Tax changes see assurers cutting disability benefits

Life companies are afraid that certain tax changes implemented this year will mean you could get more than the standard 75-percent income limit from a disability benefit provided by your employer. By introducing a scaled benefit, however, they risk the op

Life assurance companies are introducing tough scaled income limits on employer-bought group life and disability cover, which could leave disabled people and their families seriously out of pocket.

The life companies argue that the reduced benefits are justified because of the “moral hazard” of people making fraudulent claims in the belief that they will be better off than they would be while working, or simply because they do not want to work.

The moral-hazard principle is that you should not be allowed to receive more in disability income benefits than the income you received while working. Until now, benefits paid by life companies have generally been limited to 75 percent of income, with this limit applied across all disability policies you may own.

On March 1 this year, there were changes to how employer- owned group life assurance benefits are taxed. Since then, many life assurers have reduced the benefits even further, Saul Leeman, the principal consultant at Alexander Forbes Consultants & Actuaries, says. Now, scaled benefits are being implemented, which means you could be seriously out of pocket if you are disabled and unable to work.

You can receive disability benefits from three sources: a policy owned by your employer (also called an “unapproved” policy), a policy owned by your retirement fund (“approved” policy), or an individual policy you have bought directly from a life assurer.

Leeman says the scaled benefits are, so far, being applied to unapproved policies only. He says that the scaled benefits:

◆ Do not affect approved group life disability cover. The retirement fund pays you a benefit, normally as a lump sum, which is deducted from any death benefit lump sum that your beneficiaries would receive if you died before retirement age in terms of the rules of your fund.

◆ Do not affect disability cover that you buy as an individual. This It is imperative that you continually check that you are adequately assured against the unexpected, Saul Leeman, the principal consultant at Alexander Forbes Consultants & Actuaries, says.

Most South Africans do not have sufficient disability assurance, and an event such as a change to tax legislation can result in financial hardship for you and your dependants, he says. He says it is important that: ◆ You know what group risk benefits (for example, life, disability and funeral assurance) are provided by your retirement fund or employer. In particular, you need to understand when you will be entitled to a benefit and how the benefit will be calculated.

◆ Even if you are entitled to a group life benefit, you accept that you will probably have to buy additional assurance. However, you should ensure that you are not over-assured against disability, because this will result in you paying unnecessary premiums.

◆ You receive ongoing advice about your finances, of which disability assurance is only one component. was confirmed by Peter Dempsey, deputy chief executive of the industry body, the Association for Savings and Investment SA.

Leeman, who spoke at a recent Alexander Forbes roadshow for retirement fund trustees, says the current industry standard across all types of income disability policies is that you will receive 75 percent of your pensionable earnings when you are declared disabled.

There can be further limitations. For example, you may need to buy cover above the free cover limit (the amount you can be covered for without the need for a medical check-up), in which case you may be required to provide suitable medical evidence to the satisfaction of the assurer.

HOW INCOME IS DEFINED

If you are disabled, the amount you receive will also be affected by how your working income is defined in the policy. It could be 75 percent of your gross income or you may be limited to 75 percent of your pensionable income.

Pensionable income is normally your basic monthly salary (excluding all allowances, bonuses, commissions), on which your and your employer’s contributions to your retirement fund are based.

Leeman says that, on average, pensionable income is about 70 to 75 percent of total guaranteed pay. The gap can be greater if you receive a 13th cheque and this is not pensionable.

Leeman says there are significant differences in how assurance companies decide what your income is as the basis to calculate the percentage benefit on disability cover.

“So what the disabled person receives is very much less than 75 percent of their total income,” Leeman says.

He says that life companies have revised the caps they place on disability income benefits following the taxation changes on premiums and benefits in the Taxation Laws Amendment Act of 2014, which became effective on March 1.

In terms of the changes, any premiums paid by your employer for an “employer-owned” disability benefit must be included in your taxable income as a fringe benefit. However, if you claim a benefit, you will not be taxed on what is paid to you.

Leeman says the effect of the change is two-fold:

◆ If your employer is paying the premium on the group disability policy, your income will have increased on March 1 by the amount of the premium. However, this extra amount will be taxed, reducing your take-home pay.

