Retirement income provision is now taking precedence over ill-health or incapacity retirement within the UK’s social insurance system. Government Actuary Chris Daykin says the provision of sickness and disability allowance was traditionally regarded as equal to that of retirement pensions but this is not now the case.
Daykin says in a study* that the majority of people who leave work in the UK because of ill health find themselves in a financially precarious situation. “The weekly allowance is not substantial and benefits do not carry any additional earnings related payments as retirement pensions do,” he says.
Furthermore those not in occupational schemes tend not to be in private schemes either. “People in defined contribution (DC) plans often end up with very modest benefits,” he says referring to people who retire early as a result of ill-health.
The situation is expected to worsen as demographic changes affect the workforce.
Daykin points out that most claimants of incapacity benefits are over 50 in an increasingly ageing population. This means the number of people claiming such benefits will rise from 1.5m to 2.5m over the next 20 years.
Though more than 80% of the workforce will not experience a level of incapacity which will leave them with long term dependence on benefits, Daykin believes that there is “a temptation to think that it is someone else’s problem”.
“Incapacity is a typical contingency for which insurance offers an affordable and equitable way to share the risk,” he explains. Hence the current debate.
Solidarity, where risk is shared among all contributors, and mutuality, where the risk is shared within risk pools, form part of the pensions debate. Daykin believes that there has been a shift from the notion of solidarity towards greater dependence on mutuality, but unlike insurance schemes, the financing of pensions can vary.
The underlying principle, says Daykin, is that “most people expect to achieve entitlement to benefit, and the predominant characteristic can be seen as accumulating savings for retirement”. In cases of incapacity, both solidarity and mutuality schemes depend on everybody contributing but only a small percentage will claim any benefit.
“The group who are best placed to cope with long term incapacity are those who are members of defined benefit (DB) occupational pension schemes,” states Daykin, because these generally pay a pension to contributors who have become unfit to work. The trustees, using appointed medical staff recommendations, are usually responsible for any decision regarding the award of an ill-health pension. This will only be granted where the incapacity to work is permanent. Incapacity pensions are awarded for life.
Private sector workers get a better deal in DB schemes, where up to 40% are granted ill-health retirement pensions based on full potential service, though the final amount is usually calculated on final salary. Public sector workers, the majority of whom are members of DB schemes, receive ‘enhanced service’ awards, which are based on actual service and are therefore less generous.
Unlike DB schemes, DC schemes “do not provide any specific protection for ill-health,” says Daykin. Payments depend on the availability of funds, which, he points out “will clearly reflect the reduced period of contributions resulting from retirement earlier than planned”.
Favourable annuity rates may be awarded where the health problem has a direct effect on the retiree’s life expectancy.
Further protection against long term incapacity to work is available through income protection policies. However, there are currently about 1m people in DC schemes who are not covered by these.
He says that “particularly noteworthy is the fact that if you are in a DC scheme there is generally very little protection against incapacity or ill-health because of the direct relationship between the available benefit and what you have paid in”. In contrast, disability can be seen as a special case for early retirement in occupational defined benefit schemes, where special provisions apply.
Nevertheless, the benefits are generally not sufficient and Daykin believes that “it is a great worry that many people do not have access to an ill-health retirement pension”.
*Chris Daykin, Incapacity and Disability – Paying for the Consequences. Published by Politeia in London.e-mail: firstname.lastname@example.org