If you read nothing else, read this …
- The direct costs of implementing auto-enrolment will depend on factors such as how many employees opt out.
- Payroll system upgrades and widespread communication exercises could increase the administration costs of auto-enrolment.
- Some employers may seek economies elsewhere in their benefits budget to cover the costs of auto-enrolment
- Salary sacrifice arrangements for pension contributions can produce savings for employers via reduced national insurance payments.
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It is difficult for employers to calculate the true costs of auto-enrolment before it actually happens and there are many factors to consider, says Nick Martindale
Auto-enrolment will inevitably increase costs for employers, both directly and indirectly. In terms of direct costs, much will depend on how many staff opt out, and this is the great unknown.
Richard Wilson, senior policy adviser at the National Association of Pension Funds, says: “It will vary greatly by the workforce and the way employers communicate their offering. Making an assessment based on previous initiatives to engage staff might give a rough indication.”
Ian Hodson, reward and benefits manager at the University of Lincoln, set up a pension scheme in a previous role at a manufacturing firm. “We only had 20 people who actually joined it because money-in-hand for a factory worker is critical,” he says. “It is so hard to predict across the different sectors what impact [auto-enrolment] will have.”
Administration costs
But the costs will not just be confined to the direct costs of extra employer contributions. For Rosemary Mounce, group pensions manager at Arup, administration costs are the biggest concern. “We are already paying a lot into pensions, so the costs for a few more people won’t be that great,” she says. “But having to go back and cater for all these groups and put extra systems in will be expensive.”
Tim Middleton, technical consultant at the Pensions Management Institute, warns: “Employers will have to change their payroll systems and there will have to be an elaborate communications exercise. For large statutory schemes, there is a requirement to produce communications in Welsh. All these things load on costs and they won’t make things any easier for employers.”
There could be other hidden or indirect costs, too. James Kirkland, head of pensions, benefits and recognition at Telefonica, says piquing people’s interest in pensions could lead them to opt in at higher rates, where employers also have to increase contributions, while many employers will feel the need to offer life insurance alongside pensions.
“Another issue is that auto-enrolment raises the contribution rates at points that don’t dovetail nicely with our defined contribution (DC) plan,” says Kirkland.
“In our plan, if people come in at 4% they get a 4% match, but with tier one of auto-enrolment we get 4% and 5% and that doesn’t fit. It all starts to unfold and much of the costs are outside of the
original exercise.”
Mounce, meanwhile, fears the effects of extra costs being passed on by suppliers. “We don’t have to enrol agency workers, but the agencies will increase their costs,” she says. “It’s actually quite frightening when you start adding on all the knock-on impacts, not just how many people join and whether 10% or 15% opt out of it. There are a lot of extra costs coming into it as well.”
Employers will have to find the money to fund auto-enrolment somewhere, and many may look for cuts in other areas, perhaps scaling back defined benefit (DB) schemes or curtailing other benefits.
Other benefits
Kirkland says: “The things that will be played with are the other benefits and that’s been acknowledged by the pensions minister, which is helpful because the money has to come from somewhere and it’s not really appropriate that it comes from jobs.”
Employers also have a choice to make around how much they encourage staff to join the scheme, although no employer can induce people to opt out. Hodson says: “It is an opportunity to decide exactly what sort of employer you are going to be. That is a moral and ethical issue. You have to decide whether you are actually looking for people to be in the pension scheme or whether the finance director looking at five-year forecasts is saying that if 80% [of employees] go in, it will hit the [organisation] really hard.”
The announcement that employers can delay auto-enrolling staff for up to three months should go some way to alleviate the administrative cost, says Wilson. “That is really important for employers that have lots of short-term workers, in terms of managing the costs,” he says. “There is nothing worse than an admin cost for opting someone out because they didn’t want to be in there in the first place. It’s a complete deadweight cost of processing with no benefit to the scheme at all. So that’s one way of cutting costs.”
Employers can also help themselves by ensuring they have an opt-out system that allows staff to join and leave in an efficient way. Wilson adds: “Particularly if an employer has a high staff turnover and people are forever coming in and out, it won’t want to have to refund bits of money all the time, so it needs a sensible opt-out system in place.”
How and when employers enrol individuals can also have an effect on costs, says Mounce. “Small gradual changes cost more than bringing something in up front, but also it’s about how much you can simplify what you do.”
Jamie Fiveash, director of customer solutions at B&CE, which runs The People’s Pension, says some employers plan to go straight in at the eventual minimum contribution level of 3%. “They don’t want to go through the hassle of staging and will get a true opt-out rate,” he says. “The cost won’t really be 3% either, because only 60% or so might go in. Others say they want to do different things at different phases. The balance between seeing this as an employee benefit versus the admin and contribution costs is one that employers will have to weigh up quite carefully.”
Salary sacrifice
Offering staff the ability to make contributions through salary sacrifice arrangements, in which the employer will benefit from reduced national insurance payments, is another way of saving costs. The sheer numbers of staff who could join and the fact that systems have to be overhauled anyway make this an attractive option, says Mounce. “A lot of schemes that might have worried about the complexity in the past will now think it is worth it,” she says. “It is about the only decent saving you can get.”
Others are yet to be convinced, however. Lincoln University’s Hodson says: “The principle behind auto-enrolment is about having something that is clear, easy to understand and transparent. Salary sacrifice means an extra relationship with HM Revenue and Customs and extra compliance risks. We have five salary sacrifice schemes at the moment and we still get queries from individuals trying to understand how it works. People are very nervous about things they don’t understand.”
The current upheaval associated with auto-enrolment and the entry of new providers into the market also means there are opportunities for employers to negotiate better deals. Kirkland says: “One of the best things pension managers can do to manage costs is to be on the front foot with administrators and make some actionable threats.
“If someone is not coming up with the goods or wants to ship people off to Nest [the national employment savings trust] but you don’t want that to happen, find out what other providers might offer and
don’t be frightened to carry out the threat.”
Read more from the Auto-enrolment Roundtable