Absence of action may see increase of 2-3 percent in company payroll costs for DB employees. Employers less aware of impact on DC members; DC members may see drop of up to £4,000 per annum following State Pension changes.

The majority of UK employers have not yet considered, or determined how to address, the increase in payroll costs that will come with changes in the way that State benefits integrate with employer sponsored defined benefit (DB) pension plans, says Mercer’s new Contracting Out Survey. Amongst those employers with DB plans surveyed, 57 percent have not considered or determined how to address the issue. For defined contribution (DC) plans the figure is 70 percent.

From April 2016, UK State Pensions will be radically overhauled with a new Single Tier pension, expected to be at least £148.40 per week replacing the five separate elements of the current State Pension. The option to “contract out” of the Additional State Pension will also be removed, resulting in an increase in National Insurance costs for employers and members in most DB pension schemes. The Pensions Act, which will come into force on 6 April 2016, provides employers with a limited power to amend their pension schemes to offset these cost increases. However, employers will still need to work closely with their schemes’ trustees and consult effectively with employees on their proposals, before amendments can be implemented.

Mercer’s survey analyses responses from 142 employers with nearly 1 million employees. It is aimed at understanding what amendments are being made by employees in light of the 2016 changes. According to Dr Deborah Cooper, Partner at Mercer, “The Government’s aim to simplify State Pension provision is laudable but the transition will create DB and DC winners and losers. Companies need to be thinking through the implications sooner rather than later. In the absence of any action, employers will see payroll costs increase by between 2 percent and 3 percent for employees who are still earning benefits in DB pension arrangements. Furthermore, the introduction of the Single Tier pension will reduce expected retirement incomes for many members in DC schemes.”

For DB schemes, the survey found that 43 percent of employers had considered the impact of the changes and have an agreed course of action, 27 percent had considered them, but had not yet determined whether to take action. Thirty percent hadn’t considered the issue at all. Of those 43 percent of employers who had considered the implications of the State Pension changes, almost half were not proposing to amend their DB pension scheme. This was because they had recently reviewed benefits, were precluded by legislation from making changes, or were willing to accept the increase in cost (particularly where their scheme had few remaining members). For those who had decided to make a change or were still considering the issue, the most popular options being considered or selected are closure to accrual, increases to member contributions, reducing benefits or, in some cases, a combination of actions.

“April 2016 is distant but effective pension change programmes can easily take a year to complete,” said Adrian Hartshorn, Senior Partner and Head of Corporate Consulting at Mercer. “Companies need to develop a plan for implementing changes soon if they are to head-off an increase in costs. They must consider how their proposals will affect different employee groups – the complexity of the current State Pension system means that there are no easy answers.” Mr Hartshorn added: “In light of these changes, some employers may consider closing their DB schemes to existing employees. Closure isn’t a certainty, however. Our survey shows that many employers are looking to maintain DB pensions – albeit at a lower cost – by changing benefits, moving to career average accrual or adopting cash balance plans.” 

Defined Contribution Pension Arrangement

Interestingly, respondents were less aware of the impact that the changes will have on members of DC schemes with only 40 percent responding that they had considered the impact on this group action. Mercer analysis suggests that the State pensions some employees can expect to receive will be as much as £4,000 per annum less than they would have been if the 2016 changes did not go ahead. “It is understandable that employers’ focus has been on DB cost increase,” said Dr Cooper, “but for many DC members the introduction of the Single Tier pension will reduce their retirement incomes. Companies that don’t consider the implications for DC members might find that large numbers of employees are unable to retire and this will have profound impact on career progression, staff motivation and health costs.”