UK: Employee Benefits Review – Stakeholder Pensions. The Second Coming

The ghost of stakeholder pension schemes past is still with us. Some say it has haunted the pensions world since 2001, when legislation made it a requirement for employers with more than four employees to make a grouped stakeholder pension available to their staff, with the threat of a £50,000 fine for non-compliance.

This measure introduced over 300,000 new stakeholder pension schemes to the market. It would be a great achievement if it weren’t for the fact that the vast majority of these schemes have no members! The reason is obvious: membership was not compulsory and employers were not required to pay into the schemes. However, 2012 may change all of that, heralding the resurrection of stakeholder schemes in a new guise.

The next Government initiative in pension planning will arrive in 2012 – the National Pension Savings Scheme, or ‘Personal Accounts’ as they are likely to be called. The main differences with this scheme will be compulsory membership and employer contributions. It’s understood that employers will be required to auto-enrol all their staff into the new arrangements and make a contribution of 3% of salary to the plan to match the employee’s 4% contribution and tax relief of 1%. Employees can opt out, but the Government is relying on most people to stay in.

Less well publicised to date is the fact that if an employer has an adequate pension scheme already in place, staff will be autoenrolled into that scheme instead of the new plans.

Given that 80% of private sector final salary pension schemes are, according to the Association of Consulting Actuaries, already closed to new employees, it seems improbable that any of these schemes will still be open in 2012. Auto-enrolment will not swell the number of members within what is arguably the best form of pension plan. However, most members have replaced defined benefit arrangements with money purchase schemes and these will be included in this legislation. Employers will need to be aware of the additional costs and administration involved.

Employers who offer staff money purchase occupational pension schemes will be required to auto-enrol employees into these arrangements, which will lead to a dramatic increase in membership. The same will happen to employers who offer Group Personal Pension (GPP) schemes, although there is a problem under EU law which prevents compulsory membership of contract-based arrangements. However, it shouldn’t be difficult to find a solution by 2012, and it is extremely unlikely that such schemes will be exempt from the requirements.

Group Stakeholder Pensions (GShP) are a form of GPP. So, assuming a solution is found to enable auto-enrolment into GPPs, this should work for contract-based GShPs as well. Surely employers will prefer to pay into an established GShP, in their company’s name, with their provider of choice, rather than a Government-based arrangement? If employers are compelled to make staff contributions, then they should surely receive some benefit? This is unlikely if employers pay into the national scheme. Perhaps by making their stakeholder pensions perform to the standards of a decent quality scheme in preparation for 2012, it’s time for employers to give stakeholder plans a new lease of life.

Every year, UK employers pay millions of pounds in pension contributions, yet much of the workforce is oblivious to the real value of the pension funds generated on their behalf. It’s hardly surprising then that these employees are not as appreciative as their employers might hope and that these contributions often have little impact on recruitment and retention.

At a time when large numbers of final salary pension schemes are being closed to new entrants and, ultimately, to future benefit accrual, it is little wonder that any changes connected with pensions are generally viewed with suspicion. Even good money purchase schemes, whether occupational or group personal pensions, are often unappreciated – unless employers have communicated the benefits properly.

Quite simply, if you want your employees to appreciate what you are providing by way of pensions or other benefits, you need to tell them.

It’s all very well holding presentations at the time of major changes, such as replacing a good final salary scheme with a (potentially not so good) money purchase scheme, but this is only part of the solution. A year or two down the line, employees will have forgotten the presentations but may, if they are lucky, be receiving two lots of benefit statements: one from the original scheme (of which they have become a deferred member) and one from the replacement scheme. There is still no requirement to produce annual statements for deferred members of final salary schemes and, even if they are produced, they may well appear at different times of the year to the replacement scheme.

It doesn’t have to be like this. We live in an internet-driven world, so why not take advantage of it to get the message across? Systems exist for aggregating benefits under different schemes so that employees can see their potential pension income at the click of a mouse.

But why stop there? Why not include the basic state pension and other benefits from previous employers? People can carry out their own ‘what if ’ projections, such as ‘what if I retire early?’ or ‘what if I pay more?’. Suddenly, your employees have a valuable tool and their suspicions regarding pensions will (hopefully) evaporate. In addition, you will have created something that people really value.

Sick leave and absenteeism can take a heavy toll on a company’s productivity and place a huge financial burden on employers. In addition to lost revenue, sick pay and the costs of temporary cover, an employer may need to adapt the workplace, implement a rehabilitation strategy and operate a support programme for employees who become incapacitated. Employers also need to consider recruitment and retraining, and ensure they comply with the Disability Discrimination Act. In short, the costs of illness can be high and unpredictable.

