In section 11 (The role of governments), we suggest that, when setting public policies on retirement incomes, governments should focus on objectives where they have a unique capacity to influence outcomes.
Governments should avoid trying to influence or direct private provision for retirement by tax breaks (section 9) or through compulsion, ‘hard’ or ‘soft’ (section 10). That those common interventions seem not to work is only one of their many shortcomings. Citizens should instead make their own decisions about financial provision for retirement; and employers might have a say in that as well for their own employees.
Tax incentives aim to encourage citizens to behave in particular ways by either a direct subsidy (a ‘tax credit’), by allowing a deduction against other income or by giving a more favoured tax treatment of ‘income’ earned by such savings. It does not matter how they are delivered, tax incentives come with large direct costs to the government’s revenue and indirect ‘costs’ that derive from the other negative effects of tax breaks.
An employer faces similar policy issues when it decides to pay employees in a particular way and to reward ‘appropriate’ behaviour. Despite some structural similarities, an employer is not the country, writ small. When employers make decisions about financial provision for their employees’ retirement and other financial needs, other policy considerations should apply. But the central question remains similar – should an employer directly subsidise an employee’s saving programme (for retirement or otherwise) to help it achieve its business goals?
‘Pay + benefits’
The compensation practices of employers in most countries developed over many years into a ‘pay + benefits’ patchwork. The price paid by an employer to get a job done is usually divided into two:
Direct cash that can include ‘at risk’ or bonus elements;
Indirect benefitssuch as retirement pensions, the use of an employer-owned vehicle, insurance (for health needs, death cover and disability protection), subsidised loans, club subscriptions and so on.
Indirect benefits grew in number, significance and complexity. They were usually driven by:
(a) Tax laws that favoured indirect benefits over cash and some benefits over others;
(b) Personnel (HR) policy that favoured certain types of behaviour over others;
(c) Pressures from other employers that are competitors for labour;
(d) The historical need to distinguish between waged employees (represented by unions) with benefits such as overtime pay and penal allowances, and salaried employees (non-unionised) who tended to receive fixed amounts of pay;
(e) The purchasing power of employers that could gain access to benefits at a cheaper cost than employees were able to obtain on their own.
‘Pay + benefits’ is one remuneration strategy; an alternative is ‘total remuneration’ where a cash value is placed on the role and it is for employeesto decide how that is spent. Any particular employer’s actual strategy is normally somewhere between the two alternatives.
Problems of ‘pay + benefits’
There are many issues with a ‘pay + benefits’ approach to compensation. It’s important to understand these because, in New Zealand, they are increasingly the old way of structuring remuneration arrangements between employers and employees.
Here are the main difficulties:
(a) Differing tax treatments of benefits: Between 1985 and 2000, New Zealand eliminated the privileged tax treatment of all indirect benefits, including retirement saving schemes. We generally treat retirement savings (TTE) in the same way as other savings, such as through a bank account[2]- see section 9 (On tax subsidies for saving) for more on this. Cash and indirect benefits now have broadly similar tax treatments so one reason for the development of different types of benefits has gone – New Zealand is alone in this regard.
(b) Poor understanding of benefits: Employees tend not to understand (or know how to calculate) the total value of their compensation in a year. They tend to under-value non-cash benefits or even not to value them at all, especially if they are not directly relevant to the employee’s particular needs. As a result, the amounts spent by the employer are, in part, wasted. Employers may not have communicated with or educated their employees well, so part of this waste was self-inflicted.
(c) Correlation with performance: Benefits can only be indirectly related to an individual employee’s performance. Benefits that are based on pay, such as retirement benefits, have some of that linkage but other benefits do not (for example, cars, medical insurance).
(d) Standardisation of benefits: Benefit schemes can be designed only for the average condition or for the average employee. They will, by definition, over-provide for some and under-provide for others. That over-provision can also arise from duplication where, for example, two different employers provide similar coverage for the same family (for example, medical insurance).
