Managing reward: Benefits
Section five of the Personnel Today Management Resources one stop guide on managing reward, covering benefits, including: benefits strategy; company cars; risk benefits; flexible benefits; voluntary benefits; and international perspectives. Other sections .
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Benefits strategy
Within the context of an organisation's overall reward strategy a distinct benefits strategy, philosophy or set of guiding principles is often neglected. Larger, and in particular global, companies will have a formal document entitled 'Global Benefit Guidelines' or similar, which creates a framework to guide design, implementation and ongoing management of benefit plans. Guidelines will include statements of principle such as:
The organisation's target market positioning (eg, median against a comparator group of companies within that sector)
Preferred approach to pension provision (eg, DB/DC/Hybrid)
Favoured financing methods (insurance, book reserves etc)
Default approach to actuarial valuations (eg, timing and valuation method)
Minimum levels of benefit provision (eg, for life assurance cover even where market practice would not dictate death benefits)
Integration with social security and statutory benefits
Principles to be followed when managing international transfers (eg, continuous service for vesting purposes)
Preferred provider relationships (eg, employee benefit consultants or multinational pooling partners).
Regardless of the organisation's benefits strategy, or absence of it, there is a consistent pattern across the world of benefits expenditure not being valued by employees in proportion to the cost to the company. Worldwide this is resulting in a spectrum of different responses from employers. Some re-double their efforts to communicate benefit plans better (eg, through benefit statements, on-line information, e-HR solutions) while others are reducing benefit spend and either lowering total employment expense or diverting it to other focus areas such as variable pay or offsetting the ever growing expense of defined benefit pension plans.
Company Cars
The widespread provision of company cars reflects, in large part, the legacy of a UK tax system which, until 10 years ago, made company car provision much more tax-efficient than the net cash benefit of additional salary. Financial incentives were compounded by a UK business culture historically more hierarchical and status orientated than the one which appears to prevail in the UK in the early years of the 21st century. However, since 1994, company car taxation has become increasingly more punitive - first by moving to a tax charge based on list price and business miles travelled, and then, in 2002, to a system based on list price and CO2 emission levels. By far the most biting tax changes have been in the taxation of company funded fuel for private purposes. These changes have coincided with a period in which business hierarchies have continued to flatten out and a more flexible approach to benefit provision is being adopted.
Definitions
Business or job need cars: the description commonly given to those cars which are provided to employees because there is a clear business requirement - typically high business mileage incurred in the performance of job duties. A good example would be a sales representative who has to travel nationally or within a particular region to visit customers. Company vehicles such as vans (eg, a service engineer who has exclusive use of a van or light truck for the performance of their duties) would not normally be covered by the job need company car policy, although a modest tax charge is payable if the employee is permitted to use the vehicle to travel to and from home.
Status or perk cars: these are cars provided to managers, professionals and executives where market practice rather than job need is the key consideration. A proportion of status drivers would qualify for a business need car on the basis of miles travelled but the primary consideration is the status of the driver, usually determined by an internal grading system, market practice or a salary threshold. Despite common misconceptions, the tax system introduced in 2002 makes no differentiation between those who drive business need verses status cars.
Private Fuel: a declining, but nevertheless significant, proportion of organisations provide drivers with free fuel for private motoring. This may be by means of expense reimbursement or by issuing a fuel card such as the PHH AllStar card (which is accepted at most garages throughout the UK). The extension of national insurance contributions to this previously exempt benefit during the 1990s plus the rapid increase, (well above the rate of inflation), in the taxation of company funded private fuel has made the provision of this benefit disadvantageous, except for those who incur exceptionally high levels of private motoring expense. In many instances the tax treatment of this benefit has become so excessive that it is beneficial to company car drivers simply to hand-in their fuel card rather than incur the scale charge. This is influenced by the fact that the tax charge is identical whether someone receives payment from their employer for 20 or 20,000 private miles.
