All employers are looking for ways to reduce the cost of administering their pension schemes. Ceri Jones suggests there has never been a better time to make a bold move.
This is the driver behind the current trend to move from trust-based DC schemes to contract-based schemes, such as group personal pensions (GPP). Under a contract-based arrangement, the administration usually shifts to the insurance company and all the costs are picked up in the members’ annual management fees, which are automatically subtracted from the units in the investment funds. There will be significant savings in adviser and legal fees and in governance costs, as a trustee board will no longer be necessary, leaving the employer only with the task of making payroll deductions.
Making the move from a trust-based DC to a bundled contract-based arrangement usually saves 0.1-0.2% of the fund value in administration and other costs, reducing total costs to perhaps 0.3-0.4% of the fund’s value, suggests Paul McGlone, principal and actuary at Aon Consulting, but with economies of scale larger funds will recoup proportionately less. “Savings costs is one factor driving increasing numbers of employers to switch to contract-based DC, along with lighter governance, and the very big attraction of not having to deal with deferred members,” says McGlone. “It’s also fair to say that the administration for members may be better under a GPP because there will be a wider range of funds and improved switching.”
Of the costs that can be passed on to members, administration is the single biggest item. According to pensions consultant Capita Hartshead’s latest annual survey, the cost of administering a pension per member has risen steadily almost every year since 1996, and is now around one-third more expensive per head. Administration now costs £94-£97 per member each year for schemes with up to 2,000 members, dropping to £37-£47 for schemes with more than 10,000 members.
The nature of the investment arrangements put in place will impact the savings achieved. As a benchmark, the Government has mooted an annual management charge of 0.3% for the forthcoming Personal Accounts. Small DC schemes may currently experience costs of around 0.9%, according to Tony Baily, principal at Hewitt.
An effective way of passing on the costs to members is differential charging structures for active and deferred members, involving a higher charge for the deferred. In a trust-based scheme this might come up against preservation rules, which stipulate that both groups of members must be treated equally, but this is not insurmountable.
Moving to a contract-based arrangement also eliminates many of the professional fees that have been spiralling as the regulatory landscape becomes more complicated. Of the 71% of the Capita survey’s respondents who said the costs of managing their pension had outpaced other business overheads over the last five years, 52% cited an increase in professional fees and 46% cited increased compliance.
However, for DB schemes, Rash Bhabra, head of corporate consulting at Watson Wyatt, says the trend is for sponsors to seek out and pay for more advice. There are two choices, he says, either to invest your way out of trouble, which will mean spending more on advisers and using strategies such as tactical asset allocation, or to use a standard investment such as an index fund that could leave the fund short. “Companies and trustees understand this and are taking more advice, not less,” he says.
Auto-enrolment, due to be implemented in 2012, is also likely to boost employer pension contributions. According to the latest PricewaterhouseCoopers Pensions Survey, two-thirds of employers are concerned about this, particularly employers in industries such as retail and construction where 70-80% of the workforce may not already be covered. “Various academic reports suggest participation under auto-enrolment will be around 80%, but my view is that there will be great diversity from industry to industry,” says Marc Hommel, partner and UK pensions leader at PwC.
The same survey revealed that 83% of employers feel they are not getting value for money from their outlay on pensions. “A lot of organisations have shied away from changing their pension terms, but the public’s fear for job security gives companies an opportunity to reduce pension provision. My guess is that HR directors across the country are being asked by their FDs whether the money is being spent wisely on the people they want to spend it on, and whether it is possible to spend less.” For example, it may be possible to increase eligibility periods for new staff or to make employer contributions dependent on matching the member’s contribution. Other costs that can be passed onto scheme members include making a charge for transfer values illustrations over the statutory allowed, to dissuade wanton requests.
FDs and company boards are often concerned that a generous pension helps retain the very people they least want to hold on to. In banking, for example, reductions in head count are sought, but because of the legacy scheme’s generosity, branch staff are reluctant to move on. Some organisations in this predicament are trying to develop a total reward approach, taking the pension’s value into account in when calculating an employee’s total package, and perhaps balancing it with a less generous bonus, although these strategies can have implications in terms of age or gender discrimination.
“Rather than fiddling around on the periphery, trying to pass on some of the charges, there are more efficient ways to reduce costs. The obvious one is to reduce contributions,” says McGlone. “Take a firm where the average salary is £25,000 and the employer is contributing £2,500 for each member every year. The costs of administration will be around £30 per member per year for a large scheme, so it doesn’t stack up to put too much emphasis on that. Last year was all about risk management; this year it is all about stopping cash going out of the door.”
Hommel says that some clients are looking to suspend their pension contributions. “It’s a trickle that could turn into a stream,” he says, “particularly for smaller organisations that are trying to reorganise their debt facilities and need to take radical action.”
Baily notices that an employer making the move from a DB to a DC scheme will quite often be prepared to share the savings because that is the environment they are used to. “When an employer is moving from DB to DC then lots of costs will come out, but when an employer has been running a DC scheme for a long time, then the only saving left is to pass on the administration cost to members,” adds Baily.