December 2007

Getting personal

The next step in the ongoing reform of pensions takes place soon with the issue of a pensions bill setting out in detail what personal accounts will look like. While this new type of pension will not be introduced until 2012, it is important that advisers start to consider its impact when reviewing existing schemes and setting up new ones.

The changes being introduced from 2012 are both an opportunity and a threat to advisers operating in the corporate market. The opportunity arises as all employers will have to automatically enrol their staff into either a personal account or a good quality pension scheme from 2012 onwards. They will need to pay at least 3% of earnings for all those who don't opt out. Doing nothing will not be an option.

The insistence upon automatic enrolment will substantially increase membership levels in schemes. Where employers currently operate some form of auto-enrolment, take up rates approach 90% of the workforce. In contrast, membership of schemes which operate a more traditional opt-in basis may be around 60%. Where employers keep contributions at existing levels this will give a substantial boost to the amount of money going into the scheme. However, will employers accept this increase in cost?

One of the threats is many employers will either close their scheme, or reduce the level of payments they make. This second option - often referred to as levelling down - is a possibility for employers who currently pay above the required 3% level. Rather than pay a 5% contribution for 60% of staff, they may choose to pay 3% for the 90% of employees who will join via auto-enrolment. By making this change, the overall cost of the pension scheme will remain broadly the same.

The government dismisses the possibility that levelling down will be a major factor. This goes against research by Deloitte which suggests more than three-quarters of existing schemes will either close or members will suffer a reduction in contributions. While it is positive that the Government insists it is taking this issue seriously, it would be reassuring if it produced some convincing research into likely employer attitudes.

The issue of most concern to the industry - how employers providing good schemes should be exempted from personal accounts - remains unresolved. It is clear that if employers offer a scheme of suitable quality to staff (via some form of automatic enrolment) then they won't need to offer access to personal accounts. To be a 'good' scheme, defined contribution occupational schemes will need to have a minimum contribution level of 8% with the employer paying at least 3%. Charges will not be taken into account. However we don't yet have a definition of a 'good' scheme for contract-based schemes such as group personal pensions (GPPs) and group stakeholders (GShPs).

The reason for the different approach lies in the enrolment process. Occupational pension schemes can automatically enrol employees into the scheme. That is, the employer can make the employee a scheme member without the member's express consent.

Contract-based schemes such as GPPs and GShps are different. As their name implies, they are contracts and, therefore, there must be some contractual agreement before the employee enters into the contract. This agreement can form part of the contract of employment, or an employee can simply sign an application form. So 'pure' auto-enrolment won't work under these schemes.

Solving the problem

What is needed soon is a workable solution to this problem. One idea would be to make it compulsory for employers with a pension scheme to enrol all new employees from say 2009. This could be done by forcing employers to add a clause to all new contracts of employment requiring new employees to join the pension scheme. Employees would of course have the right to opt out or, in the case of a stakeholder or personal pension scheme, cancel their membership within 30 days. However, with staff turnover running at 18.1% in the UK, by 2012, take-up rates in exempt schemes would be above those ever likely to be achieved in personal accounts.

Assuming a sensible workable solution is put in place to exempt good schemes, an employer will have various factors to take into account when deciding whether to offer their staff access to personal accounts or an alternative scheme. The main issue will probably be around employee relations - will the employer be comfortable making significant changes to the staff pension scheme? This route may create tension if the employee misunderstands the motives behind the suggested change.

Product features are another obvious difference. For example the range of investment funds and the options available at retirement under personal accounts will be very limited. This compares to the extremely wide investment choices plus access to income drawdown and alternatively secured pension which is available within GPPs.

Service is another key aspect of pension scheme provision. Many product providers have spent a great deal of time and money over the last few years developing people and technology with the aim of providing first class service. Employers may not be as confident that the new personal account system will have the same level of service, especially bearing in mind the government's recent record in procuring major IT contracts.

So while there will be some employers who move towards personal accounts, there are many reasons for other employers to stick with their existing good quality schemes.

Another area currently causing controversy is financial support for personal accounts. The government does say that personal accounts should not receive any state support. This is consistent with European Union legislation that prevents the state subsidising enterprises that compete directly with the private sector, as personal accounts surely do.

However, which costs count as personal accounts policy formation and which count as personal accounts product development remains subject to fudge. The costs of policy don't count and, therefore, will not come out of personal account charges. Fair enough. Why should personal account holders pay for the normal costs of government?

The story so far

Work on personal accounts is already in progress. For example, the development and costing of administration processes. This sort of work is not the policy making of government but pensions product development. Why should the taxpayer subsidise the charges paid by personal account holders? That is why the government needs to ensure all costs are openly disclosed from this point onwards.

There are a great many twists and turns to be navigated before personal accounts are finally introduced. These developments are likely to lead to an increase in costs for employers running good quality pension schemes.

So advisers and employers need time to plan for the forthcoming changes and develop strategies to smooth the increased costs over a period of time. To allow these plans to be made with confidence, it is vital the government makes informed decisions soon so that we can work towards a position where personal accounts will not unduly affect good quality group pension schemes in the UK.

A quick guide to personal accounts

When will personal accounts be introduced?

The Government aims to introduce this new pension scheme from April 2012.

How will personal accounts be set up?

The scheme will be set up as a trust-based occupational pension scheme, with employers' and members' panels to represent their interests. It will be run by the Personal Accounts Board containing people appointed by the government.

How much will people need to pay to personal accounts?

Employers will be required to pay 3% of earnings for their employees. Employees will pay 4% with the government adding in 1% in tax relief. All contributions are based on band earnings - these are earnings between £5,000 pa and £33,500 pa, with these amounts being indexed in line with earnings.

Contributions will be phased in over three years from 2012. For employees this means an initial 1% payment level increasing to 3% then 5% (including tax relief). Employer contributions will be 1%, 2% and then 3%.

How much can people pay into personal accounts?

The maximum amount that can be paid into personal accounts is £3,600 although this figure will increase in line with earnings (from 2005) so that by 2012 it will be nearer £5,000. Transfers between personal accounts and other schemes will be prohibited, with a review to take place in 2017.

Who will join personal accounts?

All employees whose employer does not offer a 'good' pension scheme will be automatically enrolled if they are between age 22 and State Pension Age and earn more than £5,000 pa. Employees aged between 16 and 22 can choose to join and, if they do, the employer needs to pay a 3% contribution. Individuals can opt out of personal accounts although it is likely that they will be re-enrolled every three years or so.

What impact will these pension reforms have on an employer?

From 2012 employers will have to automatically put employees into either a personal account or another good pension scheme. Doing nothing is not an option. Whichever choice is made, employers will need to pay at least 3% of band earnings - phased in over a period of three years from 2012 - unless the employee opts out.

Andrew Tully
Senior Pensions Policy Manager
Standard Life