Personal accounts: the domino effect

The advent of personal accounts will affect more than just pensions. Debbie Lovewell checks out how auto-enrolment will impact on other forms of employee benefit.

The introduction of almost any piece of employment legislation will inevitably have more far-reaching effects for employers than originally intended. The latest plans for pensions reform, which will see the introduction of automatic enrolment and compulsion when it comes into effect in 2012, are no different. As well as forcing employers to review their pensions provision, it could also mean that they revisit the overall benefits package they provide for staff.

With four years still to go until the planned reforms come into effect, industry speculation is rife about what impact the changes are likely to have on both employers’ pension and wider benefits provision. In particular, there has been much debate centred on the number of companies that will reduce the pension contributions they make for employees to the statutory minimum or move staff over from an occupational pension scheme into personal accounts, as a way of dealing with potentially increasing costs or administrative requirements.

The planned changes set out in last year’s Pensions Act 2007 and the subsequent Pensions Bill introduced last December provide for the introduction of auto-enrolment for all employees over the age of 22 years who earn more than and#163;5,000 a year. Employers will also have to contribute a minimum of 3 per cent of salary for all employees who do not choose to opt out of the scheme into which they have been enrolled. In addition, staff must contribute a minimum of 4 per cent of salary, while a further 1 per cent will be added by the government in the form of tax relief.

A system of personal accounts will also be established into which employees will be enrolled if their employer does not offer a qualifying pension scheme that meets the new minimum requirements, or if an organisation no longer wishes to continue to provide such a scheme.

According to Chris Bellers, pensions technical manager at Friends Provident, government research suggests that just 1 per cent of employers are likely to move employees over to personal accounts. This is also borne out in the results of the Employee Benefits/Axa SunLife Pensions Research 2007, which shows that just 2 per cent of respondents anticipated the new measures would force them to move all employees into personal accounts. Duncan Howorth, managing director of JLT Benefit Solutions, says: “I don’t think that many employers will downgrade to personal accounts. We’ve got to a point in pensions where those that want to provide something for staff are doing that. The challenge for the industry is that we need to work with those employers who have set something up and review it in the context of personal accounts.”

According to figures from the Department for Work and Pensions, however, just 200,000 of the approximately 1.2 million organisations that will be covered by the new legislation currently provide a pension with a minimum 3 per cent employer contribution. Steve Herbert, head of benefits strategy at Origen, believes a higher figure than 2 per cent of employers will move over to personal accounts than expected, although the true number will not become clear for quite some time.

Moving staff into personal accounts, however, may impact on more than just an organisation’s pensions strategy. Thanks to auto-enrolment, many employers will inevitably find that they must begin making pension contributions for a much greater proportion of their workforce, which could steeply increase costs. This has prompted concerns that some organisations may also look to scale down the other employee benefits they provide in order to help raise the additional funds needed to meet their new contribution requirements.

Although this scenario is a very real possibility, many working in the market believe it is still too early to determine whether such concerns will come to fruition. Glenn Thomas, managing director of Jelf Corporate Consultancy, says: “At this moment in time, I don’t see it impacting on other benefits. I think the type of employer that will move to personal accounts is unlikely to be benefits rich”.

Herbert adds: “Just because pensions are going to be part of pay, it doesn’t mean that employers should move away from doing everything advisers have been telling them to do for the last 10 years.”

But for many employers with for example a 50 per cent or lower participation rate in their pension scheme, the advent of personal accounts and auto-enrolment is likely to lead to a near doubling of pension costs. If employers do find it is necessary to reduce other areas of their benefits package in line with their pension, one of the most obvious areas where cuts can be made is among some of the more costly perks they offer, such as private medical insurance [PMI] and group income protection, says Herbert.

Alternatively, employers may opt to remove or reduce the value of benefits that are traditionally linked to pensions. “Not only could a reasonable proportion of employers dumb down their contribution rate, but the benefits that sit around pensions could disappear. I think things like life assurance and group income protection could be at risk because, rightly or wrongly, they are closely associated with pension schemes,” explains Howorth.

Rather than simply removing such benefits altogether, which could prove problematic if they form part of an employee’s contract of employment, employers could look at the terms of a scheme to identify how it could be made more cost effective. Group income protection schemes, for example, can be altered to include a limited payment period of say five years, rather than continuing to pay out the benefit until retirement.

Removing or reducing benefits, however, could leave employers at something of a disadvantage when recruiting and retaining staff, or differentiating themselves as an employer from competitors, particularly if they are also perceived to have reduced their pensions provision in moving staff across to personal accounts.

