PLANNING FOR PENSIONS AUTO-ENROLMENT AUGUST 2010 Employers will be required from October 2012 onwards to enrol the vast majority of their employees into a pension scheme of sufficient quality and to contribute to that scheme.
2 Planning for pensions auto-enrolment Auto-enrolment will require all employers to make arrangements for their jobholders who are aged between 22 and State Pension Age to join an automatic enrolment scheme (unless the jobholders actively opt-out). Introduction Most of the legislative framework is now in place for the introduction of the employer duty to auto-enrol employees into a workplace pension arrangement from October 2012. This may still seem a long way off but, as this guide shows, many employers may have a nasty surprise in store in the shape of increased pension costs. Planning needs to start now. The new Government has stated that it is committed to auto-enrolment although it is reviewing the reforms and there may be some changes to the detail. Effective risk and cost management requires forward planning, and there may be significant opportunities to rationalise and control pension costs. There will be much to do, so early consideration of the issues is vital. This guide summarises the key considerations for employers and suggests a timetable for action. What is proposed? Auto-enrolment will require all employers to make arrangements for their jobholders who are aged between 22 and State Pension Age to join an automatic enrolment scheme (unless the jobholders actively opt-out which they may only do after they have first been auto-enrolled, with contributions being refunded). All new employees must be auto-enrolled within a month of being hired. For the first time UK employers will be forced to contribute to a pension scheme for their employees. Jobholders are all workers employed under a contract of employment (this includes temporary and agency workers) in the UK and to whom qualifying earnings are payable. Qualifying earnings are all earnings
3 (salary, wages, commission, bonus, overtime and add-ons like statutory sick pay) in a band 5,035-33,540 (which will be indexed in line with average earnings). An automatic enrolment scheme must meet specified quality requirements and can be either defined contribution (DC) or defined benefit (DB). See the table below for the main quality requirements. Employers will need to ensure that their schemes meet the quality requirements before they are used as auto-enrolment vehicles. For DC schemes, this may involve an annual certification process. For contracted-in DB schemes it is likely that an actuary will need to certify that the quality requirements are met. There are some key points to note: The duty potentially extends to all employers. On some counts there could be up to one and a half million employers in the UK. The Government s previous attempt to expand workplace pension coverage, stakeholder pensions, only applied to employers with five or more workers and did not require compulsory employer contributions. All jobholders with any sort of employment contract are potentially subject to auto-enrolment. As noted above, temporary workers are covered by the auto-enrolment requirement, so a student working over the holidays or an immigrant agricultural worker working in the UK for a few months could accumulate some retirement savings. Auto-enrolment is likely to increase significantly the cost of employer sponsored pension provision for many employers.
4 Pensions Commission Final Report There is almost universal acceptance that the combination of the present state pension system and the present voluntary system of private pension saving is not fit for purpose and will result in pension provision which is increasingly inadequate and unequal. It is not a forgone conclusion that a contracted-in DB scheme or a relatively generous DC scheme will pass the quality test. This is largely due to the very broad scope of qualifying earnings compared to the traditional use of basic pay in workplace pension schemes. Also, many contracted-in DB schemes have benefit offsets which may mean that they fall foul of the quality requirements. Such schemes will either need to be improved, which will increase costs, or an alternative scheme which meets the quality requirements will have to be put in place. Existing schemes (including those closed to new entrants) can qualify as automatic enrolment schemes if they meet the quality requirements, so long as they are open to future accrual of benefits or contributions. Again, such schemes which do not meet the requirements will need to be improved or an alternative scheme which meets the quality requirements will need to be put in place for existing employees. Given the enormous number of employers and employees affected, the intention is to stage, or phase in, the employer duty to auto-enrol employees over a four year period starting in October 2012. During this staging period the employer duty to auto-enrol will be imposed upon employers in batches, starting with large employers and ending with the smallest employers. During the staging period: Contributions of 2% of qualifying earnings (1% from the employer) will be required to DC qualifying schemes from each employer s staging date until October 2016. Sponsors of DB and hybrid schemes will be exempt from the employer duty to auto-enrol until October 2016 but jobholders will be able to opt in to a qualifying scheme before then. The timeline for DC staging is set out below.
5 The Pensions Regulator will have extensive powers to enforce compliance with the new requirements. All employers will be required to register with the Regulator within two months of their staging date indicating how they intend to comply with the employer duty to auto-enrol. Opting out and re-enrolment The Government has not gone so far as absolute compulsion. Auto-enrolment is designed as a form of soft compulsion, relying on people s inertia to keep the take-up rate high. Employees will be entitled to opt out, but they will have to do so proactively. Every three years the auto-enrolment process must be repeated. Those who have opted out previously will be auto-enrolled unless they take active steps to opt out again. NEST As many employers, particularly smaller ones who do not currently operate a pension scheme, will find it hard to get access to appropriate advice, a key part of the reforms is a new pension scheme accessible to everyone. This is to be called the National Employment Savings Trust (NEST). Key features include: it will be a trust-based DC occupational pension scheme, subject to regulation by the Pensions Regulator; it will meet the DC quality requirements; it will be a registered pension scheme subject to the Finance Act 2004 tax regime; and it will be less flexible than a typical DC scheme. NEST (previously called Personal Accounts ) will be run by a Trustee Corporation which will be responsible for setting up the scheme in time for the auto-enrolment requirements going live in 2012. Auto-enrolment is likely to increase significantly the cost of employer-sponsored pension provision for many employers. Existing schemes which do not meet the requirements will need to be improved or an alternative put in place. Employers will need to consider whether they wish to use NEST as the auto-enrolment vehicle for employees not currently in a workplace pension scheme, or some other, potentially more flexible, scheme which meets the quality requirements. NEST will also be an option for future pension provision for employees currently accruing benefits within a workplace pension scheme, especially where the existing scheme does not meet the quality requirements. NEST is currently under review by the Government and it is currently unclear whether any changes will be made to NEST.