Joint research by the Confederation of British Industry and Axa shows that in 2006, the cost of staff absence to the UK economy rose to £13.4bn, with over 40% of overall time lost attributable to longer periods of absence – 20 days or more. The average employee took around seven days’ sick leave in 2006, losing UK businesses 175 million working days in total.

It’s not much of a surprise to learn that the best-performing organisations lost an average of just 2.7 days for each employee, while the worst-performing organisations lost 12 days for each employee. At nine days for each employee, the public sector had the highest average absence – 44% higher than the private sector.

Not surprisingly, long-term physical illness is more significant for manual employees, while stress and recurring illness are more common among non-manual employees. Other causes of absenteeism include personal responsibilities and low morale in the workplace. The greatest impact on business is long-term rather than shortterm absence.

Under employment protection legislation, an employee’s inability to perform his or her duties due to disability is a legitimate reason for dismissal. However, the 1995 Disability Discrimination Act requires employers with more than 15 staff to modify (within reason) a job so that it can be done by a disabled person, whenever it is reasonable to do so. This could include modifying premises, providing training, or altering working hours and procedures. This should be the case whether somebody applies for a job or suffers illness or injury while already employed. It is in no way dependent upon the disability arising through work.

Employment tribunals often have to determine whether an employer has acted reasonably. High-profile cases highlight the potential costs to employers who do not take steps to deal with workplace stress. Where employers have not taken appropriate steps, awards of over £150,000 have been upheld for complaints about excessive workload or stress. However, the Court of Appeal has overturned some cases on the basis that employees must bring the stress symptoms to their employer’s attention. Such cases suggest that any employer who offers a counselling service would be unlikely to be found in breach. Also, with proper benefit structures and employment contracts in place, there is no reason for employers to fear court decisions or legislation.

Employers can take a number of steps to reduce absenteeism. They can give responsibility for absence management to senior or HR managers rather than line managers, introduce return-to-work interviews, notification procedures, occupational health services and employee assistance plans.

In particular, occupational health services are now widely recognised as a method of managing absence and employer liability claims. The aim is to reduce the frequency and duration of absence, including planned absence due to operations or hospital procedures. These services can also help to manage the costs of long-term disability payments and group income protection cover by limiting claims and returning employees to work more quickly.

Absenteeism cannot be completely eradicated, so employers should make financial provision for payment of sickness benefit. Group income protection schemes (also known as permanent health insurance) insure against the variable – but potentially huge – cost of supporting staff who suffer from long-term disability. These schemes can be a cost-effective way of providing cover. All members of the scheme can be insured up to a certain level (known as the ‘free cover’ level) without the need for medical evidence, and irrespective of their state of health. These schemes may also improve employee relations, staff morale and could help to attract and retain staff. The cost of the cover is not a benefit in kind for the employee and so does not appear on a P11D return form. What’s more, premiums usually attract corporation tax relief for the employer.

Income protection schemes provide an incentive for an employee to return to work. The schemes offer a regular payment of a proportion of an employee’s earnings during a period of extended absence through sickness, injury or accident.

Cover continues until the employee’s recovery, death or on termination of the insured period (normally retirement age), depending on which occurs first. About half of income protection claims cease within three years and two-thirds within five years. Traditionally, most income protection schemes are written with an unlimited claim period. However, shortening this period to five years dramatically reduces scheme costs, while providing sufficient cover.

Once an insurer has accepted a claim, it is usual to retain the employee on the payroll. This means that he/she can continue to enjoy other benefits, such as life cover and pensions, and remain entitled to state benefits. An additional amount can be insured to cover the employer’s liability for National Insurance Contributions on the benefit, and the employer’s and employee’s continuing pension contributions.

The aim of both the insurer and the employer is to help the employee return to work. Many insurers offer help with rehabilitation or medical treatment to reduce the length of absence.

A total of 12.8 million working days were lost due to stress, depression and anxiety in 2004/05, according to The Health and Safety Executive (HSE). Prolonged work-related stress can lead to poor performance which can, in turn, lead to staff seeking alternative employment, leaving employers with additional recruitment and training costs.

The HSE advises managers to carry out a risk assessment to find out if they are placing undue demands on their workforce. Occupational health professionals are skilled in assessing the workplace for causes of absence and this is equally true for causes of stress.

Support may include discussing workplace problems, discouraging long working hours and controlling hazards, such as noise, harmful substances or abuse.

