First, can I stress that the issues I will outline in this article will, over the coming months and years, prove to be among the most important developments in financial planning and all advisers must devote a great deal of time and thought to ensuring the implications are brought to the attention of their clients. In short, I believe this is one of the most important articles I have ever written.
I mentioned towards the end of my last article that European legislation requires the UK to prohibit employers from forcing employees to retire at a predetermined age. In this country, it is normal for employers to fix a mandatory retirement age of 65 but the Government is obliged to introduce legislation which will enable all employees to continue working as long as they wish, subject to their mental and physical ability to continue in their job.
The latest date by which the UK must introduce this legislation is 2006 and the Government has made no secret of the fact that, for whatever reason (not least the fact that it is this country's biggest employer and therefore stands to lose most money out of this development), it is going to take it right to the wire. So, employers have another three years or so to prepare themselves for what promises to be a major additional cost.
By way of background understanding, the roots of this development broadly come from the same legislation which prevents discrimination on the ground of sex, race and now age. Mandatory retirement ages have been judged to constitute age discrimination and are therefore illegal.
I would suggest that financial advisers should be talking urgently to their business clients about the financial planning implications of this legislation. These encompass pensions, group risk benefits (death benefits, permanent health insurance and private medical insurance) and business investment planning.
Let us be absolutely clear what this legislation means. If an employee passes the age of, say, 65 and is willing and able to continue working, there will shortly be nothing the employer can do to terminate that person's employment unless the employee can be shown to be mentally or physically incapable of fulfilling their duties.
Please do not, as an adviser, think that because this legislation will not come into force until 2005 or 2006, we do not yet have to concern ourselves with its implication. As we know that the legislation will come into force, every employed person in this country who is not due to retire before 2006 should now be made aware that they will not be forced to retire at any specified age. Thus, many aspects of their financial planning, which assume a fall in earned income at, usually, 60 or 65, must be brought into question.
First, as regards pensions, for a reason which I do not pretend to fully understand, it now appears that employers will, at least initially, be able to deny continuing benefits to employees who work beyond a predetermined age – probably the retirement age currently used by that employer.
Should this “concession” ever be lifted – and my crystal ball tells me it will, within five years of the introduction of this legislation, that is, around 2011 – those final-salary schemes still in existence at that time (will there be any?) will have huge additional liabilities. This is because the overall funding rate of a 1/60th final-salary scheme – typically around 18 per cent of pensionable salary – masks the fact that the annual funding rate for young employees might be less than 6 per cent while the rate for older employees exceeds 25 per cent.
Add in a few 70-year-olds with funding rates that are even higher than 25 per cent and the scheme becomes even more costly to the employer, especially when we bear in mind the fact that we are now expected to live a lot longer than was anticipated a few decades ago, meaning that the cost of funding a retirement income for a longer period of time is increasing.
Away from pensions, as we have a good few years before that particular implication becomes relevant, let us give a thought to group risk benefits, both from an employer's and employee's perspective. Group death benefits, for example, are costed by the insurance company/underwriter on the assumption that the age range of employees is distributed – albeit perhaps not evenly – between 20 and 65.
The cost of cover for a 20-year-old is, obviously, very low while the cost for a 65-year-old is, equally obviously, very high. The cost of adding a progressively increasing number of 70 and 80-year-olds will rise quite sharply, tempting the employer, surely, to question the merits of funding the scheme at all. I therefore predict that an increasing number of group death benefit schemes will close, starting before the end of this decade.
This line of thought is not only important to advisers to employers, it will also be crucial to advisers to employees, who, if my line of thought proves correct, which I am certain it will, will lose a huge chunk of valuable employer-sponsored death benefits, which surely means that they must revisit the need to make extra provision for themselves.
Clearly, much more consideration needs to be given to the implications of this change. In my next article, I will go on to examine the likely future for other group protection products and investment planning, in light of the need for many employees to recalculate the amount of retirement income they will need to fund for and at the same time replace employer-sponsored ben-efits that have been removed.
I am less certain of the certainty of this prediction of the demise of group life insurance, though, than I am of employer-sponsored group income protection (i.e. PHI) and medical insurance. You see, whilst the cost of providing life assurance to older employees is more than younger employees, it does not rise that much at the oldest ages as the underwriter knows that the cover will cease at an age below which relatively few people will die. Even with the removal of mandatory retirement ages the underwriter might assume that, before dying (without putting too fine a point on it), the older employee will retire through incapacity some months or years before dying.
This line of reasoning does not, of course, apply to income protection and medical insurance; an employee continuing in work to, say, 70 or 80 years of age is obviously – and exponentially – more likely to fall ill. The cost, therefore of providing this person with income replacement, or especially private medical treatment – is prohibitive. Advisers to these schemes must urgently take this message on board.
But these are not the only advisers who need to act urgently on this imminent development; advisers to the employees (that is all advisers, of course) must be aware, as I have outlined for life insurance, that this loss of employer-sponsored benefit creates a new need for private provision. I confidently predict that the sales of individual PHI and private medical insurance will go through the roof towards the end of this decade and therefore the 'smart' IFA firms will over the next couple of years position themselves accordingly – not least by briefly discussing this likely development with appropriate clients.
For all of these group risk benefits I anticipate that, rather than incurring these huge extra costs, (as employers will not be able to restrict benefits to younger employees; this representing the same 'ageism' as the legislation is designed to prevent) this benefit will simply be removed.
Finally, and only very briefly on to investment planning. Many clients build investment portfolios, at least partly, to subsidise their income after retirement. Now we know that employed clients will, not necessarily suffer this drop in earned income at a predetermined age, and so I would suggest that portfolio planning needs should be revisited. Moreover, in the light of the other issues I have discussed in this article, I would be very surprised if the coming years do not see a small but significant redistribution of interest and funding from investment to protection as, in the latter category, employer-sponsored benefits are removed.
In summary, this is an issue which you will be hearing more and more about over the coming months. The smart IFA, acting upon this knowledge quickly, stands to gain a great deal of additional kudos and business before everyone else realises the importance of this imminent legislation.
Keith Popplewell is managing director of Professional Briefing