Offering high earners better life assurance scheme

Employers may be able to offer high earners a more favourable life assurance scheme, says Edmund Tirbutt

Changes introduced under pensions simplification legislation in April 2006 improved the options available for group life assurance/death-in-service benefits, but many employers have not yet taken advantage.

Most still restrict life cover benefits to the traditional four-times salary, even though this is no longer necessary, and have overlooked the chance to take advantage of a more favourable regulatory structure.

Death-in-service benefits provide a payout to an employee’s family should they die while in service. Most schemes were set up on an approved basis before A-day (April 2006) and automatically became registered schemes, without employers having to do anything. But if scheme members are high earners, it could be more advantageous to offer them access to a non-registered scheme.

In a registered scheme, lump-sum death benefits count – along with pension benefits – towards a person’s lifetime allowance, which stands at £1.75 million for the 2009/10 tax year. Lump-sum benefits in excess of this will be subject to a 55% tax charge. But life cover in non-registered schemes does not count towards the lifetime allowance.

Although, in theory, there are several types of non-registered scheme, in most cases the only option likely to be feasible on tax grounds is an excepted scheme. A downside of an excepted scheme is that it permits only lumpsum benefits and cannot provide dependents’ pensions. But post-A Day flexibility means this does not have to be a problem. Guy Roberts, business development director at Portus Consulting, says: “In group life schemes, we are seeing people moving away from dependents’ pensions towards larger lump sums. Dependents’ pensions tend to be more expensive than lump sums and, because employers can now offer higher multiples of salary, the dependent can invest the additional amount for income or purchase an annuity.”

Other possible downsides of excepted schemes are minor, such as the fact that all members must have their benefits calculated in a similar way and there is a slight possibility of them incurring exit and periodic charges in relation to inheritance tax. Yet, according to Swiss Re, there are only 1,819 excepted schemes in existence, compared with 35,369 registered schemes. Simon Derby, director at i2 Healthcare, says: “When we take over schemes, we find very few excepted arrangements in place for high earners, but we encourage clients to take them out because it means life assurance benefits do not count towards lifetime allowances, and there are no real disadvantages at present. The situation could, however, change in the future if the government starts making them a taxable benefit, like they were originally when called unapproved schemes.“

Some staff may also have previous pension entitlements which put them much nearer the lifetime allowance limit than their employer realises, and recent government moves mean high earners are increasingly likely to need all the help they can get. Ron Wheatcroft, technical manager at Swiss Re, says: “Recent Budget measures are reducing pension tax relief for high earners and the government has announced that, from the 2011/12 tax year, the lifetime allowance will be frozen for five years. If inflation becomes high, which is a possibility if there is a backlash to quantitative easing, this could affect quite a lot of people.”

Having an excepted scheme can also avoid a possible pitfall of registered schemes for people who have secured enhanced protection for their retirement benefits. Sue Sneddon, employee benefits technical manager at Aegon Scottish Equitable, says: “If employers pop an individual with enhanced protection for retirement benefits into a registered scheme, it could overturn that protection, removing any ring-fencing specifically arranged by that employee and bringing all benefits back within the lifetime allowance check. This could result in significant tax liabilities the employees had purposely planned to avoid.”

So there seems a clear case for employers with high earners to seek advice on whether it might be appropriate to allow them to have at least some benefits in excepted schemes. The other main issue for larger employers to consider is whether they might be better off self-insuring rather than buying life cover.

Premiums for large schemes closely reflect claims experience, but smaller schemes tend to be closer to book rates and, with costs often as low as £1 per £1,000 of benefit, small employers might feel it is worth avoiding the possible big claims costs of self-insuring.

Paul White, head of risk benefit consulting at Aon Consulting, says: “Once employers have got several thousand employees, it can become viable to self-insure. At the moment, however, the market is very soft and a lot of insurers are so desperate to get business, they are almost quoting loss-leader rates to keep market share. But when the market moves, it could be worth taking another view as to whether to self-insure. More people should currently be buying insurance, but many large schemes, particularly those in the public sector, have always self-insured.“