(e) Changing tax treatment: As tax laws change, the pre-tax equivalent of ‘total remuneration’ changes, particularly if inconsistent changes occur across various types of benefit. The employer has no control over tax changes but may end up paying for their impact if taxes, as happened in New Zealand, are imposed on the employer (as proxy) rather than directly on the employee (such as Fringe Benefit Tax).
(f) Obstacles to participation: Employee benefit schemes tend to be unfair, particularly those that require members to contribute (like KiwiSaver). These impose a contribution hurdle so that an element of compensation is available only to those who can afford to join or who think that hurdle is important enough to jump.
(g) Lack of relevance: Some employee benefit schemes are not relevant to an employee’s needs, so the price paid by the employer is wasted. An example is the provision of life insurance cover for a single employee with no dependants. In fact, the individual needs of employees cannot be accommodated in a single level of benefits, delivered in bulk to all employees.
(h) Collective agreements less important: ‘Collective’ employment agreements are much less common than previously. Union membership in New Zealand is now about 17.2% of employees in the workforce[3]and collective employment agreements apply to about 30% of the employed workforce.[4] The emphasis in New Zealand is now on the individual employment relationship. Traditional employee benefit schemes are difficult to adapt to individual relationships that potentially have an infinite variety. One employee can have a variety of arrangements with one or more employers.
(i) Poor fit with variable pay: Pay-related benefits do not fit neatly into a variable pay environment (for example performance-based pay such as commissions or profit-sharing). Artificial definitions of pay for benefit purposes are usually needed to limit the employer’s and employees’ exposure to risk and to preserve relativities. Variable pay is usually excluded from counting in a ‘defined benefit’ (DB) retirement savings scheme or turned into a notional number to reflect the difficulty.
(j) Lack of needs assessment: In the traditional ‘pay + benefits’ environment, the responsibility for designing and delivering benefits rests with the employer so employees tend not to assess their own needs. Adequacy of coverage tends either to be assumed by the employee or, at least, not questioned, especially when the employee is not required to contribute directly.
(k) Job mobility:Traditional employee benefit schemes tend to act as ‘golden handcuffs’ and to reward service rather than performance. They can create a positive disincentive to leaving, creating situations that suit neither the employee nor the employer. Examples here include the DB retirement savings scheme and medical insurance where the employee or a family member has an indifferent medical history. Benefits that depend on pay also restrict employment practices such as reduced responsibilities, part-time work and other ways of easing the transition from fulltime work to fulltime retirement, or independent contracting. Again, this potentially disadvantages both the employer and employee.
(l) Regressive compensation component: The annual value of deferred compensation conferred on older employees under a DB scheme is significantly greater than on otherwise equivalent younger employees. Two employees of different ages doing the same job on the same direct pay will receive very different ‘total remuneration’ because of the favour conferred by the DB scheme on the older employee. If employees understood this process, the employer would find it difficult to explain the different ‘total remunerations’. Fortunately for employers, most employees do not understand what is really happening.
(m) Other distortions: DB retirement saving schemes have other unintended consequences that are inherent in their design:
(i) Female retirees advantaged: Because a female pensioner is expected to live longer on average, a given retirement pension has a higher value when compared to the same pension payable to a male. That distortion extends to the annual accrual of entitlements during service.
(ii) Employees with dependants advantaged: If the pension entitlement carries with it an automatic continuing pension to a surviving spouse or partner, again the pension itself and the annual accrual of entitlements favour the partnered employee.
(iii) Star employees advantaged:Employees who have careers marked by rapid pay increases are favoured over those with lower rates of increases. An employer may want to retain and motivate the stars but if annual remuneration is the main retention tool, the employer might wonder why normally uncounted, retrospective increases in today’s remuneration are delivered through the DB scheme’s past service promises when benefits are based on pay near retirement.
