Issued: 11 December 2003
Pensions, once ranked amongst the dullest topics imaginable, are now rarely out of the news. Members losing their pension rights when the employer goes belly-up; employers closing good final salary pension schemes; deficits running to billions of pounds – it rarely makes for happy reading.
As an employer, you may feel the pension scheme you currently offer your employees is now too expensive to sustain. You may be worried that your employees are destined for a poverty-stricken retirement. Perhaps you are disappointed with your current provider's investment returns or customer service. So, how do you go about reviewing your organisation's staff pension arrangements?
You must first establish why you are reviewing. What are your pensions objectives? How much can you really afford? Is a pension scheme a recruitment and/or retention tool? What is the attitude to risk in your organisation? In each case, the executive management team, your governing body, and the Trustees of the pension scheme may have widely differing views.
You must set a realistic budget for this exercise. If an employee benefits consultant or financial adviser offer to do this for free, you must expect a solution that is based on commission payments. Talk to your current pension provider early in the process. Appoint a professional pensions adviser. Take advice from your employment lawyer on proposed changes to contracts and terms and conditions. Your actuary may have to provide some costings, and together with your pensions lawyer will certify that any proposed scheme changes comply with legislation.
What might emerge from the review? If your current scheme is a 'defined benefits' design, where benefits are linked to pensionable service and salary, closing it to new entrants is likely to increase your costs in the short term. Closing it to future accrual of benefits is more drastic, and may have very serious consequences for the organisation. Recent legislation requires solvent employers to provide full benefits to members if a scheme is to be wound up. Check your Trust Deed and Rules – if the scheme is closed to future accruals, winding up may be triggered automatically. The cost of securing members’ benefits can be very high, and employers may find themselves in serious difficulty.
It may be preferable to keep your present scheme open if costs can be controlled. A careful review of retirement ages, accrual rates, ill health retirement provisions and member contributions may produce a scheme design that is affordable and still attractive to members.
However, many employers have found that the current scheme has to be closed and an alternative arrangement offered, either to new recruits or to all staff. In this situation, the current scheme will need to be very carefully managed to ensure all its obligations will be met. Bespoke professional advice is essential.
If your organisation wishes to continue to provide a pension linked to earnings, a 'career average revalued earnings' design merits investigation. This design can reduce the volatility in costs that has led many employers to abandon final salary schemes.
As an alternative to a single employer scheme, an "industrywide scheme" offers a one-stop shop approach with significant economies of scale. The FRS17 financial reporting requirements that bedevil single-employer defined benefit schemes are much less onerous in some industrywide arrangements.
If a defined benefit arrangement is not sustainable, you will have to consider 'defined contribution' or 'money purchase' arrangements. These include Stakeholders and group personal pensions offered by insurance companies as well as bespoke occupational arrangements overseen by trustees. While they allow employers to fix their contribution rate at an agreed percentage of salary, these schemes effectively transfer all the risk to the member – the risk of poor contribution rates, making inappropriate investment choices, low investment returns and the cost of buying a pension at retirement. Meaningful contributions must be paid in if there is to be any hope of decent benefits being available at retirement. Death in service benefits may represent an additional cost for the employer, as will the provision of financial advice to employees. When these costs are factored in, the savings may not be as great as anticipated.
In summary, reviewing a pension scheme is a challenging and costly exercise. Forewarned is forearmed.
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