How to future proof a reward strategy in light of changing pay regulations

Need to know

  • New legislation on the horizon could increase pay bills in certain sectors.
  • Changes to salary sacrifice arrangements could also impact the benefits mix.
  • Reward professionals need to communicate with employees, the wider business and government.

This year will see a raft of pay and benefits-related initiatives come into force or appear on the horizon, from the rise in the national living wage to the introduction of gender pay reporting, and the increase in auto-enrolment contributions due to take place in 2018. Against a broader backdrop of Brexit and the changes outlined in the Autumn Statement surrounding certain salary sacrifice arrangements, the pressure is on those working in pay and reward roles to make the numbers stack up without damaging employee retention or engagement.

Jeff Fox, head of strategic benefit consulting at Aon Employee Benefits, says: “Last year, we saw an unprecedented set of circumstances that created major headwinds for those in organisations who look after reward, which would include pay, benefits and anything to do with strategy.

Gender pay is going to be a big issue; if the information doesn’t cast things in the right light [employers] will have to make some fairly significant pay decisions, which could cause some challenges.”

Employers will need to think of a sustainable way of dealing with the costs related to upcoming legislative changes, says Jack Curzon, head of scheme design at Thomsons Online Benefits. “While, in isolation, the legislation may seem like a small cost, when you add them all up throughout a year they do increase businesses’ costs,” he adds.

However, different issues will impact on organisations in different ways, says Duncan Brown, head of HR consultancy at the Institute for Employment Studies. “The living wage has been very specific in terms of the sectors that are affected, and it’s largely social care and childcare where organisations have faced increased costs,” he says.

“Auto-enrolment is an additional cost, and I have seen some employers not give pay awards to help fund that, but over the entire labour market they’re recognising they’re facing a risk of higher turnover so it ends up costing them more money. The evidence is that employers at the moment have been able to absorb these additional costs, either by taking lower margins or increasing prices.”

National living wage

A report by Incomes Data Research (IDR) on behalf of the Low Pay Commission into the impact of the national living wage, published in October 2016, found that more than half of employers (55%) had not attempted to offset the additional costs, although 85% of those in the social care and housing sectors, and 71% of those in childcare had at least considered this (see graph). The most common tool under review is to alter grading structures (13% of all respondents) or to introduce age-related pay for those aged under 25 (9%).

One response could be to reduce headcount, particularly in sectors such as care, says Alison Garrow, senior associate at employment law firm Doyle Clayton. “The irony is that these higher minimum rates of pay, designed to improve benefits for employees, could result in job losses in some sectors where the organisations involved cannot afford the increased rates,” she adds.

Impact on benefits strategy

There is little evidence so far that benefits are being directly impacted, although 3% of respondents to the IDR research said they had, or were, considering reducing non-pay benefits, rising to 18% in the childcare sector, where it was the most common response. However, there is evidence that some high-street retailers have cut back on perks such as paid breaks, discounted staff rates or pay premiums for weekend or evening shifts, says Charles Cotton, performance and reward adviser at the Chartered Institute of Personnel and Development (CIPD).

“But employees in the retail and hospitality sector do value these things, so it could be that they are shooting themselves in the foot,” he adds.

Organisations should instead focus on making employees more productive, looking at how jobs are designed, for instance.

Some organisations are going out of their way to avoid cutting back on benefits. John Letizia, head of public affairs at Unum, says: “In the last few years, there has been some evidence where [employers] have not awarded significant pay rises to their employees but have increased the level of benefit provision, for example by adding new benefits to the package such as group income protection.”

Despite this, there are signs that benefits packages may be reviewed to help generate savings. “Some [organisations] may take things away or change something dramatically to make an initial saving but most [employers] are actually looking to make benefits more sustainable in the future,” says Curzon. “It might be a subtle design change to make sure that they control PMI [private medical insurance] premiums, so they’ll know that it won’t be possible for them to go up by more than 15% next year.”

