Hidden benefits

Group income protection does more to promote an ability-diverse workforce than ill-health early retirement pensions, says Paul Avis, sales and marketing director at Canada Life Group Insurance

Advisers are aware that the potential closure of defined benefit schemes to new entrants or to future accrual may drive group risk market growth as self-insured death and spouses’ benefits become unbundled. But one benefit that is often overlooked is the replacement of ill-health early retirement pensions (IHERP) with a GIP scheme. IHERP costs are often masked in the overall funding rate and so they are rarely recognised as a concern by trustees. This funding rate can also be undermined by actual capitalised cost experience.

In addition, there are other considerations involved with IHERP – it provides very little actual benefit for employees, it removes them from the private medical and death benefit schemes when needed most, it is means-tested against State benefits and it also flies in the face of the Disability Discrimination Act (1995), while preventing employers from having a truly diverse workforce. It does this by providing a mechanism to ’manage out’ those who become disabled. Ironically, it incentivises employees to ’go’ with tax free cash sums so whilst making the option illegal will never happen, macro events in the economic, accounting and HR worlds may conspire to put an end to the use of IHERP.

The loss of DB pensions as organisations respond to an era of financial uncertainty is a blow to many employees. There are a number of options open to employers reviewing schemes. Some will wind up the schemes altogether, which means that no IHERP option will be available. Most will replace the DB scheme with DC or stakeholder pensions, which have no long term absence support.

Employers moving to DC schemes may cover the pension and death benefits, but not consider the IHERP loss which is a further reduction in benefit. Some will close schemes to new entrants which means that current members will have an IHERP option, but new employees will not if they are unable to work as a result of disability. Current members may have retained IHERP options and GIP and so, in effect, be under-, over- or double- funding against long term absence.

Ideally, all employers will remove the IHERP option and use a single, standard approach to long term absence, using retention-based activity and GIP to have a disability-diverse workforce.

Put simply, employers have become used to using their final salary pension scheme as a mechanism for managing long term absence. With deficits, many eligibility definitions have been tightened to further reduce the likelihood of IHERP being granted, moves to career averaging may reduce the amounts when granted and, with ageing workforces, the incidence of applications is increasing.

Put simply, employers have become used to using their final salary pension scheme as a mechanism for managing long term absence.

This means that employers will have to consider retention or capability dismissals on the grounds of ill health. It also means pension trustees will have to relinquish pension funding to pay for this. These are limited choices, and each organisation will have to adopt the best model for their circumstances. GIP stands out, as it keeps the employee in service (with resultant benefit retention), can provide a waiver of premium for the pension benefit (thereby protecting income in working life and retirement as well as future funding contributions/the pension scheme itself) and complies with legislation. GIP also has many value-add services such as full rehabilitation support for employees.

Fifteen years ago I wrote about the missed opportunity to lobby the Goode report to remove IHERP funding from pensions. With the advent of FRS17 and full implementation of the surplus/deficit disclosure after June 2003, I find it amazing that IHERP funding rates and capitalised costs are still not routinely provided to employers and trustees. Perhaps now is the time to consider whether this option is really fit for purpose and cost-effective, and what impact it has on our wider corporate social responsibility agenda. With the group risk industry having missed a litany of opportunities, it is evident that now is the time to really focus the mind on what is best for employer and employee.

GIP enables trustees to avoid using IHERP in a DB scheme, or with the demise of DB schemes, provides support where no IHERP exists. The acid test is that without GIP, how much would you get should you become ill? You may be shocked at how little this is, and suddenly appreciate the benefits of a fully-insured scheme, so that you don’t have to rely on IHERP, whether that option is available in your pension scheme or not.