David Davison offers advice on the challenges likely to be faced by charities when auto-enrolment for pensions becomes a reality.
As the clock continues to countdown to auto-enrolment, surveys continue to suggest that employers remain oblivious to the implications of this new piece of pension legislation. Even where there is some level of awareness, getting to grips with such a complex issue is proving problematic, and it is quite apparent that organisations have had little inkling of just how far reaching the implications for them and their staff could be. Charitable employers could find themselves in a particularly difficult position.
In this article I wanted to give not-for-profit employers some guidance about the issues they’re likely to face and the sort of audit process they should actively be undertaking. As a starting point organisations really need to consider what type of scheme they provide currently and how the new legislation may impact.
No existing arrangement
While starting from scratch may appear relatively straightforward, the implementation of a scheme will require some form of infrastructure to be put in place which was not there previously. It is likely to result in increased costs if staff participate in a scheme (NEST or an alternative) and an increased administrative burden. Organisations need to plan for these increased costs and try to come up with a solution which fits their employee benefit needs and the level of administration they can comfortably deal with.
Existing defined contribution arrangement
Organisations will need to review the scheme they already have in place and the scheme contributions being made to make sure they meet auto-enrolment requirements and that their scheme will integrate with any new requirements. This could be complicated where there are tiered or service-related contributions, or where schemes operate a salary sacrifice arrangement.
A significant potential issue could be where employers have an existing defined contribution scheme which tends only to attract higher paid staff paying higher contributions. If this is the case it will tend to be very competitively priced by the holding insurance company.
Companies need to consider what might happen if, for example, you had a scheme with 500 members paying average annual contributions of £5,000 per annum, and then you looked to add another 3,000 lower paid staff paying lower average contributions and potentially with a much greater staff turnover. Is the insurer going to be happy to maintain the terms or will they worsen them for the new joiners or indeed for everyone for the future? How would employers be able to explain this to existing staff? How do you integrate these new arrangements and what part does the NEST scheme have in linking with this? It’s all unlikely to be easy. Will employers be just more inclined to join a ‘race to the bottom’ purely for simplicity? What about employers who utilise transitory, seasonal or foreign workers and how might they be incorporated?
Existing defined benefit arrangements
This is where things start to get really complicated. If organisations participate in a defined benefit arrangement will they be intending to use it as their default auto-enrolment vehicle? If so the additional costs could be very significant. It is not uncommon to see an employer with only higher paid staff participating in the DB scheme. Take an example of an employer with 300 staff and only 100 in the Defined Benefit scheme. This 100 could well have roughly the same total salary roll in as the 200 who don’t participate, so if all 200 joined that would double the pensions bill plus add considerable administrative complexity.
It would also more worryingly mean that liabilities are growing at twice the rate!! How could you assess what it’s likely to cost as are these staff actually likely to join given the potential level of contribution to DB? Would they join a DC with lower contributions? What about the administrative impact of auto-enrolling them every few years? If you had lots of older staff joining this could push up the average age of the scheme and impact on the defined benefit funding rate.
If you do not want to use the DB scheme as the default you would then need to close it to new members. If a scheme is closed to new entrants it will mean that the average age will be rising and therefore costs will increase. Within an LGPS arrangement this is usually achieved by moving the organisation to a ‘closed pool’ with higher contributions. This will increase costs initially although as the DB salary roll reduces over time as individuals leave the monetary amount is likely to reduce.
Within other multi-employer schemes there tends to be an additional cost either in the form of a levy or an increase to the contribution rate. Even if you leave the scheme open but people just don’t join there is a risk the scheme will be viewed as being closed and the levy added in any case.
A further problem for smaller employers in these multi-employer schemes is that they need to have active members to avoid triggering a cessation debt. The cessation deficit will be many times the level of the on-going deficit and many small charities will be unable to afford this, potentially driving them out of business or forcing them to come up with convoluted arrangements to make sure they keep at least one active member in the scheme.
The degree of staff take-up could also vary widely between schemes which will have an impact on costs. Clearly any impact is likely to be much more dramatic in schemes where the existing take up level is currently very low.
Multiple existing arrangements
All of the above gets even more complicated where there are already multiple arrangements in place. For example I’ve seen charities who participate in a local government scheme (LGPS) and another multi-employer scheme. Some may even have a defined contribution arrangement as well.
This is all really complex and many charities are oblivious to the implications at this stage. Indeed many charities continue to run DB schemes without being fully aware of the risks they face. There are already proposals in place to revise public sector pensions and these changes also need to be incorporated as part of this process.
Each organisation really needs to audit what they have and consider the implications with their corporate adviser and see what steps need to be taken. Whilst an implementation of 2012 or even 2014 may appear to be some time away it will be amazing how quickly time will pass, and decisions with pensions tend not to be made quickly.
David Davison is a director of Spence & Partners Actuaries and Dalriada Trustees