Some say more tweaking needed before NEST can fly

Proposed rules governing the U.K.'s new retirement plan for uncovered workers could drive some employers to lower contributions to their existing defined contribution plans, experts said.

U.K. officials earlier this month clarified proposed retirement plan reforms, including new rules on minimum contributions and automatic enrollment, that will create the National Employment Savings Trust, or NEST, a new nationwide retirement plan for workers currently not covered by an employer-provided plan. The rules also applied to employer-provided plans.

At issue is how contributions are calculated. The new rules would require employers to include variable pay, such as overtime and bonuses, in minimum contribution calculations. Experts say most employers base contribution calculations on basic salary alone.

To avoid having their benefits costs escalate from using a broader measure of compensation, some employers might reduce their benefit formula.

Also, the proposed rules would create an administrative nightmare for employers because they would have to determine whether each employee's compensation met new minimum contribution requirements. As a result, employers might abandon their existing benefit formulas in favor of the government-sanctioned approach or drop them entirely in favor of NEST. Either approach could result in lower contributions for most employees.

Some experts say that what is needed is a plan certification process that would approve an entire existing plan as meeting new government standards. Certification would obviate a complicated and time-consuming look at individual contributions.

“We are keen to make progress on that (issue),” said Richard Wilson, senior policy adviser at the National Association of Pension Funds, London. “What we are concerned about is that this will be a type of leveling down,” or reducing benefits for most participants, he said.

NEST, aimed at low- and middle-income workers, will offer total contributions of 8% of annual pay; contributions made to U.K. workplace defined contribution plans are 11%, according to an Association of Consulting Actuaries survey. The NEST plan will collect 4% from employees, 3% from employers and 1% from the government in the form of tax relief.

Among the regulations proposed by the government on Jan. 12:

• The largest businesses would start automatically enrolling employees not covered by an existing plan into NEST or their own qualifying plan in October 2012, with smaller businesses phased in over the following three years;

• Employer contributions would begin at 1% of annual pay in 2012 and increase to 2% in October 2016 and 3% a year later; and

• The Personal Accounts Delivery System, the agency that has been laying the groundwork for the NEST plan, would be merged into NEST, with PADA employees becoming employees of NEST on July 5.

“There's still a lot of uncertainty to be resolved … (but) the key is that some planning can be done now,” said Paul Macro, a senior consultant at Towers Watson in Manchester, England.

Mr. Macro said very few companies could be absolutely certain their DC scheme would qualify as aNEST replacement under the proposed rules.

In its annual survey of pension fund members released in November, the NAPF found that 8% of respondents planned to reduce existing plan benefits as a result of NEST.

“The risk that there will be significant leveling down cannot be discounted,” according to a report based on the NAPF survey, which added that another 10% of respondents said they plan to automatically enroll employees into NEST who do not choose to join their employers' existing plans. NAPF added that others might take similar paths. “Importantly, over a quarter of respondents do not yet know how they will react to 2012.”

A separate survey by the Association of Consulting Actuaries, also of London, found that 24% of respondents would level down before 2012 to limit the increase in retirement benefit costs. The ACA surveyed 309 companies with pension assets of £139 billion ($226 billion).

Steve Charlton, a principal in London at Mercer LLC, said automatic enrollment will extend retirement benefits to more workers, raising costs for companies. That will mean lower profits, possible layoffs, higher prices or other moves to pay the higher retirement benefits bill. “Leveling down while widening reach is one option” to lower costs, he said.

Consultants said that most companies — especially larger ones — do not intend to restructure their plans and will continue to offer benefits in excess of the minimum offered by NEST. Employers prefer to retain their own plans rather than offer the government-run alternative, experts said.

“Most employers are keen to provide their own pension scheme,” said Christopher McWilliam, a London-based senior consultant at Aon Consulting. “They continue to see that as a valuable recruitment tool.”

Mr. Macro added that many employers are reluctant to use NEST “simply because of the unknown. … It's got, ‘This could go all wrong,' written all over it.”

However, Mr. McWilliam said that some large companies are considering implementing a two-tier retirement plan, with permanent and senior staff in a more generous plan and temporary staff in NEST.

That's a concern for the NAPF, Mr. Wilson said. “There could be many people who could lose access to really good pension schemes,” he said, adding that reforms should increase the overall level of retirement saving.