Alongside this, organisations may look to bring in particular initiatives, such as workplace health in general, introducing low-cost benefits such as free fruit in the workplace to help prevent employees from becoming ill in the first place.

The uncertainty over the long-term future of salary sacrifice arrangements also means businesses are moving away from the concept of offering certain benefits purely for tax reasons. “The conversations that we’re having with [employers] is to effectively question whether they should be basing their benefits strategy on tax savings, when those may be gone in 10 years,” says Curzon. “In 20 years, there might be no salary sacrifice [efficiencies] or tax savings at all, so, to futureproof their strategy, [organisations] need to realise that they can’t base the principles of their benefits on that.”

In practical terms, this means organisations are already making changes to some salary sacrifice arrangements, says Fox. “We’re certainly seeing a cutback on arrangements where employers would share any national insurance savings with employees, because employers are essentially saving up for the future and acting ahead of the curve,” he says. “We’re also seeing a reduction in the level and extent of choice available, partly because some benefits have lost their tax benefits. They’re perhaps thinking about retaining the key ones so bikes [for work], pensions and childcare vouchers [which are currently unaffected by government change].”

Employers are also less likely to implement new salary sacrifice schemes due to concern around rising costs and future changes, says Kim Hayton, HR director at FDR Law. “There is a nervousness about introducing anything new unless there is a contractual requirement in place,” she says.

While pensions, bikes for work, childcare and ultra-low-emission vehicles are currently exempt from the government’s move to limit the range of benefits that attract tax and employer national insurance contribution advantages when offered via salary sacrifice, there is no guarantee that this will always be the case in the future.

The changes around the tax treatment of company cars has also seen a move away from employers offering that as a benefit, accelerating a trend that was already happening in the wake of higher costs stemming from new legislation, says Fox. “It’s not just salary sacrifice; if you offer someone a cash equivalent and they take a car with it then from April they will lose their tax benefits, so employers are saying this isn’t a benefit they can sustain any more, and that they need a fundamental redesign around the product,” he says. “There’s potentially a move away from company cars anyway but certainly that cash equivalent is highly questionable now.”

On the reward side, one option to cope with higher costs could be to reduce the use of overtime, suggests Garrow. “In cases of voluntary overtime, an employer should consider whether the work can be restructured so that the business is less reliant on overtime,” she says. “They may also be able to agree changes to when overtime applies with employees.”

But employers need to be careful in case employees have a contractual right to overtime, in which case it will only be possible to make changes with the employee’s consent.

Reward communication

Where employers do make adjustments, it is essential they communicate effectively with the workforce. The gender pay reporting requirements could be a particular challenge, says Cotton. “[Employers] should let [their] employees know what’s been found before they read it on the government website or in the local newspaper, as well as what steps [they] are taking to reduce [any gender pay gaps],” he says. “[Organisations] may need to explain to employees that the gender pay gap isn’t the same as equal pay, and it may be that [they’ve] got issues around the recruitment and retention of women, and what [they’re] doing about that.”

Meanwhile, HR needs to be stronger in resisting any pressure to overhaul reward and benefits packages, says Brown. “There’s a lot of evidence that cuts in these areas are generally quite short-termist and have damaging implications,” he says. “HR hasn’t been good enough at communicating the message that investing in people pays off, and to some extent the government has forced it on them. We have to get much better at getting value out of that additional cost.”

Reward and benefits professionals also have a wider role to communicate with government, adds Monica Kalia, chief strategy officer at Neyber. “Our current difficult environment can be countered by closer engagement with employees to ensure that their opinions are being heard, as well as with government to ensure that policy changes are not made with unintended consequences,” she says. “The fact that the government is concerned with people who are ‘just about managing’ provides a great opportunity for the reward and benefit community to have its views heard.”

Wild Card Brewery sees the value in going beyond the minimum

Walthamstow-based micro-brewery and bar Wild Card Brewery decided to pay its staff the London living wage, as determined by the Living Wage Foundation, when the business was first set up in 2012. Andrew Birkby, one of the firm’s founders, says: “The national living wage that employers are now required to pay is below the level that the Living Wage Foundation recommends, and which we pay.”

