UK: Employee Benefits Review - A Summary of Topical Employee Benefits Issues for Chief Executives, HR Directors and Finance Directors, Summer 2010 - Is It Ever Just Black and White?

Last Updated: 29 June 2010

EDITOR'S NOTE

The general election has been and gone, but it may well come around again rather sooner than we expected. So how has the world changed for pensions in particular? Well, until 22 June, (the date of the emergency Budget) not at all, really.

However, come 22 June, what might change? Nobody knows for sure, but, as always, speculation abounds.

  • Pension contributions. Rules are already in place to restrict the amount of higher rate tax relief that can be claimed by anyone earning above £130,000. However, a Liberal Democrat manifesto proposal is to remove all higher rate tax relief on pension contributions. Whether or not such a proposal will be introduced is anyone's guess. However, should you plan on making any contributions this year as a higher rate taxpayer, you should make those contributions now.
  • Abolition of the 'Pension Commencement Lump Sum' (tax free cash). It has long been thought that this would be a target, however the initial revenue this would raise would likely be no more than £150m...is this really worth doing? Personally, I doubt it. That said, if you want to be sure, perhaps you should realise your entitlement before 22 June.
  • Abolition of 'Compulsory Purchase Annuitisation'. It is possible that the effective obligation on the majority to purchase an annuity at age 75 years may be removed. Therefore, if you are 75 years old before 22 June, it may be worth deferring annuity purchase until after the Budget. Failing any material changes in the Budget, you can always buy an annuity thereafter.

But, as everyone knows, nothing is ever simply black and white, particularly when it comes to government and pension reform, so these items may transpire to be tinkering around the edges and we may see further radical change. But it's anyone's guess.

Until then, let's concentrate on what we know for sure. In this edition of Employee benefits review we suggest ways to cut costs in group risk without jeopardising employees' salaries, we revisit personal accounts – now Nest – and we discuss the pros and cons of securing your liabilities with insurers.
By Peter Maher

GROUP RISK - DIRECT COST FOR EMPLOYERS
By Matt Haswell

Employers want to keep group risk premiums low; there are various ways to achieve cost savings.

Group risk is an umbrella term that covers three company-sponsored employee benefits: group life insurance, group income protection and critical illness cover. Group risk benefits are often (but not always) fully insured. Provided in isolation or as part of a wider benefits package, these employer-sponsored products can give employees access to valuable insured protection cover under one 'group' policy.

Group life assurance is the most common employer-sponsored benefit in the UK. It often represents the sole life insurance provision for low to middle income individuals. Group income protection provides a continuing income for employees if illness or injury prevents them from working for a prolonged period of time. Group critical illness cover pays a tax-free lump sum to an employee on the diagnosis of one of a defined list of serious conditions, or on undergoing one of a defined list of surgical procedures.

These benefits are highly valued as they provide financial protection for employees and their families, yet they are relatively inexpensive for employers compared with some other components of the typical benefits package.

Although inexpensive compared to funding a pension scheme or sponsoring private medical insurance, many employers are keen to keep premiums as low as possible and in the current climate have considered adopting practices to cut costs. So how do they go about doing this?

It is, of course, easy to achieve savings by cutting back the level of benefits.

  • Reduce the amount of cover, e.g. the multiple of salary insured for life assurance.
  • Increase the deferred period of income protection schemes.
  • Limit the claim period.
  • Introduce lump sum settlement agreements.
  • Reduce escalating claims payments.

However, cutting benefits is never a palatable option and does require careful communication to employees. Pursuing options that do not impact on benefits should be considered first. The group risk market remains a competitive market; although there are less than ten insurers offering such products, their appetite for securing premium income is great.

Rebroking schemes is an obvious start but this should not be limited to the renewal date. Mid-term rebroking often reveals the most competitive premiums, so use your advisers' knowledge of the market to source deals and opportunities whenever they present themselves.

Consider the following options.

  • Combine schemes to benefit from economies of scale.
  • Use one insurer for all benefits.
  • Access affinity schemes.
  • Take advantage of insurer discounts.
  • Adopt common renewal dates for all schemes to allow insurers to quote on all schemes at the same time.

As another option, moving group risk benefits onto a flexible benefits platform can lead to immediate cost savings. Ever increasingly group risk schemes are being administered on such platforms and insurers recognise the efficiencies that this brings them. As such, insurers are offering very competitive premium rates in order to win market share.

Ultimately, commercially driven savings are there to be secured and can be huge. Make your adviser work for you – it's a competitive market.

THE NESTING INSTINCT
By Ian Luck

Nest (previously personal accounts) could spell trouble for employers by increasing employment costs with no scope for legal avoidance.

In the run up to the general election you would have been hard pressed to find any meaningful references to what the future of pension provision might look like in the UK. This was hardly surprising as, although it impacts on so many people, the changes are likely to be felt many years from now and who knows what political party (or parties) will be in charge at the time.

