Pension Scheme Design
In this article, Neil Latham, Principal at pension consultancy Punter Southall, looks at some of the key questions your organisation will need to ask around pension scheme design and selection for auto-enrolment.
From 01 October 2012 the responsibilities under the recent pension legislation on auto-enrolment began to apply for the largest UK companies. Over the next four years, all UK businesses will have to assess their employees and automatically enrol those that qualify into a suitable pension scheme.
Unfortunately, although the concept is simple, the detailed guidance that has been issued by the Pensions Regulator demonstrates that the practice is considerably more complex. Employers will need to comply with the regulations and demonstrate that they have done so. For many, this will be challenging.
To protect themselves against the regulatory, reputational and financial risks involved, employers will need to follow a robust process and capture an audit trail of the decisions taken. A key part of this process will be designing the pension scheme. This is a complex task that must balance a number of issues and meet the needs of different parties, including; the employer, the member and the provider, while being compliant.
We have set out the key questions that will need to be answered by the employer’s project team.
What type of scheme should be used?
Will the scheme be trust or contract based? Do you want control over scheme issues or will you leave this to the members? Which structure suits your ongoing governance issues? Do you have an existing arrangement that you prefer to continue using?
Who will provide the scheme?
Will you use an existing scheme or set up a new scheme with a new provider? Will you consider using NEST or one of the “super trust” schemes? What is your provider’s auto-enrolment proposition? Will they help you assess your employees and identify the auto-enrolees? Do they have a strong administration track record? Are the charges competitive? Do they have the resources available to establish the scheme by your project deadlines?
How much will you contribute?
Contributions need to meet the minimum statutory standard, but be affordable and realistic for an employer. They should help recruit and retain essential staff and should produce sufficient benefits to allow employees to stop work at a reasonable age; avoiding the need to test the competency of older workers.
Many employers want a simple contribution structure and some intend to simply pay contributions at the minimum statutory level. This can reduce the initial costs, but your scheme may not be commercially attractive to the provider market and we have seen cases where better providers have declined to tender for a scheme where contributions and salaries are low, forcing the scheme to accept a less suitable, alternative provider.
Many employers will continue to use their current definition of pensionable salary (often basic salary), rather than the new qualifying earnings band. This is permitted if the employer can certify that the contributions paid meet the Certification tests set out in the Pension Regulator’s guidance. The three tests can be applied separately to different categories of worker and the certification can last for up to 18 months. Employers will need to keep evidence of the calculations performed to certify the tests.
Where will the contributions be invested?
The new regulations require employers to designate a default investment option for the pension scheme that they will use for auto-enrolment. What does your provider offer as a default option? Is this suitable for your employees? Is it reasonably priced? How does it manage investment and inflation risks?
This is an important mechanism that is used to maximise the efficiency of pension contributions by making National Insurance Contribution savings. However, any employer using this arrangement will need to make sure they establish their scheme correctly to work with auto-enrolment.
As you can appreciate, addressing these issues is essential if the scheme is to work in practice and meet the demands made upon it from a reward, administration and investment perspective. A design that suits these objectives today will need to be reviewed regularly to keep it up to date and fit for purpose. Changes will be required, but these can be anticipated and the initial design can be flexible enough to accommodate these, if sufficient consideration is given to the issues at the outset.
Dealing with auto-enrolment is a significant project and it can take up to a year to complete properly for many employers. Compliance is not optional, so action is needed well before your staging date to kick-start the project and begin the planning required to successfully address these issues.
Neil Latham is a Principal at Punter Southall, a leading pension consultancy. He is an expert on pension scheme design and works closely with several major employers on their auto-enrolment projects.