Plan on building better level of pensions understanding

Employees can misunderstand most benefits without wrecking their lives. If they misunderstand their pensions, however, they could face a bleak old age, subsisting of cold baked beans and with added concern about paying electricity bills.

Employers that offer defined benefit (DB) schemes, therefore, should make providing clear and accurate pension communication one of their top priorities.

The iron rule is that information should be easy to understand, says Helen May, a pensions lawyer at law firm Hammonds. “Regardless of the circumstances in which an employer communicates with its employees about its pension scheme, care should be taken to ensure that the message strikes the right balance between being informative and concise [and] that pensions jargon is not used unnecessarily.”

Under the Pensions Act 2004, trustees are required to send out annual funding summaries. These must show whether the employer has funded the scheme sufficiently to pay all the members’ pensions. Details of any scheme deficit and rescue plan must also be shown. The Occupational Pension Schemes (Disclosure of Information) Regulations 1996 also require details of members’ benefits to be issued within two months of staff requesting them.

As employees approach retirement, trustees need to calculate the size of their pension pots. At this stage, staff also need to be given the lowdown on their pension options, such as taking a tax-free lump sum.

But employers should aim for well above the bare legal minimum, says Nicola Cull, a senior consultant at Watson Wyatt. “While employers are obliged to communicate [investment information] in the annual report, it’s a good idea to issue a less formal summary in the form of a member newsletter.

“Ideally, this should be a regular communication, perhaps as frequently as quarterly. This means the employer is not merely passing on information, [but] they are helping members build a better level of understanding of investments and pensions.”

However, with DB pensions, there is often more to communicate than just how the fund is doing, such as scheme changes. The National Association of Pension Funds’ (NAPF) Annual survey 2007 published in January this year, showed 22% of private sector firms that offer DB schemes expect to change their plans in the next five years, while some 15% expect to offer new recruits access to a defined contribution (DC) plan instead.

When making changes to a DB scheme, under the Pensions Act 2004, employers must invite comments on the proposed changes from staff over a two-month period. This rule covers everything from closing schemes to new members, to changing the rate at which benefits are accrued. The rule used to apply only to companies with 100 or more staff, but on 6 April 2008, the government extended this requirement to employers with 50 employees or more. David Hix, associate director at the Jelf Group, says: “Employers are obliged to give members sufficient information to understand the impact of the proposal on their pensions. To meet this requirement, and to assist with employee relations, most firms will arrange for pensions experts to present to staff to explain the changes. Some employers also offer financial advice to help workers plan for the future.”

These consultations are often, but Charles Cotton, reward adviser at the Chartered Institute of Personnel and Development (CIPD), encourages employers to take employees’ feedback on board. “When consulting, it would be an idea to see what workers think of the various options and whether there is another that they would prefer and would be acceptable to the organisation. For instance, rather than asking staff to pay higher contributions, look at reducing the accrual rate or increasing the age when pensions are payable,” he explains.

As increased life expectancy and stricter regulation have made running DB schemes tougher, many employers are tackling deficits by closing plans, either to existing members or to new recruits. This is a highly-emotive and controversial issue, which will test any HR manager’s diplomatic skills to the full. David Blake, professor of pension economics at Cass Business School, says: “[In response to proposed changes], workers could demand substantial pay increases to compensate them, [for example], for the loss of their pension scheme. Alternatively, they could move to companies with better packages.

“So an employer should be careful to inform workers that the closure of the scheme is designed to secure jobs in an increasingly competitive global economy, and, as the choice is between pensions and jobs, the firm [has] decided to go for jobs.”

There are also ways to soften the bad news, says David Ferrabee, an internal communications expert at Hill & Knowlton. “The most important thing to relay is the rationale for the decision. This is typically to do with long-term balance sheet issues and the increasing liability that defined benefit schemes put on to businesses. Employees don’t necessarily have to agree, but the rationale and the context should be clear.

“When the plan is wound-up altogether, this is a change to terms and conditions and can be very contentious – and dangerous. There has been a history of industrial action about this. In this kind of situation, the solution tends to be in the details. When the size of each individual’s pension scheme is communicated, the implications become less hard to swallow,” he explains.

