The role of reward during a recession

EXECUTIVE SUMMARY

• Benefits are an obvious target for a cost review, with many employers still not maximising the savings on benefits.

• It is better to be innovative about adjusting existing policies than removing benefits that are contractual. Most employee contracts are structured with enough flexibility to enable companies to tweak benefits without having to rewrite contracts. Changing less flexible employment contracts can only be done with the express consent of the employee.

• Companies should consider rebroking existing benefit contracts, especially as the group insurance market is currently very competitive.

• Companies offering a defined benefit (DB) pension scheme should consider whether they can afford to continue to do so and, if not, devise the most cost effective and efficient way to migrate staff onto a defined contribution (DC) scheme.

• Flexible benefits save costs in the long-term, but employers need to calculate scheme transition costs, as well as a breakeven date. For the most part, savings come from tax or NI breaks on employer-paid benefits plus the employee taking the hit for any cost hike in particular benefits.

• Employers considering changes should beware of undermining staff morale – the damage done could be greater than the savings make from changing benefits.

FULL ARTICLE

As the economic climate becomes gloomier, companies should look at their employee benefit arrangements and maximise the efficiency of their investment says Clare Bettelley

The Chambers of Commerce last month predicted that the UK will enter a recession within the next year which, if true, will force many employers to further reduce their cost base to survive. A recession constitutes two consecutive quarters of declining gross domestic product growth, which Bank of England governor Mervyn King last month considered possible.

Benefits are an obvious target for a cost review, with many employers still not maximising the savings on benefits, be it via tax breaks or duplicating products they are already paying for. However, any major changes could fall foul of employment contracts so need to be handled carefully.

Here we run through five key areas employers should consider when tightening benefits belts during a recession.

1. Conduct a benefits review
Tobin Coles, head of flexible benefits at Jelf Group, says that since most benefits are contractual, employers wanting to make changes need to first think about tweaking existing reward policies rather than going through the rigmarole of removing benefits and rewriting contracts.

Coles recommends that employers look carefully at what benefits they’re providing and consider alternative structures, such as switching a legacy income protection (IP) contract from a long-term to a limited plan.

“If a company has an IP policy which pays employees, for example, 75% of salary until retirement, the premium for that is expensive. Our experience shows that for most employees a limited term contract that pays a lump sum offers them value more quickly than if they had a long term product,” he says.

Employers may also consider rebroking existing benefit contracts. Coles believes that the current market turmoil presents a perfect opportunity for rebroking insurance premiums on benefits such as IP. “Insurance companies and product providers are suffering from the credit crunch; therefore they are very keen to ensure their business books are propped up, which means that employers can get very good premium rates at the moment.”

Company cars are a further benefit where savings can be made. Matthew Hunnybun, a partner at PricewaterhouseCoopers, suggests that employers could save around 10% of the running costs of their car fleet without affecting their employees.

“Vehicles with lower CO2 emissions benefit employees by reducing running costs, and [aid] employers in terms of tax savings. They also enable employers to tick the green agenda box too, in terms of their corporate social responsibility,” he says.

In this year’s Budget, announced in April, Chancellor Alistair Darling introduced a new 10% tax band for company cars with CO2 emissions of 120g per kilometre or less. Cars with emissions of 135g per kilometre are taxed at 15% – previously the lowest tax band – until 2010/11 when this will increase to 16% But Hunnybun says that employers first need to understand the running costs of their car fleet to be able to maximise efficiencies and their impact on the profitability of their vehicle funding in terms of cost, tax and accounting.

2. Cut pension costs
Pensions obviously present the biggest cost saving potential, given that they are the biggest liability for most employers. Those employers still offering defined benefit (DB) pension schemes should consider whether they can afford to continue to do so, and if not, devise the most cost effective and efficient way to migrate staff onto a defined contribution (DC) scheme.

For employers already offering a DC scheme, salary sacrifice arrangements should be in place to enable them to reduce their own, as well as employees’, National Insurance contributions, thus further reducing their liabilities.

Hunnybun says: “A number of clients have not yet introduced a salary sacrifice arrangement into their pension scheme. We’re finding that things like salary sacrifice have been on their agenda but it hasn’t been progressed with because, perhaps in the greater scheme of things, the savings were good but not quite good enough.”

Employers considering salary sacrifice should opt to liaise with HM Revenue & Customs (HMRC) about the legitimacy of their arrangement, though it is not mandatory to do so. HMRC requires evidence of the variation of the terms and conditions of employees’ contracts and payslips issued before and after any variation, to show that any change has been implemented at the right time.

Coles at Jelf believes that many employers have been slow to implement salary sacrifice arrangements for fear of HMRC stopping the tax break. “Inertia of salary sacrifice comes from people worrying about whether it’s effectively a tax loop rather than something that’s going to be here for the long term,” he says.

“I don’t think that is the case, and even if the Chancellor was going to close it down in the next five years, why not use it now? It seems daft not to. HMRC has guidelines on its website about helping employers to use the tax break, so I think the government would feel nervous about taking it away.”

As well as salary sacrifice, Charles Cotton, an adviser on reward and employment conditions at the Chartered Institute of Personnel and Development (CIPD), says that employers could consider increasing the retirement age of their pension scheme and/or changing their scheme accrual rate, too.

Of course, employers with a pension deficit should consider liaising with The Pensions Regulator about any changes.

