The big squeeze on benefits

If you read nothing else, read this…

• Rising inflation can pose challenges for reward and benefits professionals because it pushes up costs.
• Average earnings growth stood at 2.2% in February this year.
• Rising inflation will affect pensions, with final salary schemes being the hardest hit.
• Employers can take a number of measures to mitigate the rising cost of healthcare benefits.

Case study: Charles River Associates’ health cash plan is a winner

Global consulting firm Charles River Associates carries out an annual benefits review.

In April 2010, it introduced an employer-paid health cash plan, provided by Westfield Health, for its London-based staff. Peg Dahl, associate director, global benefits, says: “This complements the supplemental medical and dental insurance we already offer and gives employees easier and greater access to everyday healthcare.”

As well as enabling staff to access additional benefits such as optical care, maternity benefits and discounted health club membership, there is some overlap with the firm’s existing private medical insurance (PMI) scheme, including cover for scans, therapies and consultations.

Duplicating cover in this way enables smaller claims to be made through the health cash plan, helping to keep PMI premium increases more manageable.

The cash plan has been well received by employees. Since its launch, threequarters of eligible staff have enrolled and, of these, 60% have made a claim.

“We have had really good feedback from employees,” says Dahl. “They enjoy having this benefit and have made good use of it. We want to be regarded as an employer of choice.”

Rising inflation means reward professionals are trying to extract every drop of value from benefits, for employers and staff, while keeping costs under tight control, says Sam Barrett

Rising inflation, especially in a time of low wage rises, can cause headaches for reward and benefits professionals as they look to strike a balance between controlling the cost of benefits and ensuring staff feel appreciated.

The statistics say it all. According to the Office for National Statistics, average earnings growth dipped to 2.2% in February 2011, while inflation has been rising steadily. Consumer prices index (CPI) inflation reached 4.4% in February before falling back slightly to 4% in March, while retail prices index (RPI) inflation fell slightly to 5.3% from 5.5% in the same month. Ben Wells, senior consultant at Buck Consultants, says: “With pay rises lagging inflation, employees’ income is worth less. Employers want to help, especially as this may ensure they retain key staff when the economy picks up, but, with their budgets stretched, it is far from easy.”

High inflation will also hit pensions, with the effect depending largely on the type of scheme. Final salary schemes probably face the toughest squeeze. Where benefits are linked to inflation, employers may have to increase funding to maintain payments to retired staff. Danny Cox, head of advice at Hargreaves Lansdown, says: “They need to take a long-term view on this. Although inflation is rising now, the Office for Budget Responsibility expects it to fall back to 2.5% next year and then to 2% the following year. The pain might not be as bad as they think.”

Cox also believes final salary schemes may be able to reduce the impact of inflation increases by shifting to a CPI rather than RPI link for pension benefits. “The government has opened the door to this idea with the shift to CPI on public sector pensions,” he says. “CPI is around 1% lower than RPI so, over time, it can amount to significant savings.”

Impact on DC schemes is less

For defined contribution (DC) pension schemes, the financial impact on the employer is much less. For many, with pay frozen, there will be no need to increase employer contributions.

But although the cost of providing a pension could be frozen, this could be a good time to squeeze some savings out of the scheme to spend on other benefits and rewards. Robin Hames, head of technical at Bluefin Corporate Consulting, says: “Charges are still coming down in the pension market, especially on group personal pensions. The moral cap on charges is 1% but providers will drop to as little as 0.35% for active members if the plan is on a fee basis or 0.4% if it is on a commission basis. Do not be too British about it put pressure on the provider.”

Because charges are taken out of the pension contribution, staff will not notice an increase in their pay, but employers can secure a better emotional return from them, says Hames. “Communicate with employees so they understand the value of that saving on their pension pot,” he says. “Employers might also want to ask their pension provider or consultant if it has any extra tools or features, for instance calculators or educational material. This can help improve engagement with the scheme.”

Where employers offering DC schemes may feel more pressure is from employees retiring. As inflation rises, the spending power of their pension will decrease.

Annuity rates are already depressed because of low interest rates, and the downward trend will get worse. As well as interest rates, other factors pushing rates lower are increased costs for insurers as they comply with Solvency II regulation and, for men, a reduction of up to 5% because of the European Union’s gender discrimination ruling.

Secure the best annuity rate

Cox says this makes it essential for employers to add value by helping staff secure the best possible annuity rate. “When they select an annuity, they have set their income for the rest of their life, but it is not easy to weigh up the choices,” he says. “Because of this, more and more employers are introducing corporate annuity services to make retirement income choices easier.”

With the benefits set and plenty of competition for business, group risk perks such as income protection and life assurance are less likely to be affected by inflation. But these benefits offer chances to cut costs and release cash to spend elsewhere. Stephen Hackett, head of health and risk at Bluefin Corporate Consulting, says: “Life assurance premiums are still falling and although there is talk of the income protection market hardening, employers can shop around for lower rates.”

