Pensions legislation seems to be constantly changing, and the consequences for group risk benefits provision have been significant, says Sarah Coles
The pace of change around pensions never lets up. The government has brought in a whirlwind of legislation, from 2006’s A-Day’s pensions simplification to the Pensions Act 2008, and a host of revisions in between. Reward professionals have their work cut out keeping up with this tide of change and the implications for the rest of the pay and benefits package.
In particular, the impact of pensions simplification on the group risk market is still trickling through. Changes introduced under this legislation in April 2006 improved the options available for group life assurance or death-in-service benefits, but many employers have taken no action, still restricting cover to the traditional four-times salary.
Payout on death of an employee
One of the latest developments to follow on from the simplification legislation relates to an alteration to a technical rule, which means that the payout on the death of an employee is not restricted to four-times salary, but instead can be anything up to the lifetime allowance limit (currently set at £1.75 million).
The change also means that pension schemes are not obliged to offer a spouse’s death-in-service pension, which is paid to a surviving spouse if their husband or wife dies while in employment. This throws up an interesting opportunity to convert the spouse’s pension into an attractive lump sum.
Converting spouse’s pension to a lump sum
This has certain advantages. Although a dependant’s pension would be taxable, the lump sum is tax-free. It may also appeal to a modern workforce where spouses are more likely to be working and are unlikely to need an ongoing income as much as they would a lump sum that could be used to meet immediate needs, such as paying off a mortgage, or covering short-term expenses such as nursery, school or university fees. Converting the pension into a lump sum also produces an amount that is fairly attractive to pension scheme members.
Many trust-based pension schemes made the change immediately. Not surprisingly, many organisations with contract-based, insured pension schemes have also been keen to take advantage. The problem has been that insurers were not ready to take on the risk of employees staying with the pension when they are young and likely to live longer but switching to the lump sum option when their spouses are older or ill. It took until the end of 2008 for a deal to be struck.
BSkyB made pension breakthrough
The breakthrough came with BSkyB, which launched a scheme last November. Its consultants, Watson Wyatt, negotiated with its insurer, and arranged for staff to have the option to swap the spouse’s pension for a lump sum, stay as they were, or swap half of it. BSkyB only allowed staff earning up to £90,000 a year the option to convert all their benefit, to ensure those earning more did not fall foul of lifetime limit rules.
Dave Gormley, company secretary at BSkyB, says: “It is particularly relevant for younger employees who may not feel the need for any income, but may find a lump sum makes a great difference to their life.”
BSkyB achieved an initial take-up of 25% of its pension membership, but the move had a broader impact than this. The communication around it coincided with BSkyB’s annual invitation to join the scheme, and take-up reached a six-year high, even in the face of market turmoil. An employee survey showed the move increased awareness and appreciation of the plan, as staff understood the advantages of joining the pension scheme.
New rules enable cost saving
The new rules also offer advantages for employers setting up pension schemes whose ambitions may be less laudable. Paul Macro, a senior consultant at Watson Wyatt, explains: “When employers are putting new schemes in place, we are seeing a lot of interest in offering death-in-service benefits of five-times salary in return for not paying a spouse’s pension. It is a way of realising a cost saving, and employees are pleased with the extra lump sum.”
The fact such an opportunity has been missed for so long after legislation has been passed illustrates the size of the task facing benefits professionals.
But it does not stop there.
Auto-enrolment on the way
Further changes are now in the pipeline, in the shape of the Pensions Act 2008, which will make auto-enrolment, and both employer and employee contributions compulsory from 2012.
Employers not only have to deal with the potential increased costs this will bring, but may also choose to spend time and money developing any existing pension schemes to meet the new rules. If they do so with a defined contribution (DC) scheme, then it may be worth going the whole hog and spending extra to offer group risk benefits as well. David Bird, a principal in the retirement practice at consultancy Towers Perrin, says: “Most people have a DC scheme already. It is a question of how fit for purpose it is.”
Some of the finer details of the incoming pensions legislation are not yet known, but some people in the group risk industry feel that the reforms could affect pensions-related group risk perks because a number of employers which do not offer benefits will be paying for pension schemes for the first time. Wojech Dochan, head of commercial marketing at insurer Unum, says: “It should open the group risk market as a whole, as currently a lot of organisations do not provide pension or group risk benefits.”
Protection risk with DC plans
As organisations increasingly move away from defined benefit pension schemes that typically provide ill-health early retirement perks, many employees who have been moved into DC plans may find they are left with no form of income protection if their employer does not offer a group risk scheme (this is commonly known as the ‘protection gap’). This could become more of an issue as 2012 draws nearer, when some employers may look to move to even cheaper pension arrangements, such as personal accounts.
“We see it as a potential opportunity as one of the issues we face in the industry is the protection gap,” says Dochan. “What happens if staff cannot work through ill-health either in the long term or short term?” He adds that this concern will worsen as a debt-laden government relies more heavily on employers to offer workplace pension and rehabilitation provision.
Age-related chronic conditions
For example, if employees are required to work longer to build up a sufficient pension pot, they may be more likely to suffer from age-related chronic conditions while they are still in employment, which may be long-term but are not life-threatening. If employees are not covered under the terms of their organisation’s pension scheme, group risk perks could be used to control the employer’s costs of covering this type of absence.
But Declan White, group risk marketing manager at Friends Provident, disputes the view that the new legislation will have a significant impact on the group risk market, unless employers that currently offer group risk perks reduce or remove cover, for example, to free up additional funds to meet their new incoming legal obligations around pension contributions.
Group risk market affected
The legislation may even affect the ability of the group risk market to grow among employers that do not currently provide either pension or group risk benefits. “It may affect the ability to grow the [group risk] market if employers are contributing to a pension [from 2012],” says White.
So, as the pace of change continues, it will require dedication from employers to keep up with the latest rules and ensure that their employees get the most out of them.
Case Study: Babcock International
Babcock engineers a longevity swap
Engineering firm Babcock International has done a deal to take the risk of retirees living longer than expected out of its defined benefit (DB) pension scheme.
The deal, known as a longevity swap, paid Credit Suisse to take on the longevity risk. If employees live longer than expected, the bank pays the difference, but if they die earlier than expected, the bank will benefit.
Babcock arranged the deal, which will run for the next 20 years, solely for the pensioners in its scheme.
This kind of arrangement is preferable to a buyout for some pension schemes, because there is no large up-front lump sum. Instead, payments are staggered throughout the course of the deal.
Babcock was one of the first major organisations to set up this kind of arrangement, and is expected to start a trend among schemes of a similar size and nature.