3. Implement flexible benefits
Flexible benefit arrangement are an obvious cost saving initiative for employers, albeit it in the long-term; so employers need to calculate scheme transition costs, as well as a breakeven date. For the most part, savings come from tax or NI breaks of employer-paid benefits plus the employee taking the hit for any cost hike in particular benefits.

Coles says: “We are still installing up to two new flexible benefits contracts each month and obviously flex is a fairly substantial investment for any business. There are good reasons for doing so in the current economic climate, but the issue for employers is paying for the build costs and paying for the license fee of having the administration platform.

“We’ve noticed that employers always budget for the running cost of the system but they don’t tend to budget for the build costs at the front end, which could be as much as £40,000.”

To meet this need Jelf has started to offer the Myreward lease product, which is a three-year financial agreement aimed at helping employers manage the costs of implementing a flexible benefit system. It capitalises the system costs over three years and then charges it back to the employer on a lease rental basis.

4. Preparing a review
Employers should undertake a full cost-benefit analysis of their existing rewards, and assess the expected cost savings from any planned changes before attempting to implement them.

Rachael Heenan, a partner with law firm Beachcroft, says: “There are a number of factors in addition to the finances, such as staff unrest and morale. Employers have to consider whether any changes will have an impact on the business or the service they provide.

“They should work out the financial options, then work out what the strategy is going to be in terms of how they deal with staff because they want to keep the business as running as usual; they don’t want staff feeling disgruntled.”

Of course, any communication with staff about their rewards is futile without staff fully understanding their value and the extent to which they benefit from this.

Chris Noon, a partner with Hymans Robertson, urges employers to remind staff about the value of their benefits and show them how they can maximise this. “A lot of organisations don’t get sufficient value out of benefits for what they spend. Employers are typically investing up to 20% of their payroll on benefits, but you have to ask the question: are they getting that amount of value out? You tend to have two things going on: employers not doing enough in terms of benefit provision and communication and employees not caring enough.”

Coles agrees. “Take IP. It’s a highly valued benefit, but only after you’ve used it. Utilisation rates on most insurance are probably somewhere around 30%, so it means that 70% of all staff each year don’t value the benefits they get because they’re not ill.

“Employers should be asking themselves what they can provide that is high impact now and that everyone’s going to use and value. Employers should be aiming to provide benefits that are going to make employees’ lives easier, better and cheaper.”

Coles suggests that rather than becoming preoccupied with contractual legacy benefits such as private medical insurance (PMI), group IP and pensions, employers should be focusing on introducing voluntary and more highly valued benefits, which will impact employees’ everyday lives, such as cash back on their weekly food bill.

Voluntary benefits can range from healthcare cash plans and groceries to cycle-to-work schemes and gym membership. As well as being relatively easy to implement, a voluntary benefit plan is a good way for employers to positively impact on employees’ wellbeing. Non-financial benefits such as flexible working arrangements and career development opportunities may also be considered, because they are such powerful staff motivators.

5. Changes to employment contracts
Most employee contracts are structured with enough flexibility to enable employers to tweak benefits without having to rewrite contracts.

“Most contracts of employment will state that a company commits to provide to an employee group income protection, subject to an insurer approving their claim. What it doesn’t say is that IP must be 75% until retirement, or detail how the policy is structured,” says Jelf’s Coles.

Employers with less flexible employment contracts seeking to make changes to contractual benefits should be mindful of the procedures involved, if they are sure the change is necessary. Heenan of Beachcroft says: “In terms of contractual benefits, you can only make changes with the express consent of the employee or where the wording is so wide that you’ve got enough scope and discretion to vary a benefit.

“If you need to implement a change you have to go through a procedure of consultation (depending on the number of people affected) because what you’re effectively doing is terminating a contract and giving an employee a new contract.

She also points out that if there are less than 20 employees employers have to have a meeting with staff to discuss the change. If there are more than 20 staff employers have to go through the same consultation procedure that applies in the case of redundancies.

Employers may consider making changes to the benefits of key staff, to minimise disruption. CIPD’s Cotton suggests segmentation as a way of ring-fencing employees who add most value to a business, and tweaking their benefits accordingly. But Coles is wary of segmentation, arguing that it could lead employers to breach the Age Discrimination Act, given that it is that key staff may be more senior staff, and therefore likely to be older members of the workforce.

Ultimately communication with staff about changes is key, whatever employers decide.

As Cotton says: “It depends on the situation, but I think that by consulting with staff you can at least prepare the ground, rather than making an announcement that changes are about to take place. This will get staff to think about what is important and what they are prepared to give up and what the organisation may be able to give in return.”

On the up side, given the economic downturn and consequent flat recruitment market, the security of employment may be the only return employers currently need consider for some employees†

How to recession-proof your benefits package:
Analyse your existing benefits package
Consider the drivers of your benefits: retention, profit growth, staff wellbeing
Legacy benefits: do you need them and is there any overlap in policies?
Tax breaks: what are they and are you exploiting them?
Tax changes: are you prepared?
Voluntary benefits: do you offer them and if yes, can you expand your range?
Communication: do employees really understand and value their benefits?

For more information and case studies on benefits and reward strategies please visit: www.employeebenefits.co.uk

Back to Employee Benefits Report for Financial Directors – September 2008