Pool Cars: are vehicles which are generally available to employees on a shared basis, eg, to make business trips. They are usually exempt from a benefit in kind tax charge because there is no personal gain or benefit tied to a particular individual driver. Key tests of whether a car is a pool vehicle would be whether the employee has the (exclusive) right to call on the use of the car and whether private motoring is permitted.
Car Ownership Schemes: one of the responses employers have been making to the recent changes in the tax system is to explore more creative forms of car acquisition, leasing or fleet management. A company car lease taken out in the name of the employee rather than the company can be a more tax efficient and lower cost approach than traditional corporate lease rental/contract hire arrangements or the purchasing of cars.
Such personal contract car ownership schemes can take on various forms including credit sale agreements and tax-free loans structured in a way to deliver tax efficiency to the individual (eg, they can be designed in a manner which avoids a benefit-in-kind tax charge) and at overall lower financing costs to the company. Such arrangements can be quite complex and are often initiated by a company's finance director or purchasing department.
Company car taxation
Details of company car taxation may be found on the Inland Revenue's website www.inlandrevenue.gov.uk or, to calculate the tax charge of a particular vehicle, the Society of Motor Manufacturers and Traders provide a free straightforward tax calculator at www.smmt.co.uk
The formula for computing a tax charge is simply the list price of the vehicle times a percentage linked directly to the CO2 emission level (grams per km). The company car tax charge is then reported in Form P11D and the employees tax code is adjusted accordingly to ensure that tax is recovered through the PAYE system. An example calculation for a car with a 180g emission level and an £18,000 list price is shown below:
180g CO2 emission level = Tax charge of 20% of list price
£18,000 x 0.20 = £3600 pa benefit in kind charge
For a basic rate (22%) tax payer the income tax payable will be £792 pa (ie, £3,600 x 0.22) and for a higher rate tax payer the income tax payable will be £1440 pa (ie, £3,600 x 0.40). In addition, national insurance contributions will normally be payable.
Car Fuel Taxation
Following the 2002 Budget, company car drivers who receive free fuel for private motoring now incur a benefit in kind tax charge based on fuel emissions and a set figure for the year, currently £14,400. Like the company car benefit assessment the fuel benefit is based on a range between 15-35 per cent with supplements for diesels that do not meet European emission standards and reductions for alternative fuels.
For example: a car which has CO2 emissions of 195g/km incurs a tax charge of 25% in 2004/05 so the benefit in kind charge is £14,400 x 0.25 = £3,600.
If an organisation does not provide free fuel then expenses will be reimbursed, often at the Inland Revenue's Fixed Profit Car Scheme (FPCS) rates, shown below. These are the current maximum rates that can paid without a benefit in kind liability arising.
In the case of employees in receipt of a cash alternative the reimbursement rate is usually reduced to the Inland Revenue's advisory rates per mile.
Car Allocation Policy
To become entitled to a 'status' car an employee will normally need to cross a salary threshold or reach a minimum job level or grade. Once entitled, the car allocated or cars from which an employee can choose will ordinarily be defined by grade groups or job level categories. Behinds these categories, grades or levels (and often unseen to the employee) will be monthly lease costs or list prices which define the parameters of entitlement. An example is shown below.
When designing an allocation policy it is vitally important that an underlying cost factor such as list price or monthly lease cost is used to inform which cars are offered in each entitled group. For example, manufacturers will periodically revise their costs (eg, launch of a new model may result in discounting of a mark being taken out of production) and such changes will need to be reflected in a dynamic allocation policy if the organisation seeks to maintain a constant cost structure. There may be other factors also which need to be taken into account, such as insurance risk. For this very reason many organisations will not permit 'soft-tops' in their entitlement tables.
Another means of managing fleet costs is to offer flexibility by allowing employees to trade-up or trade down. In application, an employee will have an entitlement to a certain type or price of car but will be permitted to take a higher specification car in return for an employee contribution, either in the form of a lump sum capital contribution or more normally a monthly sum collected by payroll deduction. In reverse an employee who chooses to trade down would receive a monthly salary supplement.