If employees are being switched into a DC scheme, they must be told how this will affect their retirement plans. Ros Altmann, an independent pensions consultant, says: “A final salary pension scheme enables members to have more certainty, but not complete certainty, about their future pension. Whatever happens to investment performance and annuity rates, it is their employer who carries the most risk.

“However, in a DC scheme, the member has to worry about how to invest the money, what happens to investment performance and also what happens when they need to take a pension on retirement. Members should be told that they need independent financial advice in order to help them cope with the new risks they are facing.”

Another way employers are seeking to fill pensions black holes is by encouraging both active and deferred staff to quit the scheme by offering cash payments in return. However, the Pensions Regulator has furrowed its brow at this as it fears a repeat of the pensions mis-selling scandal of 15 years ago. In the 1980s and early 1990s, many people who belonged to an occupational pension were wrongly advised to transfer to personal pensions, thereby losing their employers’ contributions. The regulator, therefore, has set out guidance on employers’ responsibilities when they are offering such incentives.

Sarah Boon, a pensions lawyer at law firm Pinsent Masons, says: “Communications must clearly show members what deal they are being offered and what they are giving up by transferring out of the scheme. They should be encouraged to seek independent financial advice, and employers may want to offer money towards this.

“Cash incentives have a way of blinding people to the reality of the situation. Employers need to acknowledge this danger. It is vital the offer is made in a transparent way to avoid problems coming back to bite employers later down the line if the ultimate pension the member can secure does not meet with their expectations.”

Other employers are trying to save money by watering down terms for existing members. This could mean cutting their contribution rates or hiking up the retirement age. In such cases, employers should cut the spin and explain the reasons behind the decision. Danny Vassiliades, a principal at Punter Southall, says: “When making changes to a scheme to make it more affordable, employers need to be transparent and to put the decision in the context of expected costs and in the context of the performance of the business.

“Many employees would be sympathetic to their employer maintaining [the scheme] by providing [them with] a different level of DB pension, compared with closing the DB scheme to future accrual completely.”

One thing is for sure: more employers will have to communicate changes to their members. “I do believe we are witnessing the end of defined benefit schemes and that they were far more suited to twentieth-century employment. Defined benefit as a whole is not really a system that most finance directors or shareholders would choose, due to the costs and risks entailed in running such schemes. The burden of regulation and the very long-term nature of the liabilities do not really sit well with modern companies,” explains Altman nTips for communicating defined benefit pension schemes to employeesGive it to them straight When making cost-saving changes to a scheme, explain the rationale. For instance, tell staff their jobs will be more secure, as pension costs are also funded by the firm and come from the same pot.

Cut the jargon Avoid obscure terminology and talk to employees in their own language. If staff know what they are buying into, they will not be able to complain later.

Break it down Inform workers how any changes will affect their own pension pots and retirement plans.

It’s good to talk, but better to listen Do not go into consultation periods with fixed plans but take employees’ ideas on board.

Do not get bogged down in the finer details When communicating investment strategies, make it easy to pick out key information from the headlines, but also include more details for interested staff.

Keep in touch This sounds obvious, but do not forget to include contact details of the person to whom employees’ queries can be addressed.

Ask the experts Consider funding financial advice for staff, particularly when switching from a defined benefit to a defined contribution pension scheme.

 

Case study: The Wellcome Trust Sanger Institute

Genetic research centre the Wellcome Trust Sanger Institute uses canny communication to help employees crack the pensions code.

The institute lets staff know how its defined benefit (DB) fund is performing in an annual newsletter, as well as through regular one-to-one pensions surgeries for the scheme’s 800 members.

Kathryn Fenn, head of human resources, says: “Our trustees regularly ask how they might communicate better [around] pensions. There are two key areas we focus on: de-mystifying pensions and asking staff for their opinion on the benefit.” She adds that payslips and email are perfect for rapidly distributing time-sensitive nuggets of information. However, when a trustee is replaced or contribution rates change, the institute sends out special additional letters.

It is important to try to inject a bit of life into dry pension communications, adds Fenn.

“Financial information, retirement and forecasts are always challenging to communicate. Pensions is one of those areas that tends to have different interest from staff depending on age, and to make it interesting and relevant to those who have 30 years to go [until retirement] can be difficult. The pensions newsletter is designed to be appealing even if you have a while to go,” she explains.

Back to ‘Pensions Supplement May 2008’