Pensions World

How is the group personal pension, defined contribution and stakeholder market shaping up for auto-enrolment? asks Allison Plager

You never miss what you have got until you lose it. Maybe this statement is not worthy of Confucius, but it has a certain poignancy in relation to pensions and, boy, does it seem that we have grown attached to our pension rights. At the beginning of November, for example, BBC journalists heeded a call from the National Union of Journalists to go on strike in protest at changes being made to their defined benefit (DB) scheme. In France, proposed retirement age reforms have led to widespread protest and, although on a much quieter note, the UK government’s plans to link private pension increases to the Consumer Prices Index rather than the Retail Prices Index have been met with dismay in many quarters. It seems that messing with our pensions is one thing that is guaranteed to cause disquiet.

The biggest change for many UK employees happens when their employer decides to close the DB scheme and offer a defined contribution (DC) scheme instead, as has been happening steadily for many years and continues apace. The National Statistics Office’s “Occupational Pension Schemes Survey 2009” showed that in 2009 active membership of DB schemes fell from around 2.6m in 2008 to 2.4m in 2009, while active membership of DC schemes remained stable at approximately 1m. Crucially, 92% of members of DC schemes are in open schemes, while only 44% of DB scheme members are in open schemes.

Research carried out by PricewaterhouseCoopers published in June 2010 supports this. In the firm’s survey of 179 major employers, including 34 with more than 10,000 employees, and 38 of the FTSE 100, only 6% of companies expected to retain DB pension schemes in their current form. Furthermore, the number of companies that have closed their final salary scheme to existing employees has more than doubled since the firm’s 2009 survey, rising from 14% to 32%. Another 30% of employers intend to close their schemes to existing staff. Marc Hommel of PricewaterhouseCoopers attributed these findings to “numerous factors, including the size and volatility of funding costs, and also concerns about the inequality of pensions provision within an employer’s workforce”.

Providers of DC schemes, a selection of whom are included in the Tables with their offerings, confirm that DB schemes are in decline. Aegon’s Ross Jackson ascribes this to “ever-improving life expectancy and high running costs faced by sponsoring employers have led us to witness further shrinkage in the DB sector. Money purchase schemes are regarded by employers and trustees as a cheaper means of benefit provisions compared to their current DB vehicle.”

Table 1 GPPs - plan minima and charges

Table 2 GPPs - commission, terms and investment

Table 3 Defined contribution - features and minima

Table 4 Defined contribution - charges and investment

Table 5 Stakeholder - features and minima

Table 6 Stakeholder - payment and investment

Scottish Widows says it is “continuing to see a growing number of larger group personal pension (GPP) tender exercises (more than 1m in annual premium)”. It says the reasons for this are partly as a result of “consolidation exercises following merger and acquisition and the inheriting of a number of legacy arrangements, but also the continued decline of final salary schemes where schemes are being closed to new entrants or capping future accrual for existing DB members”.

State of flux

The DB/DC conundrum apart, a major consideration for employers is the forthcoming auto-enrolment requirement which becomes compulsory from 2012. The PricewaterhouseCoopers survey mentioned above notes that most “employers expect to use DC arrangements to comply with auto-enrolment”, but states further that “most employers (69%) do not yet fully understand the cost and other implications for their businesses of auto-enrolment”. Mr Hommel reckons “the cost to employers could eventually be up to £1,000 a year per affected individual” and says it “is a pressing issue for those employers who need to plan for this financial outlay and who risk financial penalties and reputational risk for failure to comply”.

In this respect, Towers Watson’s Paul Macro notes that “take up of company pension schemes” will increase as a result of auto-enrolment and an advantage of trust based schemes, with the potential for refunded contributions in respect of earlier leavers, is that they could allow employers to vary their contribution levels (the employee’s and employer’s contributions can be repaid if the member leaves the scheme within two years). For example, the employer could make higher contributions for longer stayers of the scheme. However, Mr Macro says that, in light of the recent “Workplace pension reforms review” carried out for the Department for Work and Pensions and published on 27 October 2010, this feature of trust based DC schemes is in a state of flux. The reviewers say:

“The most serious issue would appear to be around the difference in treatment of people who leave employment early, with trust based schemes enabling leavers in the first two years to have their contributions refunded, while contract based schemes do not. In addition, those who stay a little longer and build a pot below £2,000 receive favourable commutation terms in a trust based scheme. These differences could create a considerable incentive for employers to set up trust based schemes and, indeed, we were told that many employers are exploring such arrangements for just this reason. How to resolve this is beyond our scope, but it does need to be resolved and government should review this as a matter of some urgency.”