So, as we can see, there are many ways to counter the costs of employee absenteeism, whatever its causes, and employers would be well advised to consider their options carefully.

"The value of your investments may go down as well as up." This sombre warning is particularly apt given the recent rollercoaster performance of world stock markets. The final salary pension schemes of FTSE 100 companies can be bounced into deficit or surplus as a result of these changes, making headline news. But what about the workers and their pensions?

Various strategies already exist which help to manage the deficits faced by final salary pension schemes. But these are of little help to the increasing number of people in the UK who are members of defined contribution (DC) pension schemes, which include both occupational money purchase schemes and personal pension arrangements.

It is generally believed that equities (shares bought on the UK or overseas stock exchanges) are likely to produce better returns than other classes of asset over the longer term. Within DC schemes, most ‘default’ funds, which tend to be one kind of managed fund or another, incorporate a significant equity component. Balanced managed funds typically hold about 75% of their assets in equities and cautious managed funds tend to hold around 50%.

Market volatility (investment risk) is not necessarily an issue for people until five to ten years before they retire, as there should be sufficient time for markets to recover before the funds are needed to buy a pension (annuity). But how can people protect themselves against a sudden fall in the value of their investments when they are approaching retirement?

Many DC schemes have a ‘lifestyle’ facility that helps to reduce the investment risk for individuals by gradually moving funds out of equities into asset classes that are usually considered less volatile. This typically means moving 75% of the funds into fixedinterest investments, made up of loans to the Government (Government bonds – ‘gilts’) or to companies (corporate bonds). The remaining 25% is usually directed into cash.

Although fixed-interest investments tend to be less exciting in terms of potential return, they have a real benefit as they are closely linked to the cost of annuities. This means that if gilt prices fall when an individual is close to retirement, then the cost of buying an annuity is very likely to fall as well, offsetting a major part of the reduction in fund value. However, if equity prices fall just before retirement, annuity prices are unlikely to reduce. In fact, they could even increase, creating a gulf between expectation and reality.

Given the seriousness of this issue and the inherent volatility of stock markets, it is surprising that there are still many schemes where such a facility does not exist. This can leave members of such schemes financially exposed at retirement.

The introduction of a lifestyle facility, whether as a default investment strategy or by personal choice, may not suit everyone. It would mean that people who wish to, for example, retire five years early, would not have even started to move into the lowerrisk environment. Instead, they may still be wholly invested in a managed fund, holding perhaps 75% of assets in equities, which is potentially very risky.

There are other people for whom a lifestyle facility may also be inappropriate. For instance, if you have a large retirement fund, there may be a case for moving into an ‘income drawdown’ arrangement (more recently termed ‘unsecured income’) on retirement. Arguably, there is little point having 75% of the available fund in bonds of one kind or another (although the 25% cash might be appropriate) if you want to carry on investing the residual fund for another five to ten years, having taken the allowable tax-free cash.

If your DC scheme does nothing to lower investment risk as members approach retirement, then employers (and employees) could be in for a nasty shock if equity markets display excessive volatility during the critical five to ten-year period before retirement.

So how can the interests of the workers be protected? The introduction of an investment strategy that incorporates a lifestyle facility may well alleviate the problem for the great majority of workers, but care needs to be taken to recognise the few for whom this might be unsuitable. An even more effective solution is to arrange for individual investment advice to be given to those who are within five years of their intended retirement, to allow an individual investment strategy to be designed.

So while a lifestyle option can be useful as a default choice for corporate pension schemes, it is not an appropriate route for all individuals. People have different investment needs and attitudes to risk. It’s important that these are considered at the appropriate time.

Sickness absence management and employee wellbeing
Thursday 18 October
Moorgate

• Developing effective sickness absence procedures

• Understanding the statutory discipline, grievance and dismissal procedures

• Preparing for and conducting disciplinary meetings

• Keeping records and notes that show you have acted fairly

• Choosing to terminate employment Practical tips for staying away from employment tribunals

Staff retention – controlling costs in challenging times
Thursday 6 December
Moorgate

• Innovative approaches to aid recruitment and encourage staff retention

• Ways to minimise the costs of providing a suite of employee benefits

• Strategies for managing deficits

• How actuarial modelling can help identify and understand implications of different investment programmes

Training workshop for Trustees
Wednesday 7 November
Moorgate

This full day’s workshop enables trustees to comply with the ‘Trustee Knowledge and Understanding’ requirements of Pensions Act 2004, reflecting closely guidelines that have been issued by The Pensions Regulator.

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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