There has also been a downgrading of benefits under income protection schemes as employers move away from the traditional benefit-for-life model. “There has been a gradual shift towards five-year limited-payment terms, helped along by the 30% average premium increase when the retirement age moved from 60 to 65,” says Hackett.
Benefit redesign is all the rage in the healthcare sector, too, with employers having to ensure cost-saving exercises do not dilute the benefits too much. Gillian Gallagher, corporate account director at Jelf Group, says employers should shop around if they want a quick fix, but this might not be an option for long as rates are beginning to harden. “For a longer-term solution, employers really need to trim benefits,” she says.

Cancer cover is an effective target for cuts. Gallagher adds: “We are seeing employers reduce cover to diagnosis only and then add in a cash incentive to switch into the NHS plus cash for every night spent in hospital. This works well because the savings can be large without disadvantaging employees.”

For instance, although treatment for breast cancer typically costs between £45,000 and £48,000 over an 18-month period, one insurer was able to reduce the cost of a claim to £3,500 by moving it into the NHS.

Gallagher has also seen employers make cuts to psychiatric cover, either dropping it from 28 to 14 days or removing it entirely. “Employers are taking out lots of peripheral benefits, limiting out-patient benefits and adding in cost-control mechanisms such as excesses and six-week waits,” she says.

Health cash plans are also coming into their own, helping employers to make up for any cover gaps they create on their private medical insurance (PMI). Cash plans enable staff to claim back money towards the cost of everyday health items, such as trips to the dentist, optician or physiotherapist. Mike Blake, compliance director at PMI Health Group, says: “These cost around £50 a year and although it is an extra cost for the employer, they have a high perceived value.”

Use cash plans alongside PMI

Cash plans can also be used alongside PMI to harness further savings. Adding an excess to PMI will secure savings that outweigh the cost of the cash plan, with staff able to claim the excess through the cash plan. Gallagher says this gives a typical saving of 6% to 8%.

Cash plans also offer employers stability of pricing. As benefit levels are set, providers do not raise the premium unless they also increase the benefits, says Blake. “This stability can be very reassuring,” he adds.

Rather than shopping around or tweaking benefits, a more radical overhaul could be in order. “It is important to think about the culture employers are trying to create when looking at their benefits as they might need to change the emphasis,” says Blake. “Many offer a standard mix of benefits without any consideration of workforce demographics or what they want to achieve. Refocusing this could result in cost savings and will deliver benefits that staff really appreciate.”

Communication is also important. Total reward statements can help to underline the value and extent of an employee’s benefit package, but this can be taken a step further. “A couple of the employers we work with are looking at promoting their purchasing power,” says Buck Consultants’ Wells.

For example, if an employee has family medical cover, not only will the employer highlight the cost to them, but it will also tell [staff] what it would have cost to buy it themselves. “It does not replace a pay rise,” says Wells. “But when employers are looking to hang on to staff but cannot reward them with a decent pay rise, it can certainly help.”

The role of voluntary benefits

With budgets stretched and pay rises unusual, it can be tempting to bulk up perks packages with low-cost and voluntary benefits offering everything from deals on insurance to discounts on holidays, gym membership and supermarket shopping.

But many caution against this approach. John Chilman, group reward and pensions director at FirstGroup, says: “I have a lot of time for affinity benefits. Making money go further is important, especially at the moment.

But employers need to be careful about the perceived value of these benefits, especially if they are freezing pay.”

For example, some voluntary benefits require an employee to spend money to get a discount.

That is fine if it is their normal expenditure, but meaningless if they are unlikely to use it. Worse, if disposable income is squeezed, offering discounts on luxury items such as five-star holidays can seriously backfire.

Another hitch can occur if employees can pick up the deals elsewhere, especially if they can get a bigger discount. And with everyone from supermarkets to credit cards now offering moneyoff deals, the chances of this happening are on the increase.

As an alternative, Chilman recommends offering financial education. “We have been doing a lot with financial education,” he says. “If someone understands how to get a better deal on their car insurance or how to reduce the cost of their gas and electricity, this is much more valuable than 5% off their shopping.”

Salary sacrifice arrangements

• Increases in national insurance (NI) will make salary sacrifice arrangements even more attractive for employees who can afford to forfeit some of their income.

• For example, an employee earning £30,000 could redirect £1,000 to their pension pot. As income, that £1,000 would be worth only £680 after the deduction of 20% income tax and 12% employees’ national insurance (NI).

• In a pension pot, it would be worth £1,000 but, if the employer passes on its NI savings, it could be boosted to £1,138.

• This will not always be the right thing to do, but it is worth exploring if an organisation has a reasonable number of well-paid employees.

Read more articles on reward and benefits packages