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RR103 - Pensions and SMEs: Encouraging Savings Among SME Employees
Allinson, Braidford, Houston and Stone, 2008
Executive summary
This research aimed to determine practices that will promote higher levels of pension savings for employees in small businesses, through increasing employee participation and/or rates of contribution. The literature advocates a number of strategies for increasing levels of participation. This paper reports on the prevalence of these strategies among SMEs at present, and the potential for their adoption in the future.
Literature review
The data on pension savings indicate that in the UK the numbers of schemes, numbers of members and levels of contributions are all falling. Theory (Simon 1957) recognises the limits to employees' rationality when making decisions about pensions and, in practice, research (Harrison et al. 2006) finds that they are confused and apathetic about pension saving.
Automatic enrolment has proved to be the simplest and most effective measure to increase participation among employees. Other methods, such as streamlined joining and active decision making are also referred to, as is the principle of frequent, simple and consistent messages (soft measures) to employees. Establishing a system of matching contributions and offering salary sacrifice are both recognised measures of increasing contributions.
Method and achieved sample
Three focus groups were held with owners and senior managers of SMEs in early 2007. Groups were convened by local recruiters in Aldershot, Stoke-on-Trent and Durham. The sole recruitment criterion was that each business should have five or more employees and beyond this there was no purposive sampling.
Each focus group included two core activities: a pre-discussion questionnaire and a semi-structured discussion. Group discussion sought to:
- establish a baseline of small-business practices when engaging with pension providers
- assess employers' perceptions of pensions as financial products and their sense of responsibilities towards their employees
- collect employers' views on the strategies for increasing scheme membership and levels of contributions.
The focus group findings were compared with those from a group thought to exhibit some of the positive practices of the sort recommended by the literature. The Sunday Times '100 Best Small Companies to Work For' (Sunday Times 2006; 2007) was chosen as a convenient means for identifying companies likely to exhibit good practice. The process followed a format similar to that of the focus groups, with identical questionnaires and the same topic guides to facilitate the qualitative discussion.
The achieved sample for the focus groups comprised 18 micro-businesses and five small businesses in Aldershot and Stoke-on-Trent, with a further five medium businesses in Durham. Eight companies from the ST100 list were interviewed.
Key findings
Current patterns of provision and engagement
The evidence from this study suggests that micro-businesses see little advantage in promoting employee participation in pension schemes.
In this study, clear differences can be seen in the levels of employee uptake, according to employer size. Micro-businesses have the lowest rates of uptake, with just 4.5% of employees having an employer pension. Medium businesses have a moderate level of uptake, with 32.5% of employees with a pension. ST100 businesses have the highest rate of uptake, with 57.5% of employees with a pension.
Where schemes have been established, this has normally been done in a casual manner with little thought for what arrangements would be best for the business and its employees.
The generally low patterns of engagement in the small business sector, witnessed in this study, become a significant problem if these patterns are typical. There are approximately 400,000 SMEs with five or more employees in the UK; in total these businesses account for almost one-third of the workforce.Attitudinal factors
The sample businesses did not see pensions as providing tangible business benefits such as improved recruitment or retention. By contrast, ST100 businesses routinely offer attractive pension arrangements, albeit as part of a package of non-salary benefits.
A dichotomy is evident in the sample, with differences in attitude between smaller businesses and the ST100 sample. Micro-business owners typically believe their employees to be uninterested or largely ambivalent towards pensions and take this as a cue to disengage from action. ST100 companies generally respond with a programme of education to change opinions; this is accomplished through external experts, usually IFAs or pension company representatives. This suggests that an externally facilitated educational role would be appropriate to foster positive attitudes in both owners and their employees in micro-businesses.
Both employers and employees tend to have low levels of confidence in pension products, especially with respect to rates of return on investment and the security of funds. Micro-businesses use this belief to inform or rationalise their decisions about whether to offer pensions, whereas medium-sized companies are more inclined to take a neutral view, leaving the endorsement and explanation of pensions to professionals.
There is some evidence that attitudes are less negative in those businesses that have experienced higher than normal levels of participation. For example, with regard to administration costs, almost all businesses without active pension schemes - but none of the businesses with higher rates of participation - believe that higher levels of participation will result in significant administration costs.
Micro-businesses in this study expressed ignorance of the costs associated with pensions, anticipating more administration than is actually necessary. This information failure distorts attitudes to pensions and actual patterns of provision and uptake. Most small businesses lack detailed knowledge of their current and emergent obligations and of the pensions options open to them as employers. This lack of knowledge underpins generally negative attitudes to employee pensions, and widespread inertia.
Adoption of best practice
Business owners in this study typically lack both the motivation and the knowledge and capacity needed to make informed decisions about pension arrangements or to implement best practice. They are not normally concerned to promote participation and few if any have given any thought to how engagement might best be promoted.
The literature suggests various mechanisms, such as streamlined joining or automatic enrolment, which are recognised methods of increasing engagement with pension schemes. The findings from this study suggest that a number of these methods could be effective. Increased uptake would be most easily accomplished in medium-sized businesses, whereas micro-businesses are likely to be more resistant, and possibly lack the capacity to implement some of the suggestions.