(iv) Business risks to employer: Because the employer-sponsor of a DB scheme promises to deliver benefits at the end of long (but uncertain) periods of service and for long, uncertain periods in retirement, the employer exposes itself to uncontrollable business risks that will probably be alien to its normal operations. It acquires an investment management business with potentially large financial obligations if the returns are lower than required. A DB scheme also exposes the employer to an uninsurable inflation risk and to a numbingly complex regulatory environment. DB schemes can become an unacceptable risk of doing business[5].
In summary, a ‘pay + benefits’ strategy tends to be complex, inflexible, misunderstood, undervalued, inappropriate and unfair. Some of the problems are associated with just DB schemes; others with all subsidised retirement saving schemes, including defined contribution (DC) schemes like KiwiSaver; yet others derive from the inherently complicated nature of all collective saving vehicles and governments’ attempts to regulate their generosity (given their tax-favoured status) and their governance.
‘Total remuneration’ – an alternative approach
Employers need to get jobs done and to pay a price that is acceptable to employees. The two parties must agree on the total price and that may be a mixture of regular cash and an ‘at risk’ or variable amount that depends on performance.
Having agreed that price, the ‘total remuneration’ approach suggests there should be no restrictions on the way in which that price is delivered. It can be all cash or a mixture of cash and benefits as the employeechooses. In an extreme case, the price could be delivered entirely in benefits.
No employer subsidies
Unless an employer can establish a business case for a particular benefit programme[6], a general move to a ‘total remuneration’ environment will see the eventual disappearance of subsidised retirement saving schemes. If the government intervenes in this process (as with KiwiSaver and as in Australia with the compulsory SG Tier 2 retirement savings scheme), the committed ‘total remuneration’ employer should factor that forced contribution into its remuneration costs. Where, as with KiwiSaver, that forced cost applies only to members, employers should, as a matter of equity, allow for the compulsory employer contribution as part of ‘total remuneration’. We have more to say on this in the next section 14 (KiwiSaver in the new environment).
So, the employer fixes ‘total remuneration’ for a position and does not then impose any barrier in the delivery of the element that is delivered as a subsidy in a ‘pay + benefits’ environment.
Also, the employer will deliver that element to all employees, not just those who choose to join the scheme or who qualify to become a member after an eligibility period or other requirement has been satisfied.
Before the major tax changes to superannuation in the 1987-1990 period, membership of subsidised, occupational retirement saving schemes was low – only 22.6% of employees were ‘active’ members in 1990. That proportion fell as schemes closed in subsequent years. By 2003, only 13.9% were active members[7]. We should expect that number to fall further. Statistics New Zealand’s Household Net Worth Survey (accessible here) reports that, at 2015, the proportion of the whole population (not just employees nor those under age 65) with a ‘non-KiwiSaver’ scheme was just 8% but we do not know how that number relates to active, contributing, employed members.
Should employers still be involved?
In a ‘total remuneration’ environment, employees are responsible for making their own decisions about saving and insurance needs. Arguably, the employer has no direct interest in those decisions, just as the employer has no direct role or interest in the decisions the employees make about the houses they buy, the food they eat or the clothes they wear. Saving and insurance decisions are, or should be, personal and private.
However, employers have historically been involved in saving and insurance arrangements for employees and the reasons for that involvement may still be relevant in a ‘total remuneration’ environment. Both employers and governments have an interest in whether employees are, for example, saving ‘enough’ for retirement.
Here are some of those reasons:
(i) HR policies: When the employer wishes to move an employee on to a lesser role or even to terminate employment at an older age, an economic argument might encourage the employer to pay the employee to make the move. The cost of keeping the employee on might be otherwise higher than making the change now and paying the money. That HR need will not disappear in a ‘total remuneration’ environment but the employer must recognise such ad hocpayments are similar in character to the formal retirement saving scheme that is normally part of a ‘pay + benefits’ policy. One of the reasons that employers introduced subsidised retirement saving schemes was to formalise the retirement process and to make the termination or role-shifting easier to handle for both employees and the employer.
