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

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 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.”