◆ If you are disabled, you will receive a higher monthly income benefit than you would have received before March 1, as you will no longer pay tax on the benefit.

Leeman says these tax changes led to the life assurance companies also changing the “moral hazard” limits on disability income benefits. One of the main changes has been the introduction of sliding scales on income benefits. These sliding scales can have a severe impact on a disabled person’s income, particularly when the benefit is based on pensionable and not guaranteed total income.

JUSTIFICATION

Leeman says the life companies have raised the “moral hazard” issue to justify the changes. However, he says he doubts whether the “moral hazard” risk would materialise as a result of the tax changes.

A similar pre-emptive approach was taken to dealing with HIV/Aids, which was soon found to be unjustified, he says. The consequence was that, over the next decade, premiums, on average, declined, because the impact of HIV/ Aids- related claims was nowhere near what was anticipated.

Leeman says Alexander Forbes agrees that your disability benefit should be linked to your after-tax Your monthly income could fall if you are disabled and you rely on a group income disability policy based on a sliding scale of benefits.

Saul Leeman, the principal consultant at Alexander Forbes Consultants & Actuaries, says a typical sliding-scale benefit being applied by life companies is that you receive 75 percent of the first R7 000 of your after-tax pay, 60 percent for the next R20 000 and 50 percent of any additional amount.

Leeman says the impact can be seen in the following example:

Joe earns a total guaranteed pay package of R40 000 a month, with after-tax take-home pay of R30 000. His pensionable salary is R28 000 (basic monthly salary, excluding allowances, bonuses and commissions), on which his and his employer’s contributions to his retirement fund are based.

If Joe becomes disabled, his income permutations are:

◆ If he was disabled before March 1, 2015, he would receive a salary and should not leave you better-off than when you were working. However, the view of Alexander Forbes is that the benefit should not be reduced to pre-empt a supposed “moral hazard”.

This does not mean that disability income benefits should not be reviewed, Leeman says. He says that, in reality, all South Africans are under-assured for disability.

In 2013 True South Actuaries and Consultants found that when the impact of the loss or disablement of a breadwinner was measured, South Africans were under- assured against death by R9.3 trillion and against disability by R14.7 trillion.

The fact that group disability income benefits are based on pensionable salaries rather than total guaranteed remuneration packages, contributes to shortfalls in disability cover.

Leeman says the determination of salary for benefit purposes should “take into account the remuneration structure – namely, basic pay plus other pay package benefits, or total cost to company, or commission earnings.” benefit of 75 percent of his pensionable salary, or R21 000, from which R4 200 would be deducted in tax, leaving him with an income of R16 800. This is only 56 percent of his take-home pay of R30 000. (Note: tax deductions for things such as medical expenses have not been taken into account.)

◆ If Joe was disabled after March 1 and received 75 percent of his pensionable salary, or R21 000, no tax would be deducted. This is 70 percent of his take-home pay.

◆ If he was disabled after March 1 and the sliding-scale benefit was applied to his pensionable salary, Joe would receive R17 750, which would be untaxed. This is 59 percent of his take-home pay.

◆ If Joe was disabled after March 1 and the sliding-scale benefit was applied to his total guaranteed pay package, he would receive R18 750, which would be untaxed. This is 62.5 percent of Joe’s takehome pay.

He says employees have become used to living off the additional paypackage benefits they receive above basic pensionable pay.

The reduction of income, if you are disabled, will have a significant impact on your ability to maintain your lifestyle, particularly taking account that you are likely to have much higher medical costs.

Leeman warns that life companies, employers and retirement fund trustees could find themselves liable under the Treating Customers Fairly (TCF) regulatory regime. In terms of the TCF principles, it is important to consider the impact of disability income assurance on all retirement fund members.

“Clear communication and expectation management of benefits is required in terms of TCF, as members are exposed to a financial planning risk if they do not fully understand the implications and what they are actually covered for.”

Employment contracts and human resources practices should be reviewed to ensure that the assurance benefits are properly aligned, Leeman says.