Articles - Death in Service Pensions – at a cross roads


The ability for a dependant’s income to continue on the death of an employee to me is a massively valuable benefit but is the product and market understood by both purchasers and employees? As a married man, with a lump sum benefit and a Death in Service Pension/DISP (sometimes known as a Spouse’s Pension) I really value the cover and value the peace of mind this brings me.

 By Paul Avis Marketing Director, Canada Life Group Insurance
  
 The mortgage would be paid on my death and my wife could continue as we currently live (the Bath high-life!), enabling her to pay the lumpier bills off immediately, whilst retaining a great quality of life in the medium and long term. Without me she may argue an improved quality of life!
  
 The market:
 But this view is clearly not shared and it is important that we recognise that whilst lump sum death benefits (both Registered and Excepted schemes) continue to flourish, Death in Service Pensions (DISP) are dwindling.
  
 In 2015 there were only 2,958 insured schemes covering 399,121 employees: down from 4,078 schemes and 594,166 employees in 2011. Between 2014 and 2015 DISP benefits fell by 14.1% and premiums by 8.9% and so this is really becoming an exclusive benefit. Taking the 1.3m employers available to insure this benefit, less than 0.2% of organisations have this coverage.
  
 Since 2008 the average market rate for DISP has gone from 0.747% per £1,000 benefit capitalised sum assured to 1.293% which represents a 73% increase in premiums. Clearly with such an increase in costs, the market is both struggling to retain its current schemes and has had little or no success in gaining new employer purchasers. For employers considering de-risking Defined Benefit schemes, where this benefit is a feature, there is clearly an education programme needed to consider insurance rather than self-insurance. So why are costs increasing and whilst DB schemes have a different asset mix are they in the same place as insurers in terms of additional capital requirements?
  
 Continuing low interest rates:
 Part of the reason for an increase in costs is the low returns that insurers receive on their investments. In 2008 the yield on a 20 year GILT was around 5% and in 2016 this has dropped to just over 1% . Whilst insurers do not invest exclusively in GILTs, this is representation of the fall in investment returns and the reason that additional capital needs to be invested to fulfil the benefit promise provided by DISP.
  
 For example, based on a 50% salary DISP scheme, on the death of a £24,000 earner (noting the average 2015 salary was £27,600 so a pretty representative example) a spouse could receive £12,000 annual benefit until their own death.
  
 This pension could be paid for a long period of time, let’s say up to 30 years in payment. At 5% investment yield the capital investment required to make an annual payment of £12,000 for 30 years is £125,000 but on a 1% yield the capital required is £310,000. In broad terms for the 4% reduction there is a 148% increase in the capital required. A further impact is found where Trustees opt for scheme designs that increase or escalate benefits in payment. Based on the £12,000 annual benefit, paid for 30 years and no escalation, the figure required is the £310,000 stated above. If the benefit escalates at 5% per annum this increases to £695,000 and a 2.5% escalation would be £455,000.
  
 But is it worth it? I would argue yes as at the end of that 30 year period, having enjoyed a 5% escalating benefit, the employee’s dependant will be on £51,863 annual benefit rather than the £12,000 initial benefit. For a 2.5% escalation at the end of 30 years the benefit would be £25,171. To me that is a simply fantastic amount of benefit to ensure the survivor continue to have a quality of life, continuous support with few financial worries, post bereavement. However in the current environment whilst a 5% escalation seems a lot higher than it needs to be, with benefits potentially payable for 30+ years it certainly will be future proofed.
  
 Did I mention Children’s and Orphan’s cover can be included too? Again another area to consider!
  
 Ageing within schemes:
 A further factor in increasing costs is inherent within the eligibility definition that schemes adopt. Sometimes schemes are closed to new entrants and this guarantees that the insured population is an ageing one. If a 2 year rate guarantee exists, and the membership stays as the same people, then a 2 year increase in scheme age profile is the inevitable outcome.
  
 Whilst 2 years ageing may not seem a materially different risk, it is! In the general population of England & Wales a 40-44 year old male the mortality incidence rate is 1.7 per 1,000 of population and for females 1 per 1,000. For a 45-49 year age band the incident rate increases to 2.5 for males and 1.6 for females and so this is equivalent to a 8-9% annualised mortality increase. Whilst the working population will have better mortality the ageing impact will be proportionately the same.
  
 For employers that have not explored opening up schemes to new entrants, this could be an area for consideration as younger people / lower ages joining may increase the insured benefit, but also simultaneously reduce the average rate of that benefit.
  
 Additionally new entrants could be on a different scheme design e.g. current insured population has say 4/9ths prospective pension / LPI escalation or 50% of salary / 5% benefit escalation and new entrants could be on 25% of salary / level benefit. Whilst it may seem counter intuitive to expand DISP schemes this is worthy of exploration due to the ‘exclusive’ nature of this benefit now. In industry areas where attraction and retention of staff is the biggest challenge, DISP is a real differentiator.
  
 Increasing life expectancy:
 As people are living longer, insurers need to pay the benefits for a longer period of time. Life expectancy at birth can be heavily influenced by childhood diseases so it is useful to look at an older starting point. A man who was aged 50 in 1951 was expected to live for a further 22.2 years. The expectation for a woman was that she would live a further 26.3 years (with a gap of 4.1 years between male and female average ages at death).
  
 The equivalent expectations in 2011 were 31.1 years for men and 34.2 years for women (with a closer gap of 3.1 years).
  
 Over the last 60 years these men’s life expectancy has increased by 8.9 years and women’s 7.9 years and these additional years need to be funded.
  
 As improvements in medical science keep us alive for longer, the good news for people should continue although not necessarily for insurers that have to pay benefits for longer!
  
 Scheme design review:
 Whilst nothing can be done by organisations to change the continuing period of low interest rates, scheme design impacts can be mitigated. The aim is to retain scheme affordability whilst continuing to provide significant financial security for dependants. For example reviewing elements of benefit design such as escalation or the need to cover
  
 Children’s and Orphan’s benefits.
 One area that is coming under increasing consideration is to provide employees with additional lump sum benefits rather than providing the DISP. On this latter point as the Lifetime Allowance is now £1m and Registered Group Life scheme benefits count against that, consideration of an Excepted scheme (with the right taxation and legal advice) could be undertaken. Some of the salary multiples (especially when combined with pension funds) can be high and potentially exceed the £1m quickly.
  
 DISP is not included with the Lifetime Allowance but the payments are treated as taxable income and so considering lump sum death benefits needs to be properly thought through and, especially if the benefit has been communicated, a Consultation exercise to change benefits may be needed.
  
 In all cases, insurers will be supportive of a review as, like us, they believe this is a valuable benefit Short-term impacts of things such as continuing low interest rates should not demean the positive, medium and long-term impact that it can have on survivors over many years, once in payment.
  
 Summary:
 So for 100% clarity, personally and corporately, we believe that DISP is a great benefit. But we also recognise that communication is key to its success. Communication to the employer / Trustees of the valid reasons why costs are increasing and communication to employees about its real value are needed. Advisers should be briefing their clients about what has changed and what the options are, with a plea to them to work closely with insurers to preserve and grow this market. A number of very real consulting and review opportunities exist and for the existing market this should start with a pre-emptive discussion before next scheme renewal, not least as a further interest rate reductions could be on the cards.
  

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