DB schemes could become more costly for sponsors as a result of government reforms to national insurance contributions. Kristian Brunt-Seymour explores the options.
At a glance:
- Increase in NIC costs depends on scheme membership and accrual rate
- Companies can absorb costs, pass onto employees, or amend scheme rules
- Unions have tried to block employers passing costs onto members
The abolition of contracting out on April 6 is making defined benefit (DB) provision more costly for many sponsors.
Under the reforms companies with DB schemes in the private and public sectors lose their national insurance (NI) rebates and face increases in their own and their employees' NI contributions (NIC). Employers are considering how to address the increased costs at a time when providing DB pensions is already increasingly expensive.
The effects of NIC depend on the earnings of individual employees, although the biggest impact is expected to fall on companies that have large numbers of staff on their DB schemes.
Figures from Barnett Waddingham show members on a £30,000 salary would pay an extra £338 and the employer £822 annually. On a £40,000 salary this would rise to £478 for the employee and £1,162 for the employer.
Companies with employees in contracted-out employment on 5 April 2016 are also affected. This includes DB schemes open to new members, or schemes closed to new entrants but with members who joined before this closure occurred.
Around 60% of DB schemes and up to 1.75 million active members could be potentially be affected by the changes according to figures from the 2015 Purple Book.
Table: How are schemes affected
Source: Pension Protection Found 2015 Purple Book
Those who have already closed their schemes to entrants or have depleted numbers of active members will not be affected, nor those with little or no accrual on their schemes.
Options for sponsors
Options for sponsors facing an increase in employer NICs range from absorbing the extra cost, passing them onto employees, amending the scheme rules, or even closing down the scheme.
The government legislated for an override power option allowing companies to offset the rise by changing their scheme rules. This includes reducing benefits accrued by members, increasing their scheme contributions or raising the scheme's retirement age to spread out the costs.
Employers have a statutory period of up to 60 days to consult members before altering their contributions or benefits. This power does not apply to public sector schemes, however.
The least expensive option is for companies to pass the costs onto their staff. However, such attempts by Royal Bank of Scotland, the transport manufacturer Bombardier and automobile producer Bentley Motors have led to disputes with the organisations' trade union representatives.
Barnett Waddingham senior consultant Malcolm McLean (pictured) says this reaction from unions is unsurprising given employees are also subject to a NIC increase. He argues the two costs combined would be a ‘double whammy' for employees which could lead to some thinking they need to work longer.
However, he adds some employers already struggling to grapple with state pension reforms and increasing longevity of their members may feel this reform is the ‘straw that breaks the camel's back'.
"Employers are caught right in the middle of this," he says. "These reforms raise a number of questions as to what it might mean for the future of DB pension provision. Many have already closed down their final salary schemes on the grounds that they were already too expensive for them to support."
Mercer partner Deborah Cooper believes many may choose to do nothing and just absorb the costs. This will avoid employee grievances and potential complications arising from alterations to their scheme rules.
However, she warns absorbing the costs could affect the profitability and growth of companies that will be heavily impacted by NIC, which could eventually affect their employees anyway.
"It's going to depend on their objective as an employer and how material the DB liabilities are to you and what portion of your workforce is accruing benefits so it's going be very employer specific. They may decide that if their payroll is going to increase by around 3% and it's a material part of their payroll that's an increase costs which maybe they can't pay off."
Timing is key
Another consideration is the time it takes to make any changes, according to Hymans Robertson partner Sue Waites.
"There is the statutory consultation period if changes are made, so you're looking at four to five months to complete any pension scheme changes process properly. During this time the company would continue to pay the NI contributions," she says. "If you go down the route of changing the benefits you might want even more time to put through the changes to the benefits system along with the consultation."
Waites adds the legislation may also be a springboard for some organisations to make bigger changes to their DB schemes, such as reduction in benefits or looking at closing the scheme. If this is the case, the statutory route cannot be used to achieve this.
However, McLean says the long-term effects are unclear with smaller DB sponsors feeling under no obligation to react quickly to the reforms. As a result, the full extent of the changes is not likely to emerge until the 2016/17 financial year.
Although employers have several options to react to the NIC reforms, it is a considerable challenge and could further accelerate the demise of DB.
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