(ii) Purchasing power: In most cases, an employer can buy financial services in bulk at a considerable discount to the costs faced by individual employees. Even if the employer decides that employees should make their own decisions about saving and insurance, the employer can use its superior negotiating position to make those services available through group schemes and a payroll deduction facility.
(iii) Information/education: The employer can help to achieve its HR objective ((i) above) by actively informing employees about the long-term, financial implications of saving for retirement – helping them to make ‘appropriate’ decisions about spending their ‘total remuneration’. It will also help employees to understand what might happen if they do nothing so there are no surprises when the employee reaches retirement. That financial education may help the employer in its own business. We have more to say about improving mathematical competence in section 20 (Information and education) and on the potential role of employers in helping develop the financial literacy of their employees. As that section explains, we have no recent information on what employers as a whole are doing in this area or whether employers might be interesting in doing more.
Implications for public policy
Under historic ‘pay + benefits’ compensation strategies, the public policy focus was on employers and the retirement saving schemes they ran. That meant regulation of offers by employers and trustees, information provided by schemes, preservation of accrued entitlements and their eventual distribution (including on winding up those schemes). Those rules are necessarily (and increasingly) complex.
The ‘customers’ of public policy initiatives in a ‘total remuneration’ environment are the savers themselves. Everything the regulator does should focus on the needs of the savers to have appropriate information before committing to a saving programme, on joining, while a member and then on leaving. Some of that communication can be delivered through the employment relationship, given the employer’s potential HR objectives (see above) and, for the regulator, the much smaller number of employers.[8]
On ‘workplace’ superannuation schemes
In 2012, the Ministry of Business Innovation & Employment published the Financial Markets Conduct Regulations – Discussion Paper(accessible here). It was a 243-page document that, in summary, lay the groundwork for how the then-new Financial Markets Authority would administer financial markets – we have more to say about the FMA in section 18 (Disclosure – initial and ongoing).
The Retirement Policy and Research Centre made a submission on one aspect of that Discussion Paper[9]In summary, the Discussion Paper proposed to change the rules on occupational superannuation schemes by denying members’ access to their savings until they reached a retirement age. This was seemingly based on a view that ‘superannuation’ is (or should be) just about ‘retirement’. That ignored the fact that since the tax changes in 1987-1990, New Zealand (unlike all other countries) no longer had a regulatory stake in what occupational superannuation schemes’ main purpose should be. The then Superannuation Schemes Act 1989 (archive copy accessible here) still had a provision that defined a ‘superannuation scheme’ as being “…principally for the purpose of providing retirement benefits to beneficiaries who are natural persons… (section 2(1) – definitions). The 2012 Discussion Paper proposed, essentially, to define what ‘retirement’ meant and to say that a workplace scheme had to be about saving for ‘retirement’ and not about insurance.
In the end, the Discussion Paper’s recommendations were watered down in the Financial Markets Conduct Act 2013 so that a ‘workplace savings scheme’ can allow benefits to be paid to an employee “on leaving employment” (section 130(1)(b)(ii) accessible here). However, insurance benefits are permitted only if “they are incidental or secondary to the purposes of the scheme” (section 130(1)(c)(ii)). Saving provisions were included for then-existing ‘registered superannuation schemes’ that did not comply with the new rules.
Our point here is the same as was raised in the RPRC’s 2013 submission:
“We strongly oppose the proposal to change New Zealand’s regulatory requirements with respect to preservation of ‘superannuation’ benefits by restricting a saver’s access to their money when the vehicle is called a ‘superannuation scheme’. The Discussion Document does not provide justification for such a regulatory intrusion on members’ entitlements. There is indeed no such justification in the absence of tax incentives on the savings or unless saving for retirement becomes compulsory.”
