given further detail of a charge structure of 2 per cent up front and an AMC of 0.3 per cent.
The controversial Nest charging structure has not surprisingly grabbed most of the headlines. But exactly how employers prove their schemes are at least as good as Nest remains unclear. While corporate advisers and their clients have welcomed the latest clarifications that the government have put out, questions persist about the precise detail of the new rules. Crucially, the Department for Work & Pensions (DWP) has yet to decide just how employers can certify existing pension provision as a ’qualifying workplace scheme’, although it has said it will consult on the issue in the next few months. Further, the government remains vague on the final structure and make-up of Nest.
Clive Grimley, partner at Barnett Waddingham, says: “[The DWP has] been criticised for complexity, some of which is to do with auto-enrolment and some is to do with Nest. Self-certification is one example where regulations are horribly complicated, or we think they will be, and although the DWP will try and make the rules simpler, I don’t imagine it will prove a simple process.”
Advisers identify the government’s decision to use qualifying earnings rather than basic pay as the basis for pension contributions under the new framework as a root cause of the complexity. Under the proposed legislation only earnings above £5,035 and below £33,540 will qualify for auto-enrolment, a system that advisers say runs completely contrary to any standard occupational scheme.
We are seeing quite a lot of apathy on the part of employers which relates to the general election, as there is a hope that someone will call pensions reform off
Alison Bostock, principal at Punter Southall, says: “The difficulty is the earnings definition because nobody’s scheme is set up like that; most employers use basic or total pay. So rather than it being straightforward, everyone has to worry about whether they meet the requirements.”
Given that the DWP has reopened the door for stakeholders to give their views, advisers need to take this opportunity to make clear their proposals for a simpler system.
Lee French, head of customer relationship management at Alexander Forbes Financial Services, suggests schemes offering an employer contribution of 3 per cent of basic salary should be automatically exempted.
He adds: “[Employers] should be allowed to submit details of their scheme to The Pensions Regulator who can then decide if the scheme should be exempt or when auto-enrolment must commence.”
Param Basi, technical director at AWD Chase de Vere Consulting, says Pada needs to confirm whether an exemption would be granted if the total contribution to an existing scheme is at least 8 per cent of gross basic earnings – with a minimum 3 per cent employer contribution.
“I would then obtain certification on a five-yearly basis that the contribution paid to the exempt scheme was at least equal to the minimum level. If it was not, then an appropriate increase in the contribution rate would be activated from the quinquennial date,” he says.
The biggest risk from an over-complicated certification processes is levelling down. Rather than deal with the headache of exempting an existing scheme those employers already offering quality schemes will be driven towards the bare minimum. Such an outcome has long been a concern for the National Association of Pension Funds (NAPF), and policy adviser Richard Wilson says the organisation will use the forthcoming consultation to push for a simplified process.
“We are trying to get certification so employers do not have to change their definitions of pensionable pay. If it’s a really generous scheme and we are 99 per cent sure that everyone gets entitlements then it should qualify. For most people, contributions on basic pay are much more generous than getting a pension after the first £5,000 of earnings,” Wilson says.
A further obstacle in the path of preparations for pensions reform is the looming general election. Bostock says employers are reluctant to make any real effort to comply with legislation for fear a change of government would render any change redundant.
“We are seeing quite a lot of apathy on the part of employers which relates to the general election, as there is a hope that someone will call [pensions reform] off. It is going to be difficult to get employers to focus on this until after the election since there is no point worrying about the requirements if a new government then rips them up,” she says.
However, policy insiders say the three major political parties are behind pensions reform, at least on the principles of auto-enrolment and the implementation of a cheap, nationwide workplace pension scheme, and it is highly improbable that a new government would do anything more than tinker at the edges.
Irrespective of the outstanding uncertainties with Nest and auto-enrolment, corporate advisers can still take a proactive role in readying employers for change. In fact, according to Steve Bee, managing partner at Paradigm, worrying about legislative minutiae is something of a red herring given the majority of employers are blissfully unaware pensions reform is happening at all, leaving them vulnerable to prosecution.
Bee says: “Government has decided it will be a criminal offence not to abide by the 2008 Pension Act employer duties which are to establish a qualifying scheme and auto-enrol employees into it. That is what employers need to find out and the detail should come much later.”
However, advisers are in something of a catch-22 situation when delivering this fundamental message since those employers who are willing to listen are invariably involved with pensions already, while those who are unaware of their imminent legal obligations prove harder to engage.