The London living wage is a voluntary rate, which is calculated according to the basic cost of living. It increased from £9.40 an hour to £9.75 an hour in October 2016, with living wage employers expected to implement the new rate by May 2017. The national living wage, which is the statutory minimum for employees aged 25 and over, is set to rise from £7.20 to £7.50 an hour in April 2017.

“We do it [because it] makes commercial sense,” Birkby adds. “We think by paying our employees better than the national living wage we get more out of them in terms of productivity, staff retention and how they represent the brand. The hospitality sector has a really high turnover of staff but a lot of ours have been with us from the beginning. That saves money in terms of training too.”

As a small employer, with a 15-strong team of bar staff, brewers and drivers, paying the London living wage is its main tool in attracting and retaining staff, and one Birkby believes reflects what is important to employees. “What really matters is pounds in their pocket, because they have to put food on the table and look after their families,” he explains.

The investment seems to be paying off; the brewery picked up the Time Out award for the best bar in its borough in November 2016. “We had a very high rating on Google and Facebook and one of the recurring pieces of feedback is that staff are really friendly and helpful,” says Birkby. “It’s one of the things that leads people to give us a good review and keep coming back.”

Wild Card Brewery intends to keep pace with any future increases in the London living wage. “It’s a stretch but what we get back from our staff makes it well worth the money,” says Birkby.

Viewpoint: Executive remuneration and the future of the long-term incentive plan

Many listed organisations will be putting their directors’ remuneration policy back to shareholders at the 2017 annual general meeting (AGM) for the first time since 2014. Renewal of the policy comes against a background of increasing calls for executive pay restraint and the risk of another ‘shareholder spring’ if investors are not happy with what they see.

One of the key areas on which remuneration committees will need to focus is whether the traditional long-term incentive plan (L-tip) remains fit for purpose. The Investment Association Working Group has urged committees to look at alternatives to see which is most appropriate for the organisation’s strategy and business needs.

One of the alternative models raised by the Working Group is the annual grant to executives of restricted share awards. No performance conditions would apply to such awards with vesting being dependent only on remaining in service. As a corollary, investors would expect awards to be granted at approximately half the level of current L-tip awards in terms of value.

It seems inevitable that we will see more restricted share plans put to shareholders this year although it is unlikely that we will see a dramatic shift away from the traditional L-tip. For many organisations, sticking with their L-tip will still be a valid conclusion to reach after reviewing the alternatives. Additionally, although this may militate against the move for simplicity, we can expect to see some organisations choosing to run a restricted share plan alongside an L-tip with a balance of awards under the two. It will also be interesting to see whether organisations attempt to have a more fluid policy in place so that they move between L-tips and other structures as circumstances change.

Finally, organisations putting in restricted share arrangements should also think not only about increasing the number of shares that directors are expected to hold but also imposing an additional holding period following the vesting of awards.

David Baxter is counsel at law firm Ashurst

Key dates:

  • The national living wage will rise from £7.20 an hour to £7.50 from April 2017.
  • From April 2017, the minimum wage will increase to £7.05 an hour for 21-24 year olds, £5.60 for 18-20 year olds, £4.05 for under 18s, and £3.50 an hour for apprentices.
  • Gender pay gap reporting regulations for private and voluntary sector employers with 250 or more employees are set to come into effect from April 2017, with a snapshot date of 5 April. The snapshot date for public sector organisations is expected to be 31 March.
  • From April 2017, the government will limit the range of benefits that attract tax and employer national insurance contribution (NIC) advantages when offered through a salary sacrifice arrangement or where the employee is provided with a choice between a benefit in kind (BIK) and cash allowance.
  • The minimum employer contribution rate under pensions auto-enrolment will rise to 2% from April 2018 and to 3% from April 2019.