Integration

Almost two-fifths of all private sector final salary schemes are designed to take account of State retirement benefits, a process known as 'integration'. The most common form of integration is a deduction from pay to calculate pensionable pay which has the effect of reducing contributions and benefits.

Integration is unpopular with many members because it gives them less pension than they might expect to get.  

Integration can substantially reduce pension costs for the employer and, in contributory schemes, the employee. 

It is an important and frequently controversial aspect of benefit design since it disproportionately affects lower paid scheme members.  During 1998 a trade union 'Abolish Clawback' campaign was launched, seeking to persuade employers to remove integration factors.

How Does Integration Work?

The usual way of applying integration is to have a disregard also known as offset, reduction, abatement or deduction in the definition of pensionable earnings.

In most cases, an amount equivalent to the current value of the Lower Earnings Limit  for National Insurance purposes is deducted in the pensionable earnings definition.  This reduced amount of earnings is then used to calculate employee contributions and benefits.

Another common method is to deduct an amount equal to the current value of the single person's Basic State Pension

Unfair Practice?

Integration is frequently a controversial aspect of benefit design since it disproportionately affects lower paid scheme members.

A flat rate deduction clearly has a greater effect, in proportionate terms, on a low pension than on a high pension.  Integration can therefore be considered to be an unfair practice because not every member can expect to get proportionately the same pension as other members with identical service but different earnings.

Is It Legal?

There has been debate about the legality of integration for some years.  This arises out of the fact that in some schemes it can be demonstrated  that integration amounts to indirect sex discrimination, as it has a greater impact on women’s pensions than men’s pensions as women tend to be over-represented in lower paid jobs.  However following the High Court decision in Shillcock, pension schemes may now deduct the Lower Earnings Limit (LEL) to calculate pensionable salary, for periods before 1 July 2000.

For periods after this the Part Time Workers Regulations mean that part timers should not be treated less favourably than full timers for benefits and so any integration factor should be pro-rated for part timers.

Winners and Losers

Removing integration costs money. Usually removal/reduction or integration takes place as part of the disposal of a surplus following an actuarial valuation.  Unless there is a valuation surplus or the employers are willing to see their overall labour costs rise, it would need to be paid for by a reduction in some other part of the remuneration package, the most likely being the pension scheme itself, ie a re-structuring of the contribution/benefit design.

For example, the cost of removing a disregard equal to the Basic State Pension for future service could be met by cutting back the accrual rate from, say, 1/60th to 1/70th.  The result of such a change would ultimately be that on average the same pensions would be paid as before the abolition of integration, the difference being that the lower paid members would get bigger pensions and the higher paid would get smaller pensions.  Everyone would get a fairer amount of pensions but there would be losers as well as winners.  The winners would generally be the lower paid and the losers the higher paid.

Possible Steps to Change Integration Short of Outright Removal

In the case of part-time employees, change the disregard so that it is pro-rata as their actual hours compared to the number of full-time hours.

Only remove for future service, not past service.

Phase out the disregard over time, by freezing the amount or reducing in steps, say from Lower Earnings Level to 50% Lower Earnings Level.  

Capping disregard in relation to overall pay, eg the disregard continues to apply but will never be more than 15% of the member's salary.

Have the disregard variable and related to actual salary eg 10% of pay.

Apply the disregard only from State pension age instead of from retirement.

Phasing out integration may be preferable for employers (and members) to avoid an immediate hike in contributions.

There are other changes that could be introduced to integrated schemes, short of outright removal, to remove the unfairness for low paid/part-time employees.

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© 2003 (USDAW) Union of Shop, Distributive and Allied Workers
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