Advertorial Irish Broker Magazine October 2019

Death in service dependant’s pensions – a ‘dying’ breed?

Advertorial Irish Broker Magazine October 2019

Death in service dependant’s pensions – a ‘dying’ breed?

It is late 2019 and we remain in an era of record low ECB interest rates. Almost four years has passed since the ECB reduced its interest rate to 0%. Whilst this has been great news for those on tracker mortgages it has not been so good for those purchasing annuities or indeed employers insuring dependant’s pensions in the event of the death of one of their employees. In fact, over the past ten years, yields on German government bonds have fallen by approximately 4%. This would represent a near doubling in the cost of insuring a 40 year old dependant’s pension today.

Dependant’s pensions in the event of the death in service of an employee have traditionally been a feature of defined benefit pension schemes. Despite the continuing trend towards defined contribution pension schemes as the pension vehicle of choice for employers, there remains 713 defined benefit schemes in Ireland (Source: Pensions Authority Annual Report and Accounts 2018).

elipsLife carried out a survey of risk benefits in conjunction with the Irish Association of Pension Funds (IAPF) in July 2019 and found that almost three quarters of respondents still offer dependant’s death in service pensions, be it for a closed cohort of employees or for both existing and new employees.

Faced with the increasing cost of insuring dependant’s pensions, employers and their advisors often wish to consider alternative options. Looking to the UK, during 2018, the total level of death in service pension benefits fell by 30% from £4.23bn p.a. to £2.95bn p.a. Premiums in respect of these death in service pension benefits fell by 17% from £168m to £140m (Source: Swiss Re Group Watch 2019). Clearly, there has been a trend for employers in the UK to move away from dependant’s death in service pensions (either entirely or piecemeal) and there has been similar appetite emerging in Ireland.

So, what options are open to employers?

  1.  Maintain status quo – continue to offer the same level of death in service pension benefits and absorb the additional cost to insure these.
  2. Self-insure – look at the possibility of the pension scheme taking on the investment, inflation and mortality risks and funding the pension benefits in the event of death in service.
  3. Partially insure – consider capping the level of death in service pension benefits funded through the pension scheme with the excess being insured.
  4. Restructuring dependant’s death in service pension cover – closing its availability to new hires, changing the level of escalation that applies to the benefit (if applicable), limiting the term of payment of the benefit, or, more typically, by replacing the dependant’s pension with an additional lump sum multiple of salary.

Each of the above will have varying cost implications. Option 1 may be seen as unsustainable in the long term, particularly where new hires are eligible for the benefit. More and more employers are looking to option 4 to achieve cost savings, particularly where they have defined contribution pension schemes in place for new hires, which typically only provide a lump sum based on a multiple of salary and the employee’s pension fund value on death in service.
That being said, implementing any changes may not be as straight forward as it seems - this has resulted in many employers maintaining the status quo and having to absorb the additional cost. This may also mean clawing back spending on other employee benefits that are offered.

Considerations for employers and their advisors
Some of the considerations (not exhaustive) that must be carefully reviewed prior to restructuring death in service dependant’s pensions include:

  1. Legal aspects - employment contracts and the balance of powers in the pension scheme’s Trust Deed and Rules can determine who may need to give consent to implementing the change
  2. The level of the additional lump sum to be offered and its fairness/adequacy – for example, if an employee earning €50,000 p.a. was entitled to a dependant’s pension of 50% of salary, which escalated at 3% p.a., the replacement lump sum required to purchase such an annuity today (assuming a 40 year old dependant) would be in the region of 60 times the salary. In reality the additional lump sum offered is significantly lower.
  3. How the change is communicated to employees – do employees understand the changes and their implications? Are dependant’s well informed on what to do with the significant lump sum benefit, especially given it can be a very difficult time for the individual?
  4. The tax implications for the employer paying the premiums, the employee for whom the benefit covers and for the dependant who receives the restructured benefit.

At elipsLife, we take pride in delivering tailored group risk solutions for our customers through our selected partners. Please get in touch if you would like further support in advising your corporate clients on their group life and income protection benefits.

Personal Profile
Ross Mitchell
Head Sales, elipsLife Ireland

Death in service dependant’s pensions – a ‘dying’ breed?