New legislation on age discrimination could lead to changes in life and health insurance products. Wojciech Dochan explains
It is well known that people are on average living much longer lives. This is causing particular problems in the field of pension provision. On the State side where tax and National Insurance payers provide the incomes of those who have retired on a 'pay as you go' basis, the ratio of payers to receivers is in steady decline.
Rising longevity
The 'pension crisis' has prompted the Government to announce various defensive measures, many of them intended to encourage people to continue working and earning for longer than before. The decision to raise the State retirement age for women to match that for men at 65, was taken some time ago. Following the introduction of the new simplified tax regime, which is now scheduled for April 2006, occupational scheme members should be able to start drawing their pensions at any time between their 55th and 75th birthdays.
Rising longevity is clearly bad news for employers with defined benefit pension schemes and for insurance companies active in the lifetime annuity field. On the other hand, it would seem to bring good tidings to providers of life assurance cover, as improvements in mortality experience should lead to fewer death claims. However, proposals to end employment discrimination on the grounds of age reveal that, in the context of life cover in the workplace, it is not that simple. There are also the various forms of health insurance to consider.
Later this year the Government intends to lay new legislation before Parliament, which is intended to end age discrimination in the workplace. Unlike the proposals for pension changes, which have involved The Treasury, the Inland Revenue and the Department for Work and Pensions, the driving force behind these measures is the Department of Trade and Industry. Full implementation is scheduled for 1 October 2006.
Like so much modern UK legislation, the basis for the proposed changes is an EU Directive. This particular one, which dates back to December 2000, established a framework for equal treatment in employment and occupation regardless of an individual's age, disability, sexual orientation and religion or belief. Most of the required legislation is on our Statute Book already, for example the Employment Equality (Sexual Orientation) Regulations (SI 2003/ - 1661) came into effect on 1 December 2003. Now the age discrimination issue is to be addressed.
It appears there is to be one major difference between the proposed legislation and the Government's plans for pension change. Employers will be unable to set a specific date at which their employees are required to retire unless they have objective justification. There is likely to be a default retirement age of 70, after which an employing business would be able to require members of its workforce to cease working and earning without having to justify the decision. This contrasts with the age limit of 75, by which employees would have to start drawing a pension.
How will the coming anti-age discrimination measures affect the pricing and design of life and health insurance products? They will pose four main challenges for providers. Probably top of the list is the proposal to transfer retirement decision making power from employers to their employees. They will be free to decide when they cease work at any time up to the default retirement age of 70.
The potential for selection against the insurer is obvious. An individual, who is suffering pain and discomfort, may choose to carry on working in the hope that, if the underlying cause should require hospital treatment; is found to be a serious medical condition; or is likely to be disabling; they can make a claim under their employer's private medical insurance (PMI), critical illness or income protection cover.
Anti-selection
If the condition is likely to be life threatening, it may be the life assurance arrangement that is placed at anti-selection risk. What can the insurer do to protect itself against this threat? One obvious answer is to build into the premium rates some form of provision for the anti-selection risk.
The proposed anti-age discrimination legislation will, however, bring two key differences. First, employees will probably have much greater control over the level of insurance risk that they present. And second, the ages at which they make their decisions will be much higher: probably above that at which, in pre-legislation days, they were expecting to retire. At least, where pricing is of the reviewable rather than the guaranteed kind, insurers should be able to respond by raising premium rates for existing business as well as new.
The second of our major challenges is linked very closely to the first. It probably has more to do with the coming changes in pension legislation than with the EU Directive of December 2000. Historically, the levels of life and health insurance cover provided and paid for employees by their employer has, like the retirement provision that so often goes with it, been based on the salaries of employees and arranged to cease when they reach a specific 'normal retirement date'.
Major challenges
In the future, members of the workforce will be free to start to draw their pension at any time between their 55th and 75th birthdays. They will also be able to make the transition between full-time employment and full-time retirement by a series of stages (which will not have to follow any fixed regular pattern) instead of all at once. The changed patterns of earnings-related cover, with no set date by which it has to end, will cause major headaches for insurers' product development and actuarial pricing teams.
This leads to the third major challenge. According to the morbidity and mortality statistics, the risk of illness and death increases with age at an ever-steepening rate. This means, for example, that the expense of providing one year's life assurance cover for a man in his late 60s may be several times that for a much younger male colleague who is still in his 20s.
It is already an accepted commercial reality that employment costs tend to increase with age, which explains why it is the older workers who are so often the first to go - by way of redundancy or early retirement - when a business downsizes. Traditionally the main reasons for the additional payroll burden have been the higher salaries and, for a defined benefit scheme, the greater pension costs. It appears that the expense of providing life and health insurance may soon be added to the list.
The cost of employer-sponsored risk protection is clearly set to rise in the future. The level of increase will clearly depend on the proportion of the workforce who continue in employment beyond what used to be the normal retirement date, and how much they earn. What is more, these changes will take a few years to work their way through.
And the fourth and final of our major challenges? This affects existing employees who are not on short-term contracts. This substantial group of individuals will already have a normal retirement date stipulated in their terms of employment. How can this be removed, so that they can choose for themselves when they retire at any time up to the proposed default age of 70? How can any existing protection arrangement be adapted for their change in situation, and what are the implications for pricing? We will probably have to wait until the draft legislation is published later this year to find out the answer.
The first decade of the 21st century will see a number of major changes on the financial services front. With the Pensions Bill and the accompanying tax simplification proposals, it may be easy to put to one side the impact of the anti-age discrimination proposals on life and health insurance products. One unintended consequence is that the total cost of cover is likely to go up. This could lead to some employers closing their arrangements altogether. Is this what the powers that be in Brussels and Westminster really want?
Wojciech Dochan is head of product development at BUPA
COVER notes
•Later this year the Government intends to lay new legislation before Parliament, which is intended to end age discrimination in the workplace.
•Plans to transfer retirement decision making power from employers to their employees could result in adverse selection against the insurer on employer-paid schemes.
•Increasing retirement ages may cause long-term price increases in health-related products if claims increase.
