CIPD - Flexible benefits

Pay and reward

Revised June 2009

This factsheet:

reviews the advantages and disadvantages of flexible benefits schemes
considers how a scheme should be organised and communicated
look at the benefits that might be included
gives the CIPD viewpoint.

The basics

Many organisations have always allowed a limited form of flexibility for just one or two benefits, but it is only within the last five years that comprehensive flexible benefits schemes have started to become more common in the UK. Although generally welcomed both by employers and employees, flexible benefits schemes have often been avoided because of the cost of introducing and administering them. Our 2008 reward management survey finds that just over one in ten employers were using this type of reward with flexible benefits generally only evident in organisations with over 5,000 employees and within the private sector. This year’s survey predicts that a further 12% of employers will be adopting a flexible benefits plan within the next 12 months, though again, it is typically larger, private sector employers.

See our latest Reward management survey

Flexible benefits schemes (also known as 'cafeteria benefits' or 'flex plans') are formalised systems that allow employees to vary their pay and benefits package in order to satisfy their personal requirements. They are not the same as voluntary benefits schemes (where employers arrange bulk discounts with external providers) or net pay schemes (where employees pay for extra benefits), both of which have been used for several years. Under true flexible benefits schemes, the dividing line between pay and benefits becomes less rigid than in standard reward packages.

In most schemes, employees are able either to retain their existing salary and simply vary the levels of benefits within their allowance, or else to adjust their salary up or down by taking fewer or more benefits respectively.

Why introduce flexible benefits?

Organisations generally decide to introduce flexible benefits schemes as part of a wider move towards a more flexible working environment. Such a scheme will also increase the perceived value of the reward package offered to employees, at no additional cost to the organisation.

Advantages of flexible benefits schemes

Employees choose benefits to meet their needs, and value these benefits more highly.
Employers and employees share the responsibility for providing benefits.
During periods of change (including merger and acquisitions), flexible benefits can help to harmonise rewards.
Employers provide benefits at a known cost that is fixed regardless of the choices that employees make., so allowing them to cap future benefit costs.
Employees have a true idea of the full worth of the benefits package they receive and employers do not provide benefits that are not valued.
Employees are given a sense of control and involvement by having a choice.
Dual career couples avoid having benefits duplicated by their respective employers.
Employers are seen to be more responsive to the needs of an increasingly diverse, demanding and ageing workforce.
A competitive benefits package is valuable in attracting and retaining key personnel.
The awarding of benefits such as company cars becomes less divisive.
Employers' demands for flexible working practices are more justifiable if employees enjoy flexible benefits.
Helps to align the total reward strategy to the HR and business strategies.

Disadvantages of flexible benefits schemes

Employers find them complex and expensive to set up and maintain (although new technology is reducing both the cost and administrative burden).
The choices made may cause problems both to employers and employees (see below under 'Deciding on the amount of flexibility').

Defining the strategy

Before drawing up a flexible benefits plan, it is important to consider fully the reasons for adopting this approach. If, because of the nature of the organisation, only a limited amount of flexibility is possible, then it may be better to save the time and expense of introducing a full flexible benefits scheme and instead consider a more limited approach. This might include allowing cash alternatives to company cars, or giving employees the ability to buy or sell holiday. Alternatively, it may consider total reward benefit statements or. voluntary benefits. For more information on voluntary benefits, see our factsheet on that topic.

Go to our Voluntary benefits factsheet

Any new scheme should be considered within the context of the existing reward strategy and should assess the motivational as well as the financial value of both current and future benefits. Typically it will take at least 12 months to design, implement and communicate a flexible benefits plan.

Organising the scheme

Most flexible benefits schemes are initially based on the existing benefits provision which is used to construct a new package. Certain benefits, such as sick pay and maternity benefit, ought to remain outside the scheme. Some employers also prefer to exclude pensions from flexible benefits.

The employee is given a benefit allowance and a list of available benefits. Employees are advised of the current level of their benefits and 'cost' of buying or selling these to suit their individual needs. There is typically a limit set on how much of the salary can be used to buy extra benefits and equally there is a baseline of benefits that must be kept and therefore to the extra salary that can be obtained by selling benefits.

Cash or points?

Some schemes show each of the benefits with a cash value and the employee uses this as the basis for calculating the effect of changes. The advantage of showing a cash value is that it gives employees an idea of what the benefit is truly worth and the cost that the employer is bearing. The danger of a cash system is that it may encourage employees to feel that they are being forced to buy benefits out of their own salary. Other schemes use a points plan, where each benefit has a points rating and the employee has an allowance of a certain number of points.

Regardless of whether a points or a cash value scheme is used, all schemes make a clear distinction between notional salary and the final value of salary that is actually paid in the year (regardless of whether this is higher or lower than the notional salary). The notional salary continues to be used as the basis for items such as pension calculations and salary reviews.

Deciding on the amount of flexibility

When schemes are being introduced, it is important to estimate the likely take-up of specific benefits. This will enable employers to obtain the most accurate possible quotations for the provision of each benefit. One problem associated with the introduction of flexible benefits is that the process of making selections actually changes the profile of the group requiring a particular benefit.

All schemes are costed on the basis of predicted selections; where employees make significantly different choices, these are regarded as 'adverse selections'. For the success of the scheme, the relative values of the benefits should be set so as to avoid too many adverse selections. They should also be arranged such that employees are not encouraged to make imprudent selections that will jeopardise their own security provision. The inclusion of core benefits guarantees a minimum level of protection. There must be a compromise between excessive flexibility that encourages inappropriate choices and too narrow a choice that does not meet the employees' expectations.

