There’s life cover, but not as we know it

11 November 2022

I don’t suppose many advisers with clients in the Public Sector have lost much sleep over the recent news that there’s no regulatory requirement to provide a life cover option under the Local Government Pension Scheme (LGPS) AVC. So, administering authorities should henceforth find it easier to review and switch AVC providers.

The same may or may not also be true of other public service pension schemes including the NHS and Teachers’ schemes where additional life cover is also an AVC option and where any regulatory requirement will similarly depend how the relevant regulations are worded.

So what? I hear you ask. Quite simply this piece of news throws public sector lump sum death benefits into the spotlight and indirectly raises the question of why any public sector client might want to make top-up contributions to secure additional life cover and the very serious secondary question of whether the standard lump sum death benefit paid by these schemes would be adequate in any particular client circumstances.

Because as a general rule of thumb, these cash pay-outs are likely to be calculated on lower salary multiples than you might typically expect to find under good employer arrangements in DC world. On the flipside, they are benefits provided under a pension scheme, so entitlement doesn’t cease if the member opts out or leaves service. But the calculation does change. And this will generally be less generous.

The table below shows at headline level the lump sum death benefits payable under some of the largest public sector career average arrangements for active and deferred members.

Active members 2 x pay  3 x full-time equivalent pay  3 x pay
Deferred members  2.025 x accrued pension 2.25 x accrued pension  5 x accrued pension

 It’s really not a stretch of the imagination to see how at 2 or 3 times pay, the putative pay-out from these schemes is unlikely to meet survivors’ cash needs given that the average UK house prices stood at some £286,000 in June 2022. And the shortfall is likely to be even greater for many individuals such as clinicians who may have significant private or non-pensionable earnings which won’t count towards the pay multiple at all.

And advisers will need to ensure that they consider life cover needs where their client is opting out of their pension scheme for pensions tax or other reasons. Make no mistake, deferral can significantly reduce the amount of the lump sum, particularly where the individual has short service. For example, in the case of a clinician with pensionable pay of £95,000 who dies with 5 years’ service, the cash lump sum drops from £190,000 on death as an active member to just £18,527 on death in deferral (assuming 2.5% annual pay inflation and 3% CPI).

Don’t get me wrong. In the round these schemes provide generous family benefits including ongoing pensions for surviving adults and eligible children. But survivor pensions are inflexible. I can’t use some of next year’s widow’s pension to meet my cash needs today. So although the capital value of the family benefits will almost certainly seem generous when you’ve totted it all up, the shape of it might be a misfit and extra life cover may be needed.

That’s where the money purchase AVC scheme comes in. It gives members the option of paying extra to increase the lump sum pay-out on death. Whether providers continue to make this option available and whether the rates are competitive compared to an individual policy is another matter. But life cover contributions paid this way are generally relievable pension contributions, so the tax advantages mean they need to be in the mix if the amount of the lump sum death benefit is an issue. Either way advisers would do well to ensure that scheme benefits would meet cash needs on death.

About the author

Justin Corliss

Senior Pensions Development and Technical manager

Justin’s first foray into Financial Services was in Australia in 1997 with Commonwealth Bank of Australia working predominately in retail mortgage lending. In 2002 Justin and his British wife moved to Scotland where he worked in broker consultant roles with both Scottish Widows and Scottish Life before spending a brief period as an Employee Benefits Consultant dealing predominately with Auto Enrolment and associated business consultancy. Justin is involved in developing adviser facing content, presenting, writing articles and commenting for the press. Justin has studied continuously since arriving on these sunny shores and holds the Advanced Diploma in Financial Planning including the CeMap and Lifetime Mortgage qualifications. His primary focus is pension planning and he holds the AF3 & AF7 qualifications. A huge sports fan, Justin will happily discuss the merits of the Australian cricket team for hours on end.

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The firm is on the Financial Services Register, registration number 117672. It provides life assurance and pensions. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London, EC3V 0RL.