Calculating the cost of auto-enrolment

There is no way to sugar the pill: auto-enrolment compliance presents a significant financial burden for employers. It is an enormous project and there are many underlying costs.

To fully understand the extra costs, employers should first carry out a cost-impact assessment. Mark Wilson, head of employee benefits at RSM Tenon, says: “We would put payroll data through our system and then, depending on a number of options and assumptions, come up with a range of costs an employer might be looking at.”

Contribution increases

The most obvious additional cost is the gradual increase in contributions, which will be sizeable and continuous as levels ramp up until 2018. Dale Critchley, technical reforms manager at Friends Life, says: “It could be gradual or ‘big bang’: employers can start with 2% and increase it to 5% from 2017, and then 8% from 2018. But it goes to what they want to achieve. The cheapest is not always the best value.”

For instance, a minimum employer contribution of 1% may just be an added cost rather than an opportunity to add value. Employers should project the cost of increased contributions to see what they can afford. Critchley adds: “There are modellers out there, and we certainly have them, that show what the cost of the increased contributions is likely to be. It allows employers to put in current salary data, number of employees and likely opt-out rate.”

Administration challenges

Administration has been highlighted as a key challenge since auto-enrolment began. Costs here can include the use of an external hub, merging payroll and pension providers, keeping records of opt-in and opt-out rates, or switching providers. Critchley says: “It may be painful to move the pension scheme now, but it will only become more painful if the number of employees increases post-auto-enrolment. What may seem like a big job now can only get bigger. While the bonnet is open and employers are looking at the pension scheme, they might want to consider if this is the right pension scheme for the next five, 10 or 15 years.”

Clare Abrahams, head of auto-enrolment at Lorica Employee Benefits, says: “Most providers offer an external hub free of charge, but that depends on whether an employer is using several different pension schemes. It’s about figuring out what processes can be put in place and whether additional resources are needed.”

There is also the added cost of these extra resources, such as hiring new staff to manage the long-term administration process. Iain Chadwick, consultancy director at Johnson Fleming, says: “Where there is a need to check data and do the verification, all that is going to require people. The system still needs to be operated by somebody. There is still a significant people resource needed to manage that interface and make sure everything is correct.”

To ensure value for money in the inevitable costs of auto-enrolment, employers need to educate and communicate with employees above the legislative requirements. Abrahams says: “If employers concentrate on enhancing members’ financial education and making them aware of exactly what they’re getting in the pension scheme, that could work out a lot cheaper than actually giving them a salary increase. It is all about appreciation.”

Cost-management options

A number of options are available to manage the costs of auto-enrolment. For instance, many employers are choosing to postpone auto-enrolment by up to three months to save on contributions. Another common choice is to provide tiered pension options, so auto-enrolled employees go into a minimum contribution scheme rather than an existing, higher contribution scheme.

Wilson says: “There are ways to do as little as possible, but this can also end up with a reasonable bill if you have not been significantly involved in pensions before. You may have a low pensions take-up and relatively low contribution levels, and then you find you have to increase them to comply with the legislation.”

Another option is to introduce a salary sacrifice arrangement. Abrahams adds: “The savings involved with salary sacrifice can really cut down costs. If [an employer] pays 1% extra on someone’s salary, compare that with if they actually increased pension contributions by 1%. Because of national insurance, that can be a much more efficient route.”

Employers can also turn the spotlight on other parts of the benefits package to see if costs can be saved. Wilson says: “Are you getting the type of investment in relation to the suite of benefits, for example, or is there a way to design something that could offset the costs?”

Ongoing costs

The main focus of auto-enrolment so far has been the lead-up to an employer’s staging date, but it is important to remember that there are initial costs and then ongoing, long-term costs. Chadwick says: “We hear a lot of stories about additional costs that people weren’t expecting. It is only when they get to the detail stage that they realise it isn’t as straightforward as it looks.”

Wilson adds: “There is an ongoing set of requirements, whether that’s additional payroll or governance costs. There is also an ongoing need to continue to comply. The other additional cost is the fines. The escalating penalties are incredibly high.”

Ultimately, there is no sense in undertaking this huge project without ensuring there is some value to the business at the end of it. Critchley says: “It is all about the return on investment employers get for the costs they’ve incurred. They need to be careful they don’t avoid lots of costs but then get no benefit for what may be thousands of pounds of employer contributions spread over the next 30 or 40 years.”