How SMEs can deal with a capacity squeeze

And so it is for UK businesses that fail to get their operation’s auto-enrolment ready well ahead of their staging dates: all the very best providers and advisers may be gone.

For the full The Specialist report on auto-enrolment, click here to download the PDF

The UK’s largest employers have already passed their auto-enrolment deadlines and the good news is that this has been largely successful.

The entire industry is already at full stretch. Whether you are looking at providers or advisers, they are maxed out [on auto-enrolment] already

However, next year’s staging dates cover much smaller employers – starting with 350-499 workers in January, ending with just 59 in November – and present the pensions industry with a huge influx of companies, most tackling pensions for the first time.

There have long been predictions that there would be a capacity crunch during the later stages of the auto-enrolment process, but only now is it starting to become clear how serious this might be.

Steve Herbert, head of benefits strategy at corporate adviser Jelf Employee Benefits, says: “The entire [pension] industry is already at full stretch and probably has been since the start of this year. Whether you are looking at providers or advisers, they are maxed out [on auto-enrolment] already.”

According to the Financial Conduct Authority, there were 21,258 qualified financial advisers in operation in the UK at the end of July this year, yet it is estimated there are more than 30,000 companies with workforces between 50 and 250 individuals that will need to be auto-enrolled in the next 18 months.

By the time auto-enrolment has been completely phased in by 2018, 1.35m employers will have been forced to comply with the legislation.

According to research from the Personal Finance Society, published at the end of August, nearly half (49 per cent) of firms with between one and 49 employees – representing more than half a million businesses – will seek to employ an adviser when choosing a pension.

These figures demonstrate the cavernous gap between the availability of quality advice and the anticipated spike in demand.

Even where employers choose to bypass advice, there is a strong possibility they may struggle to find a suitable provider.

The Pensions Regulator has already warned that the industry is not yet fully prepared for the needs of the many thousands of medium-sized employers with staging dates next year.

“Many providers are still developing their propositions for medium, small and micro employers and it is important that progress continues, especially in the run-up to quarter two 2014, when we anticipate that large numbers of medium employers will need assistance,” it has said.

In theory, no employer should be without a pension provider since the government introduced Nest, which has a statutory obligation to take on any company irrespective of size or workforce demographic.

However, Nest is under no obligation to offer any of the administration, payroll or other essential services auto-enrolment requires. Nor does it offer bespoke schemes designed to work with specific workforce requirements.

It is also far from clear that the government-backed scheme will be free from its own capacity constraints as tens of thousands of schemes reach their staging dates next year and in 2015.

Auto-enrolment is almost removed from pensions; it’s about business planning. Can payroll cope? Will existing systems work with the new demands? How much will the added functionality cost?

So employers expecting to enjoy a genuine choice of provider may be in for a shock unless they have allowed plenty of time to attract a suitor ahead of their staging date.

David Hodgson, director at employee benefits consultant RSM Tenon, says: “Providers are beginning to take a firmer stance and demanding a six-month lead-in time.

“Our experience from talking to leading commercial providers is there will be some that will look at the scheme data and see what they can do, while others simply give a flat no.”

Among the providers setting criteria for acceptance is Scottish Life. The company has an ideal requirement that new business comes in at least six months before the employer's staging date¹, though it will accept a shorter lead-in time in some cases, subject to other conditions.

This additional demand sits alongside the provider’s long-held requirement that companies have more than five scheme members making an average contribution of £750 a year.

Business development manager Jamie Clark says the insurer has little choice but to set such limits since it has to protect both profits and reputation.

“We are looking at employers who are preparing early for auto-enrolment as that will be crucial to make sure everything is compliant,” he says.

For the full The Specialist report on auto-enrolment, click here to download the PDF

“There is a risk to Scottish Life, and indeed any provider, if something goes wrong with a scheme at set-up, causing the regulator to take action against them for getting it wrong. We are cautious and conservative about that.”

Scottish Life is not alone in setting tough admission criteria. Fellow providers Aegon and Prudential also prefer clients to have more than a year until their staging date before taking them on.

Even where employers have an existing scheme with a particular provider, it does not follow that they will automatically be able to extend that arrangement to be AE-compliant.

Clark says: “The reality is that there are parts of an employer’s worker demographic that we wouldn’t offer terms for, so Nest might be the only option for them. We can help set up a hybrid solution with Nest, but that takes time.”

Further, employers may find their existing providers impose significant charges for implementing auto-enrolment software and systems that prove prohibitively expensive.

Hodgson says: “Some employers think because they always had a pension with a particular insurer all will be well, but then they discover that provider is charging £15,000 for their auto-enrolment software and it’s not economically feasible.”

Of course, not all providers are setting limits. Standard Life has refused to limit customers to particular timeframes or contributions. Instead it is working with advisers to come up with products that might best service the smaller and medium-sized employers in a more mass-produced way.

Aviva has adopted a similar stance. Both insurers have linked up with IFA and employee benefit consultant LEBC to provide an off-the-shelf product that includes online administration, member communications and fund management.

Glynn Jones, divisional director at LEBC, says some insurers are confused about auto-enrolment, leading them to make “strange decisions” about who they will admit and who they will refuse.