Before implementing a flexible benefits scheme organisations may find it worthwhile to survey their employees as to the type of benefits they favour and value. This would also assist in maximising the value of the package to both employer and employee.

Choosing and changing benefits

Once the scheme has been agreed, the choice of benefits is presented to the employees. To ensure a positive reception, it is important that the choices (and the implications of those choices) are clear. If the options are too complicated, or the method of making the choices is perceived as being difficult, then employees will simply default to their existing benefits package and much of the time and money spent in introducing the scheme will have been wasted.

Many of the computerised systems that are used for administering such schemes include an option that allows employees to model their own choices. Various selections can be made until the employee is satisfied with the outcome.

Most schemes allow for changes in benefit selection to be made by a fixed date, once a year. Prior to this date, employees are sent a personalised document reminding them of their current selection and benefit allowance for the forthcoming year, and giving them the opportunity to amend the selection. It is important that this document is simple to use with the costs of the options laid out clearly. If the document is not returned by the specified date, the benefit package will typically remain at the previous levels or default to a standard package. Organisations should consider how to deal with those staff who will be off work during the selection period, for example on maternity leave, on extended holiday or secondment.

Schemes may restrict the amount of change between one year and the next. Typically if there are several levels of available benefit, employees may only alter benefit by one level at each renewal. In addition, benefits (such as life assurance) for a spouse or partner may not exceed those for the employee.

Although reviews take place annually, most organisations will allow changes to be made to the selection outside the normal renewal dates in exceptional circumstances. These typically include:

marriage or divorce
birth or adoption of a child
death of a dependant
long-term sickness absence
promotion.

Who should be included in the scheme?

Early schemes were often only for senior employees (because they received more benefits and also represented a small proportion of the workforce), but this tended to be divisive. Many companies who have flexible benefits schemes now offer them to all permanent employees. If the wider workforce is to be included in the scheme, it is important that any pilot should be based on a representative sample of the final spread.

Tax and National Insurance implications

The tax situation for benefits is complex and collection methods vary between organisations. Some benefits (such as life assurance) attract no tax whereas others are regarded as benefit in kind and are taxed accordingly. Depending on the arrangements that an employer has made with the Inland Revenue, these benefits may be taxed at source, through an amended tax code or through the end-of-year P11D. It is important that the tax implications of any selections are made clear to employees.

Contents of flexible benefits schemes

Although there is no such thing as a typical flexible benefits scheme, there are certain benefits that appear in most. Many schemes differentiate between core benefits, some parts of which are financed by the employer, and voluntary benefits, which are paid for by the employee. The core benefits are those that a best-practice employer might be expected to provide and which, though the employee might adjust them, may not be entirely removed from the package.

Core benefits in a typical scheme

The contents of any scheme depend on local circumstances, but core benefits that appear on many schemes are:

holidays
life assurance
private medical insurance
critical illness insurance / long-term disability insurance
personal accident insurance.

Other benefits that may be included

The number (and type) of benefits in a scheme is a compromise between offering employees a wide choice and keeping the administration manageable. According to our latest reward management survey, other than pensions, the most common benefits that appear in existing schemes include:

dental insurance (9%)
childcare vouchers (6%)
critical illness insurance (5%)
cycle to work scheme (5%)
health screening (5%)
private medical insurance (5%)
healthcare cash plans (4%)
permanent health insurance (3%)
life assurance (3%)
gym (2%)

Communication and education

The most important elements in ensuring the success of a flexible benefits scheme are effective communication and education. If employees are made aware of the reasons for, and benefits of, introducing flexible benefits they are less likely to dismiss the scheme as simply a means of reducing costs. In general new schemes are more likely to succeed if they are introduced on a cost-neutral basis (ie no overall gain to either side).

Before setting up a new scheme it is advisable to consult employees over what type of benefits they would like to be offered. All suggestions should be given fair consideration, but care should be taken not to encourage undue expectations that it will be impossible to meet. By incorporating the views of employees, the scheme is more likely to receive a positive welcome. Once the scheme is in place, good communication is still essential so that employees are able to understand fully the benefits offered, and make appropriate choices. For instance, pharmaceutical firm Astra Zeneca adopted a phased approach when it brought in its flexible benefits scheme. They began with 'awareness' for six months, followed by 'engagement' for a further three months, and then 'enrolment' for another three months, with the full embedding of the policy by the end of a year.

Examples of communication methods

As many means as possible should be used to communicate the details of the new scheme. Possible methods include:

road shows and open days
intranet, including bulletin boards
videos, CD-ROMs
newsletters
individual letters to employee's home address
meetings, Q&A sessions, focus groups
demonstrations with computer modelling
telephone and e-mail helplines
one-to-one consultations.

Flexible benefits and anti-age discrimination legislation

There is currently no exemption for employers that allows them to make distinctions between employees of different age groups in providing insurance related benefits, such as private medical cover, income protection and life cover.

There may be scope for a challenge if the availability and cost to employees of such benefits under a flexible benefit scheme is dependent on their age.

For more information on the age discrimination legislation, see our factsheet on age issues in the workplace.

Go to our Age and employment factsheet

CIPD viewpoint

Flexible benefits are a hot topic, fitting in well with the wider total reward debate and talk of the mass customisation of reward. As a practice, flexible benefits are set to increase as new software becomes available and the cost of implementation decreases allowing more organisations to set it up. Flexible benefits are seen as an ideal way of addressing diversity in benefits, as reinforcement of cultural change, harmonisation of reward practices, especially during merger and acquisition, and an effective means of cost management. But they are not a 'magic' solution and need to be managed as part of an integrated reward strategy with clear goals and excellent support processes.

Flexible benefits