The new rules introduced by the Financial Markets Conduct Act 2013 have caused significant disruption and now need to be unwound. If we really want to encourage employers to engage with their employees on issues covered in this report, we need to make the regulatory environment as friendly as possible. The legislation actively intervenes to discourage such engagement.
Terms of reference for 2019 Review
There was no mention in the Terms of Reference for the Retirement Commissioner’s 2019 Review of the issues associated with occupational superannuation schemes and the potential roles that employers might play in their employees’ retirement saving decisions. However, a ‘generous’ interpretation of the first Term of Reference might extend to a consideration of these issues.
“1. An assessment of the effectiveness of current retirement policies for financially vulnerable and low-income groups, and recommendations for any policies that could improve their retirementoutcomes.”
Whether or not the 2019 Review looks at the role of occupational superannuation schemes, someone will eventually need to address the following questions.
Questions New Zealand needs to discuss on occupational superannuation schemes:
Some of the following questions are connected to those in the next section 14 (KiwiSaver in the new environment) and also section 20 below (information and education):
What are employers currently doing about the retirement saving arrangements of their employees? The most recent, comprehensive information we have on this is a 2003 report prepared for the Periodic Report Group.[10]
How have employers reacted to the restrictions introduced for ‘workplace savings schemes’ by the Financial Markets Conduct Act 2013?
How many have a superannuation scheme, other than KiwiSaver, that is currently open to new entrants? What are its main provisions? How does the employer see the future of that scheme in a KiwiSaver environment?
What are employers’ attitudes to extending their present roles into information/education programmes?
What do employers think of KiwiSaver in relation to their own HR objectives? How many employers think that KiwiSaver as it is, will be all that they will do about their employees’ retirement saving needs?
How many employers have a ‘total remuneration’ policy, as opposed to ‘pay + benefits’? Of the ‘pay + benefits’ employers, how many have formally adopted that policy, as opposed to having it by default (by doing nothing)?
How many employers help employees with information and education on issues associated with saving for retirement? Might they think of doing more? Might those that have no involvement think of starting some kind of information/education programme?
[1]This section is based, in part on Michael Littlewood’s ‘Total compensation’: a new way of doing things, International HR Journal, Vol. 4/No.3, Fall 1995, 17-2
[2]KiwiSaver is, currently, a relatively modest exception to the TTE, tax-neutral treatment. There is an annual subsidy of up to $521 a year if the member alone saves at least twice that amount. Also, investment income in the KiwiSaver scheme is taxed on a more favourable basis than had the investment income been received directly. That applies to all superannuation schemes that are ‘Portfolio Investment Entities’ (PIEs). However, the Tax Working Group has suggested significant increases in the advantageous tax treatment of KiwiSaver – see section 9 (Tax subsidies for retirement saving) for more.
[3]Union membership return report 2017, New Zealand Companies Office, accessible here.
[4]Union membership and employment agreements – June 2016 quarter, Stats NZ, accessible here.
[5]The business risk explains the intervention of accountants in the disclosure requirements for employers’ annual accounts.
[6]For example, specialised medical insurance cover for travel to less-developed countries.
[7]Source: Report of the Government Actuary for the year ended 30 June 2006, accessible here at page 10.
[8]As of February 2016, there were 182,277 ‘business units’ with employees but 6,678 of them employed 45% of all employees - source, New Zealand Business Demographic Statistics, Statistics New Zealand (2016) accessible here. Even ‘addressing’ the 182,277 employers is more efficient than dealing with 2.1 million employees.
[9]Submission to the Ministry of Business Innovation & Employment on the Financial Markets Conduct Regulations – Discussion Paper, 12 December 2012 – the ‘problem’ with ‘superannuation’ by Michael Littlewood, February 2013, accessible here.
[10]Tier 2 Retirement Savings: Employers’ and Employees’ Attitudes and Practices, 2003 ESR Consortium accessible here. We were two of the three authors of that report.