So the legislation introducing personal accounts, which has now been renamed as the National Employment Savings Trust (Nest), remains in place – ready to inflict the most far-reaching changes to the pension landscape in about fifty years.

Since the early 1960s, it has been a requirement for nearly all employees to be members of either their employer's pension scheme or the second tier of the state pension system, providing an earningsrelated pension in addition to the basic state pension.

Come 2012, employers and employees will still make earnings-related contributions towards the second tier of the state benefit system, but the pension payable will cease to be earnings-related. This will (eventually) become a flat-rate top up to the basic state pension. The link to an earnings-related pension will be broken for millions of people.

Instead, employers will be required to establish a qualifying workplace pension scheme (QWPS) for their eligible employees. They will then have to enrol their employees into the scheme and contribute on behalf of any employee who decides not to opt out of the scheme. If the employee remains in the scheme, the employer will eventually be required to pay a minimum of 3% of the employee's band earnings (currently between £5,035 and £33,540 per annum).

Employers unable to, or unwilling to, set up a QWPS of their own will have to make these contributions into the default government-run scheme – Nest.

These requirements are being phased in between October 2012 and September 2016. Every employer has been allocated one of forty-three dates during this period when they will have to comply with the regulations. Based on the estimated numbers, the million or so employers that exist in the UK will have 10 to 12 million employees within pension arrangements; perhaps up to half of which will be in Nest.

So what might drive employers to settle for Nest over a pension scheme that they have designed, chosen, and can oversee?

It is hard to see efficiency at the centre of that decision. After all, the record of recent governments controlling huge projects is not great. Couple that with employees, once they have been auto-enrolled into the pension, being able to opt out and receive a refund of the contributions that they are required to pay, only to be re-enrolled three years later, and you can see the nightmare that might ensue.

Perhaps cost will be the deciding factor. One of the main features of Nest when it was first introduced was that it would have a low annual management charge of 0.3%. Now, 0.3% is low even for the largest and most attractive of employer-sponsored schemes available on the market today and a lot less than the government-imposed stakeholder charging structure. So it is hard to see that being possible.

However, the charges that will be levied under Nest were recently confirmed as 0.3%. But, in order to cover the cost of establishing the scheme and paying back the government loans that will be required to ensure that someone wants to run it, there will also be a 2% charge on all contributions from outset for an unspecified period. Exactly for how long this will be required is unknown and will no doubt depend on how successful Nest is in attracting and retaining members.

So that is the equivalent of a 98% allocation rate, which itself may sound strangely like pensions have come full circle for anyone that remembers capital units. As such, it will not be as easy for employers as they might have been hoping to opt for Nest to ensure that their staff have the cheapest option.

A wider concern for employers and advisers alike has always been ensuring that the pension into which an employee is automatically enrolled remains suitable. This is particularly true for low earners where the current means-testing of the state benefits system is such that employees might lose the benefit of every penny that they have saved within their private pension arrangements. A particularly difficult thing to swallow if you had no choice in whether you joined the pension in the first place due to an automatic enrolment process.

However, there might be some good news on the situation. The new Pensions Minister, Steve Webb, said: "It will have to be addressed before 2012 if the launch of personal accounts is not to be undermined by doubts – ill-informed or not – about whether it will be worthwhile saving." It will not be easy to sort out the problems that means-testing poses, but it is good to see that it is at the forefront of the new Government's mind.

The Government's document, Programme for Government, contained even more good news: "We will simplify the rules and regulations relating to pensions to help reinvigorate occupational pensions, encouraging companies to offer highquality pensions to all employees, and we will work with business and industry to support auto-enrolment."

Nest is interesting by its omission, but it is clear to see that if you have been putting off making any changes to staff pension arrangements, hoping it would all go away, you are going to find that auto-enrolment appears before you like a very large cuckoo.

INSURING SCHEME BENEFITS - AN ATTRACTIVE OPTION
By Peter Maher

Due to buyout costs becoming more agreeable and recent product developments, securing liabilities with insurers is now a worthy option for schemes.

The most straightforward method of discharging scheme liabilities is to secure, or buyout, benefits, for both deferred and pensioner members, with an insurance company. Indeed, on wind-up of a defined benefit scheme, this is the ultimate means by which the scheme can guarantee to meets its liabilities.

In general, however, the cost of such a buyout is much higher than the normal assessment of a live scheme's liabilities, referred to as the technical provisions under valuation regulations. As such, the cost is generally viewed as prohibitive.

However, recent market turbulence and, in particular, historically high corporate bond yields, have led to buyout costs becoming much more attractive. Combined with relatively recent product developments, including the option of buy-ins as opposed to buyouts, this has led to more schemes considering securing some or all of their liabilities with insurers.