Rachel Vahey, head of pensions development at Aegon UK, says: “The employers that already have a relationship with a financial adviser are the ones asking what they need to do. The challenge is getting in front of the thousands of employers without any clue this is coming their way.”
This problem is particularly acute at the smaller end of the spectrum, although the DWP claims the phasing process will allow smaller companies ample time to meet their employer duties and adds that the Pensions Regulator will contact each employer ahead of their compliance date.
However, Grimley questions whether the government appreciates the issues facing the very smallest employers and suggests this sector of the market needs greater attention and support.
“I don’t think [the DWP] fully understands how micro employers work and it is being extremely naive thinking micro employers will go to their adviser or accountant to get advice. These guys have never engaged with pensions in their lives so why will they start now?” Grimley asks.
In the minority of cases where employers are engaged with pensions reform, now is the time to tackle the thorny issue of how to pay for auto-enrolment. Even before employers are obliged to contribute to a workplace pension for all qualifying employees, the cost of retirement benefits were a sticky issue, and the prospect of finding funds for hitherto unpensioned employees is daunting.
Wilson says: “The cost of setting up auto-enrolment and paying contributions for previous non-joiners is a big worry. Many employers offer good schemes and they are already paying in a lot so they are questioning whether they can afford to extend the benefit to everyone.”
Advisers will need to guide employers through the options, which will undoubtedly call for some tough decision making, such as deciding whether pension contributions come from profits, passing the costs to customers or by reducing other employee benefits. To make these kinds of plans, employers will first need to gauge some idea of how much pensions reform is going to cost.
I don’t think the DWP fully understands how micro employers work and it is being extremely naive in thinking micro employers will go to their adviser or accountant to get advice. These guys have never engaged with pensions in their lives so why will they start now?
Basi says: “[Employers can] review their existing arrangements and consider the additional cost of auto-enrolment based on numerous assumptions in terms of opt-outs. They can look at employment and recruitment trends and budgets for the next two to five years and check HR resource capacity.”
Employers also need to check their current contracts of employment and ensure that no existing clauses are affected by auto-enrolment. For example, Grimley notes that death in service benefits are often paid by default to members of the company pensions scheme. Employers need to decide whether they are happy to extend this expensive benefit out to all auto-enrolled employees, and if not amend contracts as soon as possible.
As a means of staggering the pain of funding auto-enrolment, the government has introduced phased contributions that oblige employers to pay just 1 per cent of payroll in the first four years gradually moving up the requisite 3 per cent for employer and 5 per cent for employees by October 1017. The motivation for a transitional phasing of contributions is that employees either won’t notice the reduction in their pay packet or will be able to absorb such a minimal amount that they don’t opt out.
Rather cynically, however, it appears employers are already exploring how they can bypass this phasing process and immediately auto-enrol individuals at the higher 5 per cent contribution rate, the idea being that the reduction in take home pay is such a shock to the system that they opt out. Meanwhile, the employer follows the gradual phasing process for its own contributions thereby keeping its own costs to a minimum.
Bostock says “Employers have asked if they can start off auto-enrolling members with a 5 per cent contribution rate, which they will certainly notice, while the company pays the minimum 1 per cent. The answer, it appears, is they can.”
While it may be possible to encourage employees to opt out of scheme membership using this kind of route, any other attempts to dissuade the workforce from joining the scheme is likely to receive short shrift from the regulator. Communicating auto-enrolment to the workforce is a key employer duty and, irrespective of whether the employer believes that joining the scheme may not be in the employee’s best interest, they must ensure every individual is made aware of the scheme.
Vahey says: “The legislation is very prescriptive which makes it simple for employers in a way; they have a legislative duty to communicate this and they can’t use intuition or common sense. Employers cannot enter a conversation with people about whether it might not be in their interests to join because to do that might come under the banner of coercion.”
Even without all the necessary legislative detail the widely shared opinion is that the first set of employers will reach the final destination for pension reform on time and in line with the DWP’s timetable. However, the very largest employers were always least likely to present a problem for the government; rather it is the hundreds of thousands of smaller employers that are more likely to trip up on their employer duties.
The government needs to get a move on and get the final pieces of reform in place so that it can focus all its time and energy on establishing an effective communication programme that can be supported by the wider pensions industry. The longer employers have to prepare for change the more chance there is of preserving existing higher quality schemes, while at the same time encouraging employers with no provisions to go further than offering the bare minimum.
Pensions reform promises a genuine opportunity to radically improve the financial security for millions of individuals at retirement but this will only work if employers are on side. Government needs to equip advisers with the right tools now if they stand any hope of achieving this important goal.