If you read nothing else, read this …
•Pressure on the funding of final salary schemes means trustees are likely to tighten up on ill-health early retirement requests.
•The rapid shift to defined contribution schemes leaves employees without a financial lifeline if they become too ill to work. Employers are filling this gap with group income protection.
•Group income protection policies can cost an arm and a leg but employers can save money by putting a limit on the number of years a plan will pay out – typically two or five years – rather than until normal retirement age.
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Employees who retire early on the grounds of ill health can put a financial strain on final salary pension funds, often as much as 1% of annual payroll or more. The advantage to employers of using the pension route is that once these staff have retired, they are no longer on the payroll, which removes all further responsibilities from the organisation.
Employees in final salary schemes are lucky, compared with their counterparts in defined contribution (DC) schemes who, if taken ill and perhaps retiring early, are likely to get back little more than their pension contributions, if that.
While trustees of final salary schemes have the right to impose strict qualifying criteria to sick members, in practice, many are pretty lenient and rarely check employees’ progress.
So now that general pension funding is under serious pressure, employers and trustees are looking at ways to reduce such costs as ill-health early retirement.
At the same time, caring employers which have switched to DC pension schemes, and therefore no longer offer the ill-health early retirement benefit, are considering ways to cope with the problem. David Cross, partner in healthcare and risk at consultancy Watson Wyatt, believes that in the first instance pension trustees of final salary schemes are likely to start tightening up the rules. Another option for many employers is to invest in group income protection insurance, which pays the employeeÂ’s salary. “ThereÂ’s a cultural difference between the two strategies. With the pension route, you are retired and the employer doesn’t need to be involved with you any more. With income protection, sick employees retain all their employment rights,” says Cross.
With insurers involved, the employee’s health is also regularly monitored and rehabilitation plays a large role as insurers want to cut their own costs.
Peter Fenner, spokesman for healthcare company Bupa, says that by using group income protection, employees can also afford to continue making pension contributions. The maximum level of payment is 75% of gross pay minus the amount they receive from the state in incapacity benefit.
The cost of such plans varies but range between 0.4% and 1.5% of payroll. Jane Dale, director of group risk at Legal & General, reports an increasing number of employers are turning to group income protection for ill-health retirement purposes. “We try and help companies save money. This is linked around the issue of absence management. We help with rehabilitation because it saves us money and this is also fed through to the employer by keeping premiums down,” she explains.
Premiums can be pared back sharply if employers request longer deferred periods, for example, of six months. The payout period can also be limited to save money.
While the most comprehensive and expensive plans pay out until normal retirement age, cheaper policies are limited to payouts for periods of two or five years. A Legal & General comprehensive policy for a white-collar workforce of 100, for example, costs around £50,500 a year, while a plan that pays for just two years costs £4,400. Iain Henshall, employee benefits consultant at IFA firm Towry Law, says: “If an 18-year-old employee has an accident and can’t work, in theory he can remain on the payroll until 65. Not many people have a job for life now so this [has become] inappropriate. This is why many employers look for cover for a [limited] period”