What can employers do to rebalance pension gaps in organisations?

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Need to know:

The UK corporate governance code was strengthened in July 2018 to oblige organisations to align new executive directors’ pensions with those available to the wider workforce.
Despite political and shareholder impetus, so far executive pension rates are drifting down quite slowly, with 25% of pay viewed as acceptable. This is the benchmark set by the Investment Association’s 'name and shame' policy.
Aligning pay will be most difficult to achieve in auto-enrolled schemes, which also heavily penalise women for their working patterns

Out-sized boardroom pensions are under increasing scrutiny by shareholder and regulatory organisations, amid growing unease at the disparity between the pension contributions made by employers for their top executives and other workers.

The UK corporate governance code was strengthened last July, and now requires organisations to align executives’ pensions with those available to the wider workforce, or explain why they are failing to do so. These accounting standards, set by the Financial Reporting Council, have the force of law for listed companies that have to prepare annual reports. However, the Guidance on Board Effectiveness, published alongside the code to suggest good practice, provides a let-out in regard to current employees whose pension benefits are written into their service contracts, which is effectively a stay of execution until a director leaves.

The Investment Association (IA), which represents firms managing £7.7 trillion, has a 'name and shame' policy, targeting organisations that pay executives a pension contribution of 25% of salary or more. Over 40 FTSE 100 constituents fall into this category. The IA also names employers which offer new executives a higher rate than the wider workforce; and which do not publish a strategy on alignment in their remuneration policy.

Slow progress

Some progress has been made as executives move jobs. At Aviva, for example, incoming chief executive Maurice Tulloch receives a pension payment worth 14% of pay, compared with 28% for his predecessor, Mark Wilson. A few employers have attempted homogenous rates across the payscale, such as HSBC which has reduced pension payments for new executives from 30% to 10% of salary, not far off the average 9% for its bank staff.

While few employers have reduced contribution rates for their current CEOs, attrition from revolving doors is beginning to make an impact. A contribution rate of 25% is emerging as the magic number with which employers feel comfortable, at least for the time being. For example, Deloitte’s annual Directors’ remuneration in FTSE 100 companies report, published in October 2018, showed that between 2017 and 2018 the median chief executive pension contribution was 25%, while the average upper quartile chief executive pension contribution fell from 30% to 25%.

Shaun Southern, a partner at Lane, Clark and Peacock, says: “If [employers] are looking to take action and reduce executive pensions then it’s important they do so properly, otherwise they are open to the charge that it’s simply a PR exercise. Having spoken to a number of [organisations] on this issue, there isn’t much appetite to increase pension contributions for their general workforce to close the gap: the cost of offering a higher level of pension benefit to the wider population is prohibitive. Therefore, we are likely to see executive pension levels drift downwards until pressure subsides, at least among listed companies.”

Annual allowance issues

The tax framework around pensions has exacerbated the problem, because the introduction of the annual allowance taper in 2016 made large additional cash payments necessary to maintain the real level of pension benefits executives historically enjoyed. However, these payments attract income tax in a way that pension contributions do not.

Alan Morahan, managing director, employee benefits consulting, at Punter Southall Aspire, says: “The issue has become further muddied because of the introduction of the tapered annual allowance which limits tax relief on contributions up to £10,000 per annum: contributions above this are taxed at the individual’s marginal rate. Contributions over this amount are often given as a cash allowance, which is subject to tax and also incurs both employer and employee national insurance. This is the type of thing investors will pick up and question why contribution rates are being set at levels that simply result in executives receiving more cash.”

Pension rate equality

The governance code probably aims for all employees to be moved onto new organisation-wide pension contribution rates. However, the code is vague and does not define ‘workforce’, so it is unclear whether executive pension benefits have to align with the average rate for the whole workforce including directors, or only with the management strata, or whether they might even have to be scaled down to the average for the bulk of the workforce.

Alignment is particularly unrealistic for employers that have provided the benefit through auto-enrolment, with an employer’s contribution of just 3%. Steve Webb, director of policy at Royal London, says: “When automatic-enrolment came along, some employers chose to stick with their existing scheme for employees who were already members and then to opt for a secondary scheme for auto-enrolment, which was often run on the statutory minimum contributions. This was not exactly levelling down, but has created two-tier pension arrangements leaving many lower paid on inferior terms.”

Gender pension gap

While gender pension inequality is exacerbated by fewer women holding senior positions, its roots are in the traditional work patterns of women, such as working part-time and taking time out as parents and carers. Women are particularly punished under the auto-enrolment regime, which excludes those earning less than £10,000 a year. Access to auto-enrolment can also be limited by temporary contracts, zero hours, and working multiple jobs that do not take employees above the threshold. This helps explains why the gender pension gap is around 60%, while the gender pay gap is around 30%.

Women account for three-quarters of all part-time workers, for example. Deborah Cooper, risk and professional leader for UK retirement business at Mercer, says: “It seems incredibly unfair that the government can manage to tax these part-time jobs, but [it] cannot aggregate them for pensions and national insurance.”

Kate Smith, head of pensions at Aegon, adds: “The removal or reduction of this earnings trigger would reduce the gap but there’s no government appetite to do so. “Employers could also provide access to returnship programmes to actively encourage parents back into the workplace when their children are older to make up the pension contributions they missed out on.”

Initiatives from the government would be helpful. Consumer organisation Which? has called for all new mothers to be given a £2,000 pension top-up. Shoko French, senior consultant at Hymans Robertson, says she would also like to see more employers topping up contributions above the minimum requirements during periods of maternity and part-time working.

“The employment world is being shaken up in a way that people don’t understand and legislation no longer copes with,” adds Cooper. “At some point, this will have to resolve itself. We see [organisations] where the owners are fabulously rich and their workforces are on the minimum wage working in sub-21st century conditions, but most employers just do what they can. There is a link with populism; people are frustrated with the various sources of inequality. At some point, there must be a sensible shake up; there are so many gaps in employee protection and access to pensions.”

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