Contrarily, he says Standard Life recognises that those employers reaching their staging dates in 2014 represent the insurer’s core business and it wants to be in a position to profit both now and in the future.

“The 2014 staging zone is Standard Life’s heartland; it’s the UK blue collar/white collar mix, with a 10 per cent employee turnover.

“These people pay money into pensions anyway and [auto-enrolment] will just increase that. If Standard Life can get a massive slice of that market, once people have to increase contributions [in 2018] they [Standard Life] will have an inflow of money forever,” Jones says.

The provider has also collaborated with Barnett Waddingham, another employee benefits consultant, to develop additional relationships with the SME market.

In its half-year results for 2013, the company reveals the importance of this sector to the insurer’s future profitability.

“While the broader UK pensions industry faces potential capacity issues, the investment we have made in our technology and processes means we are ideally placed to meet demand from employers. We expect a total of 300 implementations this year and around 3,000 in 2014 as auto-enrolment becomes a reality for smaller employers.”

The regulator is also working with providers and advisers to ensure there are opportunities in the market for smaller employers that are less desirable to providers.

“The regulator has been working with providers to understand the issues they face and is encouraged to see a number of models designed to meet the demand in the years ahead,” says a spokesperson.

Mastertrusts such as Now Pensions and The People’s Pension offer yet more in the way of alternatives to traditional insurers, since these are competing with Nest and are able to take in a wide variety of employers.

However, there is no doubt that the capacity crunch means employers wishing to avoid a last-minute scramble to find a provider, or wanting to cherry-pick from the best, must work to make themselves attractive.

The critical factor is time. As noted, some insurers are already stipulating an 18-month lead time before the staging date, and once employers understand the amount of work involved these preparation demands seem quite reasonable.

“Auto-enrolment is almost removed from pensions; it’s about business planning,” says Clark. “Can payroll cope? Will existing systems work with the new demands? How much will the added functionality cost?

“Will the employer need legal advice to oversee changes to contracts of employment? Who is responsible for contract and agency workers? There are huge amounts to consider.”

Perhaps, then, it is unsurprising the regulator is so preoccupied with time. It says employers must leave at least six months before their staging dates to get themselves in order and repeatedly points to the importance of early preparation.

“Providers may be unwilling to work with employers who leave preparations to the last minute,” it warns. “Employers or their advisers may need to leave enough time to approach a number of providers to identify those that offer the most suitable scheme.”

Data are another challenge for employers. Jones says it takes time to clean employee records and ensure they work with providers’ systems. “Clients don’t necessarily understand these critical issues,” he says.

Contributions are yet another important element since the greater the amount paid into the scheme the more attractive it is to the provider.

With current mandatory contributions set at just 1 per cent, there is little to make small employers with a low-paid workforce attractive to an insurer unless they are willing to go beyond the bare minimum.

RSM Tenon’s Hodgson recommends employers pay a 2 per cent contribution, leaving employees free to make an additional voluntary contribution if they so wish.

“This will make the scheme look more attractive [to insurers] because employers can say they are more likely to get a higher take-up rate, which makes the scheme more profitable for providers,” he says.

While the industry and regulator are desperate to make clear the sense of urgency, plenty of employers remain lackadaisical.

Research from the regulator shows that as of autumn last year, just 65 per cent of micro employers were aware of the key tenets of pension reform, while the Personal Finance Society survey shows one in 16 micro firms (6 per cent) believe auto-enrolment is irrelevant to them.

Keith Richards, chief executive of the PFS, says: “The government must do as much as it can to clarify that auto-enrolment applies to all employers, and that they should start preparing as soon as possible. A decisive media campaign, particularly targeted at micro employers and encouraging them to seek advice if unsure, would do much to dispel any misunderstanding or confusion.”

For the full The Specialist report on auto-enrolment, click here to download the PDF

Scottish Life’s Clark shares this view, calling for a rejuvenation of the Department for Work and Pensions’ advertising campaign. Meanwhile Herbert at Jelf says employer organisations, such as the Federation of Small Businesses, have a role to play “in reaching into the smaller crevices of the pensions market”.

Just how damaging a capacity crunch may be to the future success of auto-enrolment is hard to gauge but there is a fear it could derail pension reform.

Were employees to perceive Nest in a negative light since it is the catch-all default scheme, an employer’s failure to get an alternative in place may discourage the workforce from joining up.

“We like Nest and we think it’s a good scheme, but because it is created by government it may not be perceived as quality by employees,” says LEBC’s Jones. “That perception will not help.”

There is a willingness from industry and government to tackle the supply and demand problem, but the overriding view is that for many thousands of employers the destination will be Nest.

However, employers will still need to have their houses in order to be admitted into the government scheme and the early indications are that some companies simply may not be ready on time.

The watchdog has made clear it is willing to bare its teeth when it comes to auto-enrolment compliance and it may well have to do just that, unless there is a positive shift in awareness and attitude towards this cornerstone of pension reform.

Gill Wadsworth is a freelance journalist

¹The original version of this article, published online on September 25 2013, stated incorrectly that Scottish Life was “unlikely” to accept companies that are within 12 or even 18 months of their staging date.