UK: Looking at Life Assurance Benefits

Article by Nick Clapp

The provision of what should be one of the more straightforward employee benefits to provide and to administer can have more complications when providing this benefit to your executive staff.

With the advantages of a company life assurance scheme (relatively cheap premiums, removal of medical requirements for the most part on individuals) it is one of the standard benefits offered to executives and should form a part of any executive’s compensation package. In this article, solutions for the current taxation environment are explained, as well as looking ahead to the implications of tax simplification and the possible impact on executives’ life assurance.

For the vast majority of employees, the provision of any company life assurance benefit is currently through an approved group life assurance scheme. This ensures tax relief is available on both the lump sum benefit paid to beneficiaries and that premiums do not incur a P11d tax charge for employees. There is a limit on the amount of lump sum and death in service pension benefit that can be insured under an approved scheme. High earning employees who commenced their employment after 1 June 1989 are restricted under an approved scheme to a lump sum life assurance benefit of four times the Earnings Cap. The Earnings Cap for the financial year 2004/2005 is £102,000, this amount being reviewed in the Budget annually. The Earnings Cap was introduced in June 1989 and therefore, all members who were working for their current employer at that time are exempt. Limits on death in service pensions can be more convoluted, however essentially the overall maximum is 4/9ths of the Earnings Cap for affected employees.

Benefits can often be promised to members on the basis of total uncapped salary. Executives’ needs for life assurance is linked to their lifestyle and to exposures (such as mortgage payments) that they will leave their dependants. Such exposures and lifestyle levels are normally related to their full uncapped salary. Whereas executives have time to review their finances and prepare for retirement, life assurance provides no such luxury. Our experience is that most employers look to provide benefits based on full salary, hence the need for unapproved benefits. With unapproved policies being a P11d tax chargeable benefit, employers might want their employees to make a conscious decision if they wish this benefit to be provided.

Under the 2003 Budget, the legislation imposing a tax liability on any secondary death under a policy has been amended, and "Excepted group life policies" are now available. Employers need to be sure that the criteria for accepting a group policy are met. Many insurers have been slow in responding with group terms for unapproved benefits. Providing individual polices has both implications on the price and medical underwriting implications. You should query from your advisers if any special arrangement is available to them for unapproved life cover. It is possible to negotiate with a specialist insurer policies that neither give rise to a second death tax liability nor require individuals to submit medical evidence provided a simple declaration can be signed by the employer declaring the individuals involved to be fit and healthy. This provides the best of both worlds.

Usually, employers provide life assurance benefits linked to a multiple or proportion of salary. As such, differentiation for executives is usually provided through their salary differentials. An increased benefit multiple is usually therefore seen as unnecessary. There are other, more logical ways of targeting specific executive compensation than life assurance. Where there is a separate executive pension scheme, it may be appropriate to provide different life assurance benefits.

For executives, benefits can often exceed the free cover level available under the life assurance scheme established by the company. This is the level of cover an insurer provides before making extra cover subject to the provision of satisfactory evidence of health. Individual medical underwriting is both tiresome for individuals and, more importantly a potential exposure to the employer if cover is declined. Even if a caveat on the contract of employment exists, this is not ideal for the employee and makes the scheme less attractive to insurers when looking to switch cover (in effect a company is having to declare a substandard executive life). However, a specialist adviser with sufficient influence in the market can help a company obtain specially tailored solutions, often effectively removing the underwriting burden altogether.

The impending Tax Simplification Rules will have an immense effect on any existing unapproved life assurance benefits with effect from 6 April 2006. Essentially, a lump sum of up to £1.5 million will be able to be provided without tax implications (a major increase from the four times Earnings Cap limit). Furthermore, there is no limit on the death in service pension benefit that can be paid. With unapproved benefit incurring a P11d taxation charge, such policies should be reviewed prior to the renewal date preceding 6 April 2006 (which gives limited time).

Before amending benefits it should be established whether the current insurer will provide any increased benefit and the employer is not increasing its uninsured exposure. In addition, a greater flexibility can be made to the benefits offered under the new rules. As examples, will a greater tax-free lump sum be insured to replace a portion of any death in service pension which would be taxed as income? Is a flat benefit for executives of, for example £750,000 simpler to administer than the multiples of salary?

Key employees will usually place a high importance on their life assurance cover and a periodic review of the arrangements put in place by the company is essential. With the changes in legislation taking effect under the "tax simplification" banner, it is imperative too that companies explore with their advisers the options and implications well before 6 April 2006 in order to ensure that arrangements can be put in place in time.

Deputy Practice Head, Aon Consulting Risk Benefits Practice

Authorised and regulated by the Financial Services Authority

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.