SuperLife

Role of superannuation in a total cost enviroment

 

Central to any organisation’s people policies is the way it remunerates its employees. In the current environment, what should be the role of superannuation in the employer’s remuneration policy?

Contents of the article:

  1. Introduction
  2. Remuneration aproaches
  3. Historical practice 
  4. Superannuation in a total cost environment
  5. Adding value
  6. Business advantages - medical insurance, death cover, disability income, retirement savings, KiwiSaver
  7. Conclusion


1. Introduction

While it sounds a bit trite, the “people” policies and objectives of an employer have to aim to recruit good people, retain and motivate them, and then ultimately facilitate their exit from the organisation. 

To be competitive today, an employer has to achieve these goals with the same or lower cost, and/or higher productivity, than that achieved by its competitors. 

Central to any organisation’s people policies is the way it remunerates its employees.  In the current environment, “what should be the role of superannuation in the employer’s remuneration policy”?

Questions from a business perspective...

  • What do you do when an employee dies and leaves a dependent family with no income?
  • What do you do when an employee gets sick, and needs an operation, and the public waiting list is six months?
  • How do you exit an employee that is disabled through ill health and can’t work?
  • What do you do when an employee gets to retirement after a significant period of service and has no savings? 

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2. Remuneration approaches

First, let’s understand remuneration policies.  There are two basic remuneration philosophies that can achieve the people objectives for an organisation: “total cost” and “pay + benefits”.  Both can be equally appropriate, but in different circumstances.

Under a total cost approach, an employer agrees the total value of an employee’s package, and pays it as salary or a combination of salary and benefits.  Any amount taken or provided as a benefit, including any associated taxation costs, is deducted from the total package, before the payment of the residual as salary is made.

In contrast, under the pay + benefits approach, the benefits are provided on top of the salary (pay).  In some cases the benefits are automatic.  In other cases they are voluntary.  In cases of voluntary benefits, if employees don’t take them (e.g. they don’t join the superannuation plan) they don’t get additional salary in lieu.  The benefits in this context should therefore be designed to meet or achieve a business purpose.

Separate to the total cost, or pay + benefits philosophy debate, is the issue of what portion of remuneration should be “at risk” and subject to performance criteria, and what portion should be the base entitlement.  Again, there is no single answer but performance pay applies equally well under both total cost and pay + benefits philosophies and need not favour one approach or the other.

3. Historical practice

Historically (pre KiwiSaver), many employers adopted the “pay + benefits” approach to remuneration, where the major “benefit” was subsidised superannuation.  This, more often than not, arose because of tax considerations, and/or a paternalistic philosophy. 

However, in some cases, it also arose because it was consistent with the employer’s culture and business needs at the time.

Today, without tax considerations influencing the decisions, with consumerism creating greater demands on a person’s pay, and with changing career patterns, the traditional superannuation plan is viewed as less relevant for many employers and employees. 

For this reason, the philosophy of “pay + benefits” has largely been replaced by a philosophy that places the decision in the employee’s hands.

The last decade has been a period that has seen, more and more employers using the “total cost” approach.  A total cost approach does not however mean no superannuation.  

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4. Superannuation in a total cost environment

Under a total cost approach, the employer defines the total value of an employee’s remuneration package (let’s call it “$X”).

Having determined the total value of the employee’s remuneration ($X), our “total cost” employer should be indifferent whether the employee wishes to pay off debt, have an overseas holiday, meets a child’s education costs or save for retirement.  An employer need only be concerned where the future consequence of a poor decision might fall back on the employer.  This is when the employer is faced with the so called “moral dilemma” of helping employees in times of severe financial hardship.

Under a total cost approach therefore, subsidised superannuation, or employee benefits in general, should only be part of the remuneration policy if it can also contribute to the overall “people” policies of the employer.  If it doesn’t, then it is a less efficient form of remuneration, and an employer will not get back at least a dollar’s value for each dollar spent. 

In the absence of significant tax incentives or compulsion, superannuation must either deliver value, or meet a specific business need.  

5. Adding value

Under a total cost approach, the employer defines the total value of an employee’s remuneration package (let’s call it “$X”).

Having determined the total value of the employee’s remuneration ($X), our “total cost” employer should be indifferent whether the employee wishes to pay off debt, have an overseas holiday, meets a child’s education costs or save for retirement.  An employer need only be concerned where the future consequence of a poor decision might fall back on the employer.  This is when the employer is faced with the so called “moral dilemma” of helping employees in times of severe financial hardship.