Some of the larger businesses included in the study do have relatively high rates of participation. This suggests that the commonly expressed view among employers about there being a lack of demand among employees may not be totally valid. In a number of cases, mechanisms such as providing better access to information and the use of 'champions' are associated with higher participation rates.
'Soft' measures aimed at pension promotion are more likely to be used in the ST100 companies. These measures include the repetition of messages about pensions, and bundling pensions with other desirable products such as life assurance.
Automatic enrolment into a pension scheme was not practised by any of the businesses in the study, except through non-compulsory contribution schemes (which leads to low levels of employee contribution). Simplified joining is practised to an extent, with many schemes offering default options. One business operates a form of active decision making whereby employees have to make a decision about whether or not to join the scheme after 12 months service.
As well as, or instead of, increasing pension participation, several employers are interested in helping employees achieve higher levels of saving through alternative means. The most popular method is using salary sacrifice to add saved National Insurance contributions to the fund. Five of the ST100 businesses have opted for a scheme where employees can only participate if they make a minimum contribution, and one practises a modified form of pre-agreed pension-saving programme.
The medium-sized businesses in this study share similar characteristics with the ST100 companies (size, dedicated HR resource), and moderate rates of pension uptake. These shared characteristics mean that medium-sized businesses are more able to adopt most of the best-practice ideas.
Micro-businesses are too small to consider many of the 'soft' measures advocated in the literature. For these businesses, simpler measures such as automatic enrolment would be the most effective means of increasing rates of uptake.
Role of pension providers
Focus group participants cite many instances of dissatisfaction with pension providers and IFAs.
Choosing the right provider was claimed by several participants to be very important in achieving high rates of participation. There is a widely held view, supported by the experiences of the ST100 businesses, that pension providers have a crucial role stimulating demand. It is commonly believed that a higher level of customer service from the pensions industry might well raise levels of participation and contributions, particularly if this were based on an understanding of the concerns of small business owners and the variable personal circumstances of employees.
The small-business sector is highly heterogeneous and SMEs value adaptability and flexibility, with businesses opting for providers that accommodate their particular situations and needs. Some of the businesses participating in the study had changed providers to get a better service.
This study finds some evidence for a shrinking market for the provision of pensions to SMEs, with fewer providers offering a more limited range of products. There are also indications that the market in the SME sector is being distorted by the commission arrangements of pension providers. The impact of this is that micro-businesses are further dissuaded from active participation, because sourcing an appropriate pension has become harder.
Attitudes to and capacity for change
The prospect of being compelled to join the National Pensions Savings Scheme in 2012 was not met warmly by the micro-businesses in this study; invariably they would rather wait until forced to take action than act now.
The sample businesses were aware of some media attention given to pensions, but vague about the specific contents of any government proposals (for example, mandatory participation within a system of auto-enrolment or the levels of employer contribution involved). If this finding is widely replicable then approximately one million small businesses may lack the awareness, motivation or capacity to plan proactively in order to establish the most appropriate arrangements for their businesses and their employees. Without appropriate advice and support, large numbers of small businesses will not actively address the new obligations they are likely to face in 2012. By deferring the necessary decisions, these businesses may well reduce the options open to them, and this may ultimately result in their adopting inappropriate and costly systems.
Role and use of agents
The general lack of knowledge and capacity within the small business sector indicates that there will be a key role for agents in promoting and supporting the establishment and operation of new pension arrangements throughout the sector.
There is evidence from the study that appropriate and effective advice can be crucial to the adoption of good practice.
Recommendations
Intermediaries qualified to give investment advice, such as accountants, could support both medium-sized and micro-businesses in adopting better pension savings arrangements for their employees.
Support in medium-sized businesses could focus on implementing policies that encourage pension savings. Medium-sized businesses adopt best practice measures only partially. Although they have often implemented good practice, such as salary sacrifice, this does not extend to schemes such as automatic enrolment or active decision-making.
Support in micro-businesses would need to be more extensive. Not only is there a need to encourage micro-businesses to adopt measures to increase rates of participation and levels of contribution, there is also an educational role for intermediaries. This would involve addressing information failure and offer support to educate owners and their staff.
Further research should assess the costs of the administrative burden and quantify the impact on businesses, according to the size of each business. Implementation is a greater issue for smaller businesses because of their limited capacity to respond, as well as the relative cost to their business.
In addition, further research could empirically quantify the impact on pension uptake of the suggestions for best practice, especially for those ideas that at present have no supporting evidence (soft measures, matching contributions and salary sacrifice). Research should also look at which measures are most effective in firms of different sizes.
Some support from the government would be most appropriate for micro-businesses, in recognition of their more difficult and lengthy transition for adopting these improved methods of pension uptake.
Although this paper is concerned with the present voluntary arrangements for employer pensions, there are also implications for the introduction of personal accounts. This study has found there are a greater number of problems in micro-businesses, not only in implementing these ideas, but also in the general administration associated with pensions. Although full exemption from personal accounts is not necessarily desirable, there is a case for some support from the government, specifically for smaller businesses that are exposed to a relatively higher burden.