Historically, many employers have used the pension that they offer to differentiate themselves in the employment market, for example, by retaining a defined benefit [DB] scheme or by offering higher contributions to a defined contribution plan. As moving over to personal accounts or reducing employer pension contributions to the statutory minimum will place employers on a more level playing field, they may look to introduce cheaper but highly visible benefits that will appeal to employees. This may be particularly effective for organisations with groups of staff that do not currently attach a great deal of value to pensions, such as graduates who are more likely to prioritise repaying student debts or getting on the property ladder above saving for retirement.

Rachel Vahey, head of pensions development at Aegon, explains: “It could be that employees value other benefits ahead of pensions as they can see more of a tangible benefit.”

Possible options could include perks such as tax-efficient childcare vouchers, which are inexpensive for organisations to offer to staff and are eligible for national insurance savings for employers as well as employees. Howorth adds that non-financial or lifestyle benefits, such as tax-efficient mobile phones or bikes for work schemes, are also particularly likely to flourish. “Where employers now have the opportunity to personalise what they are offering, that is highly attractive to people,” he says.

But tailoring the benefits an organisation offers to suit its workforce’s values will not always necessarily involve introducing new perks. Instead, employers may choose to look at the manner in which they offer their existing package. Andrew Tully, senior pensions policy manager at Standard Life, says: “For bigger employers, a flexible benefits scheme would be a way to get buy-in from employees as it gives them an element of choice around perks. That’s a good way to get all employees to appreciate what the organisation is offering”.

Just how far personal accounts will impact on employers’ wider benefits provision, however, remains to be seen. “Pensions generally are the most expensive benefit that an employer offers so I’m not sure that they will take a pension scheme out and put another benefit in or vice versa,” explains Tully.

Bellers adds: “If employers reduce their pension costs, will they reduce other costs as well? I’m not sure they will.”

The general consensus in the industry is that employers should actively communicate the benefits they currently provide for staff in order to maximise employees’ appreciation of their package. If it then becomes necessary to reduce the value of an organisation’s pension benefits, staff may be more understanding if they understand what the rest of the package they receive from their employer is worth. This can also help employers to gain a competitive edge. “I’m hoping that what will happen through pensions reform is that it will emphasise the package employers offer,” says Vahey.

Many organisations have not yet begun to consider the possible implications on their business. This may partly be due to the fact that the government hasn’t yet announced some of the finer details surrounding personal accounts, such as the full exemption criteria for pension schemes outside of personal accounts. “I don’t think the whole issue of personal accounts is yet on many employers’ radars. What we need are a few more key facts and figures to drop into place. It’s an opportunity for organisations to take stock and look at what they are trying to achieve in providing pensions and benefits,” explains Howorth.

This need to review benefits provision, which is facing so many employers, represents a huge opportunity for advisers. “If you leave employers alone, they’ll probably keep doing what they are already doing. It’s a big opportunity for advisers as employers need help over the next few years working out the best benefits package for employees. A lot of employers won’t know what they want to do, which is a great opportunity for advisers,” explains Tully.

Overall, employers would be wise to begin reviewing how personal accounts and the new pensions legislation will affect benefits provision sooner rather than later. As Herbert explains: “There are ways and means of getting costs down, but employers need to be looking at it now rather than in four years.”

Those that wait may find that 2012 creeps up on them much quicker that anticipated.

Expert view – Mike O’Brien, Minister of state for pensions reform

How will personal accounts work?

Pensions reform under the Pensions Act 2007 and Pensions Bill 2007 is designed to increase take up of pensions in the UK workforce. Due to come into effect in 2012, the planned reforms propose automatic enrolment for staff into a qualifying pension scheme and the introduction of personal accounts for employers who do not run an eligible occupational scheme.

Under the terms of the legislation, all employees over the age of 22 years who earn more than and#163;5,000 a year will be enrolled into a qualifying workplace scheme or personal accounts. The latter system will be set up at arms length from the government by the Personal Accounts Delivery Authority.

In order for employers’ existing occupational pension schemes to be considered exempt from personal accounts, they must meet certain criteria.

Although the finer details of this have yet to be fully decided, proposals unveiled in last December’s Pensions Bill indicated that contributions must amount to 8 per cent of qualifying earnings including overtime payments, commission, statutory sick pay and statutory maternity pay for schemes to be considered exempt. This is a change from current qualifying earnings, which are typically a percentage of employees’ base salary. Qualifying earnings will also be based on a figure between and 5,035 and and 33,540, according to the bill’s proposals.

The bill has led to fears that employers may have to close their existing pension schemes if they do not meet with the proposed criteria. Even if they keep schemes open, increased costs may force employers to reduce their contributions to the minimum 3 per cent.