Under a total cost approach therefore, subsidised superannuation, or employee benefits in general, should only be part of the remuneration policy if it can also contribute to the overall “people” policies of the employer.  If it doesn’t, then it is a less efficient form of remuneration, and an employer will not get back at least a dollar’s value for each dollar spent. 

In the absence of significant tax incentives or compulsion, superannuation must either deliver value, or meet a specific business need.  

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6. Business advantages

In each of the key benefit areas, there are some circumstances where a subsidy can be supported even in a total cost approach.  This is where there is a clear business benefit to the employer that is greater than the cost of subsidy.  Let’s look at some specific examples where the business case for a subsidy can be justified in a total cost environment.

Medical insurance

To operate effectively, an employer needs healthy employees.  In some cases an employer will therefore benefit by its employees having medical insurance.  For example, employees with medical insurance tend to seek medical help earlier on in an illness.  They

therefore return to work sooner, i.e. are off work for a shorter period of time.  The cost of any subsidy could result in lower employment costs.

If education and the lower costs from group purchase do not encourage all employees to buy medical insurance, there may be advantages in offering a subsidy (e.g. $100, or meeting the administration costs, or paying 50% of the premium etc.) to further encourage employees, and to ensure the business “need” is achieved.

Voluntary extension of this cover through cheaper bulk buying rates, to the employee’s family, reinforces the message to the family, that the employer is concerned about their well being.

Many employees view this benefit as being of high value as the immediacy of recovery of cost is tangible and the comfort they derive from knowing they can protect their children is very real to them.

Death cover

It is often a difficult time for an employer when an employee dies and has made no provision for his/her dependants.  A universal but low level death/disablement cover (e.g. 1 times pay) therefore, might also fit into the “benefit the business” category.  This is often peace-of-mind insurance for the employer, and can create a significant goodwill factor with employees at a relatively low cost.  Death cover tends to have a high perceived value.

Disability income

Disability income insurance is another benefit that offers a possible employment advantage.

If an employee is disabled (particularly through sickness), it helps the employer to exit the employee with dignity, if a disability income benefit is available.

There are several ways an employer could encourage employees to take out disability income cover.  The obvious way is to pay all or part of the premium.  However, it may be better to treat disability income insurance as an extension of the employer’s sick leave policy.  Traditional “waiting periods” for disability income insurance are 1, 3 or 6 months.  If the employer allowed a maximum of three month’s sick leave to accumulate the insurance cover can run from the end of that.

Everyone then knows where they stand.  It deals, in advance with what is likely to be a stressful situation.  The cost of the premiums can be compared to the cost of management time and the costs of any severance pay that might otherwise be incurred in exiting a sick employee.

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Retirement savings

For many employers, the issue of subsidising an employee’s retirement savings can create as many potential problems as it does solutions.  Student debt, growing mortgage commitments, child education etc. place significant demands on the allocation of an employees disposable income.  To pre-determine how an employee should invest, whether by debt reduction or savings, can potentially create a barrier to employment (unless a subsidy places a total cost above the market and is viewed as a “bonus” of employment).

However, there is a growing concern that the capacity or capability of employees to save for retirement is not high.  This concern is emotionally emphasised by publicity about the ability of Government to meet the retirement income needs of the elderly.  An employer may, in this environment, gain some value by encouraging employees to save.

Consideration could be given therefore, to meeting the administration fee of a wholesale product.  Such products enable employees to more easily save through having payroll deductions and by having a ready made and relatively uncomplicated set of investment products to choose from.  The greatest barrier to saving, is the complexity of savings products and the wide range available.

If an employer is prepared to incur some costs in this area, the money might be usefully directed to education.  Running regular, independent financial seminars for employees, has the potential of achieving a better pay back than the alternative, i.e. meeting administration costs or directly subsidising contributions.

KiwiSaver

Separate to the wider issue of retirement savings is the issue of KiwiSaver.  With KiwiSaver, an employer needs to decide on whether they incorporate the employer contribution into an employee’s remuneration or treat it as a compliance cost on top.  For many employers there will be advantages in integrating it with a wider superannuation policy and creating a “superannuation component” to an employee’s remuneration.

7. Conclusion

Whether or not an employer should provide medical, death cover, disability income or subsidised savings is an individual decision and may be driven by non-financial considerations.  There will be clear business advantages in some cases but not all.  What is important is that a dollar spent on benefits adds at least a dollar’s value to the employer’s position.

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