In addition to trading up and trading down the more widespread practice is to offer a cash alternative paid as a non-pensionable annual cash allowance. The tax and National Insurance treatment of a car cash allowance is identical to that applicable to salary. However, for employees who are not prepared to pay the benefit in kind charge or who are inclined to purchase their own used car rather than a new company provided vehicle, the economic benefit of a cash alternative is persuasive.
Market Practice
Authoritative market data can be sourced from www.monkspartnership.co.uk or www.irseclipse.co.uk. However, for general guidance on UK market practice see the table .
Risk benefits
Risk benefits is the generic title given to those, usually insured, benefit plans which give employees and their dependants a measure of financial protection against the contingencies or "risks" of life. The main forms of risk benefit plan are described below:
Life cover: the organisation will typically provide to the employee's estate a lump sum death benefit expressed as a percentage of salary. This may or may not be tied to the employee's participation in an occupational pension plan. Normally life cover will be via a group life contract and can be paid free of tax to a nominated beneficiary, subject to the approval of the pension fund trustees when bundled with a pension. For those in final salary schemes the benchmark standard was to provide a death benefit equal to four times pensionable salary. As the incidence of final salary (defined benefit) pension plans has declined so too has the average multiple of salary death benefit. The cost of life cover to the company is highly influenced by the age profile of the workforce and the nature of the industry sector. As with all forms of insurance, the higher the risk profile, the higher the premium.
Medical benefit plans: provide employees with access to private health care in line with a tariff of benefits agreed between the company and the medical benefits plan provider. In practice a broker or employee benefits consultant often acts as intermediary advising the company on the most appropriate plan design. Although Bupa and Axa PPP are the best known healthcare plan providers there are in fact a large number of organisations creating a competitive market, both in terms in of pricing and service levels. The plan may operate as straightforward insurance or in larger company schemes is priced on a 'cost plus' basis, ie, last year's claims fund plus a per member administration charge. Employees are sometimes asked to pay the first £50 or £100 of a claim, just like an excess on a motor insurance or home insurance policy. This is a decision for the employer, as a possible feature of plan design.
Permanent Health Insurance (PHI): sometimes termed a long-term disability (LTD) or income protection plan. These plans replace a proportion of salary in the event of long-term disability, although the benefit payments will usually be contingent on strict definitions and medical evidence. Plans replacing between 50-75 per cent of salary are commonplace, especially at management and executive levels or certain sectors such as financial services and IT. For those in final salary pension plans the benefit may be 'self-insured' and paid in the form of an ill health early retirement pension. State benefit (incapacity benefit) is generally offset from the amount paid by the PHI plan.
Critical illness cover: this is a benefit plan designed to pay out a cash amount in the event of serious illness. In effect it is a lower cost lump sum version of PHI and is becoming an increasingly popular benefit stimulated by the decline of final salary pension plans and the relative expense (and limited appreciation by most employees) of PHI plans.
Flexible benefits
A flexible benefits plan provides employees with choice over the mix of cash and benefits they receive. Each employee is provided with a benefit allowance with which they can purchase the company sponsored benefit plans which best suit their personal preferences, lifestyle and family status. These factors will change over time, eg, due to promotion and the flex plan invites employees to make selections, either annually or upon a life event such as marriage or the birth of a child. As well as permitting the mass customisation of benefits tailored to personal need, flexible benefits improve the communication of the value of employer funded benefit plans and can be an important building block creating or reinforcing the employer brand.
It is highly exceptional for an organisation to offer complete flexibility, instead permitting employees to exercise choice over and above a core (ie, minimum) level of benefits. Core benefits would normally be a minimum level of life cover, pension, holidays (the UK statutory minimum applies anyway) and perhaps some form of medical or disability cover. These core benefits tend to be irreducible:
i) because the employer will, perhaps for reasons of paternalism, want to protect employees against the contingencies of life and/or
ii) such restrictions protect the business from future risk (ie, employees later complaining that the company encouraged them to make inappropriate choices).