Changes to affordability

Over the two-year period from June 2007, the overall affordability of a typical pension scheme buyout has risen by about 10%. This figure is made up of two components, the affordability for deferred members, who have not yet reached retirement age, and that for pensioner members who are already in receipt of pensions. The Pension Insurance Corporation Risk Transfer Index, August 2009, compared the relative costs of two typical groups of deferred and pensioner members respectively from June 2007 to June 2009.

The statistics for the relative cost of a deferred member buyout demonstrates that, over the last two years, although the cost of a buyout at the end of the period was similar to that at the beginning, the cost is volatile, with changes of over 15% occurring over a three-month period.

The relative cost of pensioner member buyout shows a somewhat different picture, with a relatively steady decrease in the cost to secure pensioner members by up to 15% to the end of May, although as bond yields have dropped the costs have crept back up.

Activity in the pensioner market in particular has grown significantly. Many more schemes are seriously considering securing pensioner liabilities than in 2009.

How long will this opportunity last?

The cost of securing liabilities is very closely linked to the bond markets, with insurers now more likely to factor corporate bond yields into prices. Bond yields were at historically high margins over government securities for much of 2009. Some of these margins have relaxed as markets gain greater confidence about the risks of defaults. There will be ongoing volatility in the terms available, especially if ongoing quantitative easing and increased government borrowing conspire to push gilt yields higher over time.

Access to terms

One issue facing trustees considering securing liabilities is access to terms. Given the increasing attractiveness of the market, and that insurers can usually only make capital available to write a fixed amount of business (this is capital hungry in the medium term to meet solvency requirements), insurers will often set minimum and maximum case sizes. Some will only quote for cases over £20m and we have experienced one who will not write anything over £50m. This can change from day to day, however, adding to the volatile nature of the market.

Solvency II – costs might increase

There has been much discussion in insurance circles of late about the impact of European requirements, known as Solvency II, on the capital security required by insurers to write guaranteed annuity business. This has led to some commentators suggesting that the cost of such business might increase by up to 20% over the next two years to meet these requirements. This is another potential reason to seriously consider securing some or all of a scheme's liabilities sooner rather than later.

Buy-in vs buyout

One objection in the past to securing pensioner liabilities was that, if benefits for particular members were secured in full, did that treat them more favourably than those members left behind, without secured benefits, who remained dependent upon the sponsor's covenant?

The use of a buy-in arrangement for pensioners resolves this issue, making the decision primarily an investment one. Whereas a buyout secures benefits in a member's name, the buy-in secures benefits in the trustee's name and pays all instalments via the trustee. Therefore, if, for any reason, payments to individuals need to be reduced in the future (for example to meet a pension protection fund level of benefits instead of full benefits), the balance of any instalments are still there as an asset to be distributed to meet other members' benefits.

So what does this mean?

The cost of insuring liabilities has fallen considerably recently and an opportunity may still exist for some schemes to take advantage of this. Rates are potentially rising again, but for many the use of a pensioner buy-in in particular may well be worthy of consideration.

The variation in annuity terms will, from time to time, change the commerciality of a buy-in exercise. What does not change, however, is the ability of such a process to de-risk a pension scheme in terms of both future mortality and investment risks.

THE 'HR MOT'
By Rachel Stone

  • How well are your HR systems working?
  • Are they providing your business with the support and structure you need?
  • Are you up to date with changes in employment law and practice?
  • Do your policies, procedures and forms reflect the latest requirements?

Our HR MOT will rigorously examine your core HR systems, polices, procedures and practices. As well as checking for compliance with the latest employment legislation, we provide you with feedback on the effectiveness of your HR systems.

A thorough review of your people policies and practices

The HR MOT looks at seven core areas of your company's approach to people management.

  1. People and the company strategy
  2. Employment legislation and compliance
  3. Motivation and feedback
  4. Recruitment and selection
  5. Pay and benefits
  6. Internal communications
  7. Training and development

Carrying out the HR MOT

The review process consists of four steps.

  1. Time spent on-site with your company. We'll meet your senior people, interview some of your employees and gather information on your strategy, policies and procedures, as well as hear about how your systems work in practice. Usually this is a one or two day visit, but may require further time if you have a multi-site operation.
  2. A review of all the documentation and systems information to identify gaps, and to look at areas where updating is required to reflect legislative changes.
  3. Production of a detailed report, together with advice on how to implement recommended changes in your company.
  4. Presentation and discussion session for your board/management team to look at planning and implementation issues.

Timescales

Our HR MOT usually takes four weeks from the start of the on-site visit to the production of the final report and revised documentation.

Implementing changes may take longer, particularly where these involve consulting with your workforce. We can provide a clear plan of action for you as well as the letters and announcements you will need to successfully manage the change process.

If you would like support with the implementation of new systems, or would like us to design and deliver training for your managers and supervisors in the new systems, we would be happy to help.

Benchmarking

We can also conduct a benchmarking exercise for your business, comparing your policies, procedures and practices against those of other businesses in your sector, or against best practice organisations

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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