Mr Macro says that this matter needs to be sorted out urgently as it will affect employers’ decisions with regard to auto-enrolment, ie whether or not to go with a trust based or contract based scheme.

Equality is undoubtedly an issue and, according to Mercer’s Tony Pugh, “most employers do want to treat their employees equally”, but so is cost. There has been a lot of thought given to auto-enrolment and Nest over the last couple of years, but employers and their advisers need to look at “modelling their pension solution now”. The recent clarification will have stirred employers, but the scale of the problem will differ. Some employers already have massive take up of their pension offering “so can feasibly enrol new members into the current plan”, while others may have “thousands of non-members” among their employees, perhaps making it too expensive to allow them to joint the existing scheme. Thus some employers are likely to offer a “basic solution, possibly Nest” for new joiners and then “allow them to migrate to the main company scheme after a specified period”. It is effectively a matter of economics, says Mr Pugh.

In similar vein, “employers will need to review the impact that auto-enrolment will have on the total amount of money that they will be paying out in terms of pension contributions”, says Friends Provident’s Martin Palmer. He agrees that the employers “most likely to see a large increase in costs will be the ones that have the lowest current take up rates” and that some of them will have to decide “whether they can afford these increased contributions or instead level down possibly into Nest”. He adds that the final auto-enrolment regulations will be the final factor, and “for example, anything that will require them to change the structure of their existing pensions arrangements is likely to make it more likely that some employers may elect to move to Nest”.

On the other hand, Fidelity’s Richard Nesbit says “employers who already offer a ‘quality’ pension scheme, ie combined contributions of 8%, are likely to retain their existing arrangement. They will see an increase in cost through auto-enrolment, but with a phased approach, should be able to plan financial provision accordingly”. He envisages “a large increase in assets under management within our existing book of business when auto-enrolment takes effect”.

Communicate!

Given that the point of a pension scheme of any kind is to attract employees to join it, communication is key. Auto-enrolment will be a help in that, as 2012 approaches, the national media is likely to provide coverage of its implications, so people are more likely to be aware of retirement provision, but regardless of that it continues to be important to keep scheme members up to date with investment, scheme changes etc and to make sure that the pension scheme suits their requirements.

“Organisations need to be realistic about what members can deal with,” says Mr Pugh. They should learn as much as they can about their members to ensure that they are giving out the right message. For example, it may not be sensible to talk about pensions to employees in their 20s whose main concern is likely to be dealing with debt or saving for a mortgage.

He suggests it may be worth considering offering a “savings plan, perhaps a corporate ISA” as part of “building a culture where individuals look after their own investments”, although he mentions that this would require more financial education. With regard to a corporate savings plan, Scottish Widows agree that there is “a growing demand for non-pension savings vehicles to sit alongside the core pension scheme”.

Towers Watson’s research report, “Pension adequacy – the challenge for DC pension plans”, says that a more outcome focused governance approach when designing and operating DC pension plans that are more effective in helping individuals achieve a better pension outcome is desirable. It concludes that the requirements of individual members around expected investment growth and around levels of risk tolerance will vary enormously across different individuals and across different DC plan memberships.

Towers Watson’s Gary Smith says: “It is essential that DC plan fiduciaries really understand the profile and segmentation of their plan’s membership, in terms of their retirement outcome expectations and what they think is adequate. Fiduciaries need to build their investment and engagement strategies around this understanding and the derived implications for investment risk and return as well as targeted communication messages. What is right for one DC plan and its membership profile will almost certainly not be the most appropriate for another.”

Food for thought

Finally, spare a thought for the stakeholder scheme which was introduced in 2001 with much fanfare – will Nest see the demise of stakeholder pensions, which many tend to see as a poor relation in the pension scheme family?

Probably not. Tony Pugh believes that there is not much difference between stakeholder pensions and group personal pension, as the charges are pretty similar.

The main difference is that the GPP may offer more varied funds with higher charges than the stakeholder scheme permits. In essence, stakeholder schemes still have a place.

Overall, the months leading up to auto-enrolment are likely to be busy for employers as they decide how to cope with new joiners.
Cost will be key, as will communicating the benefits to employees.

Allison Plager is a financial journalist; allison.plager@lexisnexis.co.uk