Highland scheme mulls insurance policy for ill health retirement costs

Minutes revealed that, between April 2017 and March 2018, there were 20 cases of ill-health retirement within the Highland Council at an average cost to the pension fund of £81,500 per ill health retirement.

The key for the scheme is that they have actually ticked all the boxes and done it all properly

Ruth Bamforth, Walker Morris

Different pension schemes have their own definitions of what sickness means, but members are generally considered for an ill health early retirement pension if they are unable to carry out their normal job due to mental or physical illness.

For corporate pension funds, a member’s eligibility for ill-health retirement depends on the individual scheme’s rules, but with public sector plans, such as the Local Government Pension Scheme and the Scottish LGPS, the benefits that have to be provided are set out in regulations.

Enhanced ill-health benefits can prove costly

Minutes from the Highland Council’s latest pensions committee and board meeting on August 9 2018, during which a retirement monitoring report was circulated, flag the 20 cases of ill-health retirement between 2017 and 2018, citing the £81,500 figure as a “substantial cost”.

The minutes highlight that ill-health retirement is a benefit of the fund, and “depending on the severity of the illness, the payment to the scheme member could be enhanced and this could be a considerable cost to the fund”.

The committee is now looking into whether the scheme would benefit from taking out an insurance policy to protect it from ill-health retirement costs.

The minutes add: “Although this policy could also be expensive, an undertaking was given to consider this option.”

The percentage of ill-health retirements in the council’s Development and Infrastructure Service has been high compared with some other services.

During the meeting, it was explained that in a recent department restructure, the service had taken on a large group of staff and “this would partly explain the increase”.

Ruth Bamforth, director at law firm Walker Morris, notes the extent to which an ill-health retirement benefit is enhanced can have significant cost implications.

For example, if a member satisfies the ill-health criteria, they may just get the pension to which he or she is entitled – with no enhanced pensionable service.

Many schemes enhance the pension payable to those who retire early due to illness if they meet certain criteria, sometimes to include the pensionable service a member could have completed to normal retirement age.

“The more you enhance the benefit, and the younger the person is, the more costly it’s going to be,” Bamforth says. “That is potentially going to be a real problem.”

A numbers game

David Davison, partner and owner of Spence & Partners, says taking out an insurance policy to protect the scheme from ill-health retirement costs is something that a number of LGPS funds have already addressed.

“As with any insurance policy it provides certainty at a cost. It also serves to smooth out the costs. Ultimately, you’ll only know based upon actual experience if it was a good investment or not,” Davison says.

Strathclyde Pension Fund – another Scottish LGPS fund – has an insurance policy in place for ill-health retirement costs, and gives its participating employers the option to be covered under the policy.

On its website, the fund tells employers: “As an ill-health retirement can have a significant impact on an employer’s contribution rate, you may care to take out ill-health liability insurance.” It adds that premiums are deducted from the employer’s contributions.

Source: HCPF

There is “an aspect of inconsistency” across both Scottish and English funds, says Davison. “Some do it and some don’t, and [this] could be something that could be addressed with scheme consolidation.”

Schemes could join forces to benefit from a reduction in cost – getting better terms on such insurance policies than they would on a standalone basis.

Davison adds: “Insurance is a numbers game, so with a larger population you’d expect the unit price cost to be lower. Therefore, larger pools are likely to mean lower costs for the insurance.”

Alternatively, he notes that with a larger pool of pension funds there may be more of a case for self-insurance, as any experience is spread over a larger population.

Some schemes can self-insure

Indeed, many LGPS funds are so large that the risk posed to the pension scheme by ill-health retirement costs is low.

Kirsty Bartlett, a partner at law firm Squire Patton Boggs, says: “As far as I am aware, just because of the sheer size of most LGPS funds, they tend not to insure either against ill health or death in service.”

Some funds will assume a predicted level of cost and make an allowance within the actuarial valuation. Others will decide that, in the event there is ever an ill-health early retirement, the specific scheme employer has to pick up the extra cost.

But “if it’s a big fund… they may decide effectively to self-insure”, Bartlett says.

The £1.9bn Highland Council Pension Fund is one of the smaller Scottish LGPS funds – dwarfed by the likes of the Strathclyde Pension Fund with its net asset value of £20.9bn.

“Because you have a smaller population of people, there’s more volatility in things like ill health and death in service,” says Bartlett.

If a fund has a lot of small employers, just one person taking an ill-health early retirement pension could have a significant impact on the individual employer.

It may be that employers take out insurance against their own risk, or the administering authority may decide to take out insurance on behalf of the whole fund, Bartlett explains.

“It’s certainly something that is quite common in the private sector but less so in the LGPS, although it is possible and I know there are some funds who do it,” Bartlett says.

Follow correct processes to avoid complaints

The Pensions Ombudsman’s 2017-18 annual report shows ill health came fourth in its top 10 list of subject matters for closed investigations during the year.

Ill-health retirement can be an emotive subject for members. If people feel they should have been awarded an early ill-health pension and have not got it, or if they feel they have not been awarded enough in terms of enhancement, they may complain to the ombudsman.

“It’s very unusual for the ombudsman to tell schemes what they should do, because usually there’s an element of discretion involved,” Bamforth says.

Instead, she says the case tends to be remitted back to the scheme and they are told to go through the ill-health test process again.

Ultimately, it is important to make sure the pension fund is properly governed, making sure they have done exactly what the rules say, have followed the right processes, and ensured all the right evidence has been collected.

“The key for the scheme is that they have actually ticked all the boxes and done it all properly,” Bamforth stresses.

Bartlett agrees, emphasising it is crucial to ensure the proper process has been followed and “make sure you’re actually texting against the right criteria”.