Cost of pensions auto-enrolment to companies "shouldn't be exaggerated", expert warns

Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, was responding to an annual funding report (registration required) by actuarial consultants Lane Clark and Peacock (LCP). Although employers would need to factor in the costs of implementing automatic enrolment, planning "earlier rather than sooner" would help keep costs down, he said.

"The figures fail to take account of the fact that auto-enrolment is to be phased in gradually," he said. "Only the largest employers will have to auto-enrol their staff this year, and the pension contribution required from employers will start at 1% and only rise to 3% in October 2018. This gives employers time to offset some of the additional costs through their general remuneration policy."

The largest employers will have to start auto-enrolling workers into a suitable pension scheme from 1 October 2012, with smaller employers to follow in a staggered implementation programme. All existing companies will have to have enrolled their staff by April 2017, while new employers will have until February 2018. Companies will be required to automatically enrol 'eligible jobholders' aged between 22 and the State Pension age who are earning more than £7,475 a year.

The 'big four' supermarkets will be the first companies required to implement auto-enrolment, according to the report. Morrisons and Tesco have indicated that they plan to use their existing pension schemes to meet the legal requirements, while Sainsbury's and Asda are expected to auto-enrol employees into less generous defined contribution pension schemes.

The LCP report, now in its 19th year, provides analysis of the defined benefit pension schemes operated by the FTSE 100 leading companies by share capital. Defined benefit pension schemes are those which promise a set level of pension provision on retirement no matter what happens to the value of the underlying investment, meaning that the employer bears the full risk of investments not performing as expected or increased life expectancy. Shell, the last FTSE 100 company to offer defined benefit pension provision based on final salary to new employees, closed its scheme to new members this year.

According to the report, the combined deficit of FTSE 100 company pension schemes more than doubled over the last financial year to reach £41 billion as of the end of May, despite high levels of company contributions. FTSE 100 companies paid a total of £21.4bn into their pension schemes in 2011, with almost £11bn of that going towards reducing deficits rather than benefits for current employees. LCP claimed that this would rise to over £26bn by next year if firms contributed at the same rate, given the onset of auto-enrolment.

Bob Scott, author of the report, said that the increased deficit reflected record lows in corporate bond yields and poor returns on equity investments. Both of these factors affect the assumptions actuaries use when calculating the cost to schemes of providing defined benefits, effectively increasing the size of the deficit.

"The challenge this poses to the UK's leading companies is compounded by the significant volatility in deficits on a day-to-day basis," Scott added. "Deficits have fluctuated by as much as £10bn in a single day as uncertainty continues to characterise both equity and debt markets. Against this background, we have seen companies pay very substantial pension contributions: four companies paid over £1bn into their defined benefit pension schemes in 2011 and, earlier this year, BT made a further £2bn payment to accelerate the removal of its deficit - the largest ever one-off deficit contribution to a UK scheme."

The figures also showed a continuing trend among pension schemes towards reducing the amount of assets held as equity investments. 35% of scheme assets were held in equities at the end of 2011 compared to 43% at the start of the year and nearly 70% ten years ago, which LCP said reflected the "changing nature" of schemes and a general move towards less risky investments.

However, the "overall" funding picture for schemes was more challenging due to potential regulatory changes designed to make pensions more secure. Committing "ever more company resources" towards potential European solvency standards would, Scott said, mean companies were less able to provide benefits for current and future employees – a view shared by lobbyists in the UK, including industry body the National Association of Pension Funds (NAPF).

"Auto-enrolment will extend basic pension provision to many more people but the extra costs may well lead companies to level down their existing commitments," Scott concluded. "As a result we can expect more cutbacks in the benefits for future service with a corresponding impact on FTSE 100 employees."