Above and beyond core benefits the items which are commonly included in a flex plan are:
Pension contribution levels or contracting-out plans
Company cars and private fuel
Holidays
Tax and financial advice (usually confined to executives)
Life cover (above core level)
Dependant benefits (eg, spouse's pension)
Medical benefits/health care cash plan
Dental/optical benefits
Critical illness/disability plan
Luncheon vouchers
Health screening
Childcare facilities/vouchers
Introducing a flex plan is a major project and requires extensive planning and project management, often with the assistance of reward management consultants and/or tax advisers and plan administrators. Although the market is highly underdeveloped currently and only one in eight companies (CIPD Reward Management Survey) claim to operate any form of flex plan a number of high quality flexible benefit solutions are coming to market in response to the rapidly increasing demand. In this developing market it is possible to pay £15-£100 per employee pa, for flex administration with only a loose correlation between price and quality. An important precursor to the development of a flex plan is a feasibility study, best undertaken by a consultant with in-depth knowledge of the provider market.
Voluntary Benefits
Whereas a flexible benefits plan is populated by benefits which are financed by the employer, a voluntary benefits plan is usually introduced at nil or low cost to the company. Voluntary benefits are lifestyle benefits covering retail, leisure, health and financial services. The employer may brand a voluntary benefits plan or limit involvement to that of 'introducer', providing access to a wider range of benefits at discounts to normal retail price. In the past employers would negotiate with individual suppliers, eg, using their group purchasing power to secure for staff discount annual travel insurance. However, it has become increasingly popular to enter a relationship with one of the growing number of packaged voluntary benefit plan providers. The advantages of this approach are that is accelerates the launch of a voluntary benefits plan, removes the need to negotiate with individual suppliers and broadens the spectrum of benefits which can be made readily available to employees.
The items included in a voluntary benefits plan might include:
Personal lease/ car purchase
Tax and financial advice
Home and car insurance
Personal computers
Retail/ leisure vouchers
Discount health club membership
Annual travel insurance
Bicycle purchase
Package holiday/ travel discounts
Concierge services
Preferential loans/mortgages
Savings plans
Breakdown cover (AA, RAC, etc)
Personal accident/ critical illness insurance
A high proportion of voluntary benefit plan providers have designed their offering as a distribution channel for the sale of insurance and financial products. They are able to offer access to a portfolio of voluntary benefits at nil cost because they are making their profit margin in the sale of their financial products. It is, therefore, important for employers to recognise the risks associated with acting as an introducer of financial services products, as well as the benefits of a voluntary plan.
International perspectives
The UK is unusual in the importance attached to company cars. While market practice in many other countries is to offer job need, perk cars or executive leave vehicle programmes, probably only South Africa offers cars more extensively than the UK.
In mainland Europe a high proportion of risk benefits are provided via the social security system or collective labour agreements, not individual plans.
Worldwide, medical benefit plans continue to face pressure from medical inflation running significantly ahead of CPI. Many employers are responding by transferring more of the burden of healthcare costs to employees.
Traditional flexible benefit plans in the US tend to be 'health and welfare' plans focused on medical and dental expenses, life and disability, in contrast to UK plans characterised by a wider range of flex items. Added to this, modest levels of vacation and the absence of company cars in the US limits liquidity, ie, fewer benefits available to be converted into cash.
The tax system distorts benefits provision. For example, in India there was a proliferation of benefits in areas where tax concessions made benefit provision more efficient than salary. This is changing, but tax systems do continue to promote benefits which are expensive to administer.
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Source: Monks
Partnership |
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Feasibility study and business case Plan design and provider selection Tax, NI, pensions and employment law Management and administration Piloting and implementation Branding and communication |
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Grade level |
Car entitlement |
List price |
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1 |
BMW series 7 Mercedes E class Jaguar S type |
£30,000-£50,000 |
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2 |
BMW series 5 Mercedes C class Saab 9-3 |
£20,000-£30,000 |
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3 |
Vauxhall Vectra Ford Mondeo Peugeot 407 |
£14,000-£20,000 |
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Section two: Job evaluation and grading Section three: Base pay and salary structures Section five: Benefit plans Section eight: International assignments Section ten: Resources/ jargon buster
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