6 Impact on employer costs The reforms are aimed at improving access to employer pension contributions for employees and increasing private sector pension savings generally. Public debate so far has centred around the feasibility of NEST, the interaction with the State Benefits S ystem and the challenge posed to existing workplace pension schemes. What has had less attention to date is the effect on the pension costs of employers who already operate a pension scheme. Employers should now begin to consider the potential impact of auto-enrolment on their pension costs and remuneration strategy. Take, as an example, an employer with 1,000 employees, 300 of whom are members of the employer s existing DC scheme, to which the employer contributes 5% of basic pay (and employees contribute 3%). To keep the example simple, let us also assume that average basic pay coincidently works out to be the same as average qualifying earnings, say 20,000 pa, so the average employer contribution is 1,000 pa per employee, and the DC quality requirement is met. The following chart indicates the sensitivity of the employer s pension contributions to an increase in the take-up rate following the introduction of auto-enrolment were the employer to use the DC scheme as the auto-enrolment vehicle: The potential increase in employer pension contributions would be especially significant where the existing pension arrangements provide generous (expensive) benefits but cover only a small proportion of total employees. Many employers will therefore see the 2012 reforms as a trigger to review their existing pension provision for employees, with any savings made on current scheme members being used to offset the cost of auto-enrolment and higher pension take-up rates for other employees.
7 Actions for employers All employers will need to evaluate whether their existing scheme(s) meet the quality requirements. Many employers will also wish to review their future benefits strategy. 2012 may seem a long way off but employers should now begin to consider the potential impact of auto-enrolment on their pension costs and remuneration strategy. Having done so they can begin to determine their approach to meeting the challenge of the new pension system. A possible timetable for the key employer actions is set out below: There will be a number of questions for employers to answer, including: where existing schemes do not meet the quality requirements, what actions are required, and what costs would be involved in meeting the quality requirements? whether to use an existing scheme as the auto-enrolment vehicle? Where the scheme is generous and/or has a low take-up rate, this may be costly; whether to change the design of the existing scheme? whether to cut back existing pension provision, or take other steps, to mitigate the increased costs flowing from auto-enrolment? whether to end future accrual in DB schemes and auto-enrol all employees in an alternative scheme in the future? whether to use the NEST scheme as the auto-enrolment vehicle or some other, potentially more flexible, alternative?
Next steps To find out more about how auto-enrolment affects you please contact Mark Folwell, Chris Clough or Tony Bacon or the partner who normally advises you at LCP on +44 (0)20 7439 2266, email enquiries@lcp.uk.com, or visit our website www.lcp.uk.com. Mark Folwell Partner mark.folwell@lcp.uk.com +44 (0)20 7432 6663 Chris Clough Partner chris.clough@lcp.uk.com +44 (0)20 7432 6609 Tony Bacon Senior Consultant tony.bacon@lcp.uk.com +44 (0)20 7432 0639 LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics. Lane Clark & Peacock LLP London, UK Tel: +44 (0)20 7439 2266 enquiries@lcp.uk.com Lane Clark & Peacock LLP Winchester, UK Tel: +44 (0)1962 870060 enquiries@lcp.uk.com Lane Clark & Peacock Belgium CVBA Brussels, Belgium Tel: +32 (0)2 761 45 45 info@lcpbe.com Lane Clark & Peacock Ireland Limited Dublin, Ireland Tel: +353 (0)1 614 43 93 enquiries@lcpireland.com Lane Clark & Peacock LLP St Helier, Jersey* Tel: +44 (0)1534 887600 enquiries@lcp.uk.com Lane Clark & Peacock Netherlands B.V. Utrecht, Netherlands Tel: +31 (0)30 256 76 30 info@nl.lcpeurope.com LCP Libera AG Zürich, Switzerland Tel: +41 (0)43 817 73 00 info@libera.ch LCP Libera AG Basel, Switzerland Tel: +41 (0)61 205 74 00 info@libera.ch LCP Asalis AG Zürich, Switzerland Tel: +41 (0)43 344 42 10 info@asalis.ch All rights to this document are reserved to Lane Clark & Peacock LLP ( LCP ). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. LCP is part of the Alexander Forbes Group, a leading independent provider of financial and risk services. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC301436. LCP is a registered trademark in the UK (Regd. TM No 2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 30 Old Burlington Street W1S 3NN, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members (as defined under the Act) of the Institute and Faculty of Actuaries, a Designated Professional Body. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Lane Clark & Peacock LLP. *No regulated business is carried out from this location. UK c0710/0710