Storing up trouble
While employers are being compelled into playing an active role in the implementation of pension auto-enrolment, there appear to be a number of sizeable obstacles in their path which either have not been fully considered or are not being adequately addressed.
Without doubt, auto-enrolment presents a huge opportunity to help get the UK’s retirement planning back on track. For too long, politicians have tinkered with pension rules and regulations, adopting layer upon layer of legislation with no accountability on their part, and achieving very little other than ensuring that the majority of the public isn’t interested in pensions and isn’t engaged with retirement planning.
Auto-enrolment is a chance to put right at least some of the mistakes, lack of ambition and downright meddling that have taken place in the past. This is an opportunity to get people engaged and to get them to understand that they cannot rely solely on their employer or the government to look after them in retirement, and that they have to do something for themselves.
However, while employers have a major responsibility in making auto-enrolment happen, they are facing the prospect of severe capacity issues. It has been estimated that mainstream pension product providers can support the setting up of around 2,100 new pension schemes each month, although providers are looking to ramp-up capacity during 2014. As ever-increasing numbers of employers reach their staging dates, this number looks hugely insufficient. It is believed that, at the peak, capacity for around 70 times this amount might be needed.
This also assumes that product providers will be keen to accept increasing numbers of new schemes. However, that simply isn’t the case. Providers are commercial organisations and so will only take on new schemes that they believe will be profitable business for them. This is understandable, as they are accountable to their shareholders or owners, and they do not have a moral or civic duty to accept all employers. How long would the chief executives of these firms last if they ordered their company to accept swathes of business that will lose them money?
So, as auto-enrolment encompasses smaller and smaller firms, a greater number of companies will be deemed unprofitable by providers. We are already seeing this, with most of the mainstream product providers being particularly picky about the schemes they will accept. As providers become even more selective, this will cause significant problems for small and medium-sized companies (SMEs) which have to implement auto-enrolment.
The government’s proposal to cap pension charges, while on the surface a welcome move, could actually lead to further capacity problems. If a provider cannot run a particular scheme profitably within that cap, they will simply decline the business. The government has suggested the charges cap should be set at 1 per cent or 0.75 per cent per annum, although other organisations, such as Which? and Legal & General, are arguing that 0.5 per cent is a better target.1 Legal & General already declines all business it cannot make money on by charging 0.5 per cent per annum. If other providers are forced to follow suit, smaller employers really will struggle to source suitable pension schemes.
Auto-enrolment creates a number of other potential risks for SMEs. As well as the actual pension contribution costs themselves, other issues include: the costs of implementing and running auto-enrolment; resources being taken from other duties in the company; recruitment and staff-retention risks if other employers ‘level up’ their benefits packages; and possible financial penalties and reputational risk if they get it wrong.
The Pensions Regulator has already launched a number of investigations into possible non-compliance on the part of large employers that have launched auto-enrolment. If large employers, which are likely to have greater internal resources, access to experts and deep pockets, are struggling to comply, what hope is there for their smaller brethren?
With little if any product provider capacity available to them, many SMEs will be forced to use the National Employment Savings Trust (NEST) as their pension scheme provider, even if it isn’t the most appropriate choice. NEST is the government-sponsored pension scheme that has a public service obligation to accept any employer who wants to use it for auto-enrolment.
There is nothing inherently wrong with NEST. However, unlike other providers, NEST provides no administrative support to employers, and so small companies, which are more likely to have limited if any internal HR resource, will be very much left to their own devices.
This situation is unlikely to change because NEST is limited by statute from providing services other than operating as a pension scheme. This means that employers using NEST will have to self-serve online and can receive no support regarding compliance. NEST cannot help an employer budget for the costs of auto-enrolment or advise on the right pension contribution structure. It also has no functionality to produce the communications required, except for offering standard templates and a huge manual. This creates a problem as many employers will need the support of their provider to ensure they comply with the complexities of their new duties.
Using NEST could also create problems for employees, through a lack of help and support. Employees aren’t even given a phone number so they can speak with someone if they have any problems. This approach is unlikely to help employees become engaged with their pension arrangements and may lead to them either not increasing contributions or, even worse, opting out of auto-enrolment altogether.
Because NEST has an initial contribution charge of 1.8 per cent on each payment made into the scheme, it can also be a comparatively expensive option for older employees, making it more unsuitable for firms with an older demographic.
The initial contribution charge was put in place to help pay off NEST’s loan from the Department for Work & Pensions and was supposedly just a temporary measure. However, the size of the loan has continued to grow. As at 31 March 2013, it stood at GBP239 million, up from GBP171 million the previous year. In the 12 months to March 2013, NEST received just GBP61,000 in contribution charges, so it seems these initial costs might be in place for some time to come. We estimate that the effect of the contribution charges is that NEST will not become good value, compared with other providers, for anybody who has less than 15 years until retirement.
A double whammy for SMEs is that the availability of good-quality independent financial advice will also be scarce. As with product providers, independent financial advisors will be severely stretched in trying to meet the demand from employers and so they will need to be selective about who they work with, most likely starting with their existing corporate clients first.
The Pensions Regulator has reported that more than half of SMEs plan to consult an external advisor prior to launching auto-enrolment. This is perfectly sensible but what happens if that external support isn’t available? For employers yet to enact auto-enrolment, the clock is ticking.
What is the answer for employers?
To start with, employers must plan as soon as possible. The Pensions Regulator suggests this should be at least six months before a company’s staging date. However, some product providers argue that a period of 12 or even 15 months is more sensible. Even then, there are no guarantees of companies getting access to a choice of product providers or to independent financial advice, although the sooner they start the better their chances are.
For many employers, which are understandably focused on the day-to-day running of their business, delaying as long as possible might seem the best solution, but this could prove a false economy.
Employers should find out when their staging date is and start planning as soon as possible. They need to secure appropriate professional advice to model the likely costs up to their staging date and beyond. They must then make sure that their payroll and other support infrastructure is adequate.
Then employers should determine the right contribution structure for their business, ideally using salary sacrifice to reduce business and employee National Insurance costs. They must ensure they are focusing on the auto-enrolment objectives of the business, whether that is just basic compliance or structuring a full employee benefits package and communications plan.
That is all well and good, but who is going to help employers to achieve these tasks? There seems little doubt that many will struggle, so the best approach for employers is to act now and reduce the likelihood of being a victim of insufficient provider and advisor resources.
- 1Legal & General has now capped auto-enrolment pension charges at 0.5 per cent per annum (‘Capped charge for all workplace pension customers’, Legal & General Media Centre)
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