Employers in Derbyshire Pension Fund should be aware of the potential additional costs they could incur if one of their members is granted ill health early retirement. The purpose of this page is to inform employers of the risks of ill health early retirement, and possible ways to help mitigate these additional ill health costs.
Impact of ill health retirement on LGPS employers
When one of your current employees can no longer work and retires due to ill health, there is an increase in the pension liability for you as the employer. This is known as a shortfall cost. This cost results from:
- early payment of the member’s pension
- an increase in the benefits payable to the member (either based on full prospective service to normal retirement age for a Tier 1 retirement, or 25% for a Tier 2 retirement)
The size of the shortfall cost will vary depending on a member's:
- age
- service
- ill health retirement tier
This is illustrated in the following table. The figures shown represent the actual shortfall costs for members in the Fund. These cases resulted in an immediate increase to the liabilities (and hence an increased cost) for the member’s employer:
Potential costs of ill health retirement
| Member age | Salary | Service | Tier 1 shortfall cost |
|---|
| 45 |
£11,000 |
5 years |
£185,000 |
| 44 |
£25,000 |
2 years |
£322,000 |
| 31 |
£32,000 |
11 years |
£503,000 |
| 53 |
£88,000 |
23 years |
£714,000 |
Current employees may also be awarded Tier 3 ill heath early retirement. The additional costs for these are typically lower as Tier 3 pensions are only payable for a maximum of 3 years. They do not include any enhanced prospective service.
Impact on employer funding positions
When a member retires due to ill health, the shortfall cost is added to the employer’s liability at the following triennial valuation. All else being equal, this worsens the employer’s funding position and balance sheet. For small employers, this could lead to a significant increase to their deficit (or a significant reduction to their surplus).
Impact on employer contribution rates
The Fund’s current approach to ill health risk management means that shortfall costs in respect of ill health early retirements are not immediately payable by the employer (unlike certain other forms of early retirement such as redundancy). Instead, the shortfall costs are recovered through an increase to the employer’s contribution rates determined by the actuary at the subsequent triennial valuation. For small employers, this could result in a significant increase to their contribution rate.
There is a risk that some employers in the Fund may be unable to meet the shortfall cost arising from an ill health early retirement. In the worst-case scenario, the worsened funding level and increased contribution rates may have a significant impact on an employer’s financial position.
External ill health insurance policy
An insurance policy option is available to all Fund employers to help mitigate against potentially significant ill health shortfall costs known as Ill Health Liability Insurance (IHLI). This is done independently of the Fund. It is provided by Legal & General and administered by the Fund’s actuary, Hymans Robertson LLP.
By obtaining the premium rate quotation, this should not be interpreted as the Administering Authority of the Fund recommending or endorsing Legal & General’s Ill Health Liability Insurance product to employers in the Fund. It is each employer’s responsibility to determine the suitability (or otherwise) of the insurance and to decide whether to proceed with taking out the cover.
Any employers interested in learning more about mitigating ill health risk wishing or to obtain further information about the insurance should contact Hymans’ IHLI team directly, email ihli@hymans.co.uk
How the ill health insurance policy works
Our employers pay a premium to the insurer. The premium payable would be derived by multiplying the premium rate by your LGPS pensionable pay. The premium rate is typically between 1% and 2% of pensionable pay per annum.
In the event of a Tier 1 or Tier 2 ill health early retirement of one of your current employees, the insurance policy would pay you the shortfall cost calculated by the Fund. This should then be paid to the Fund where it would be added to your asset share to cover the cost.
Additional resources
Further information on ill health retirement in the LGPS and the Fund’s approach to managing the risk can be found in the: