While still in the midst of implementing auto-enrolment, the pensions industry is set to have another social responsibility thrust upon its shoulders. Due to the Care Bill coming into effect in April 2016, which caps the amount people will pay for care at £72,000, eyes are now on the retirement market to help individuals pay for this.
The timing of this is apt, as while increasing longevity is a much-discussed issue within the pensions industry, conversations have yet to really drill down to the quality of those extra years and what that means for pension provision.
Healthy life expectancy
According to a recent report from the International Longevity Centre UK, Linking state pension age to longevity, life expectancy for males born during 2008-2010 was 78.1 years, with 63.9 years disability-free and 63.5 years of healthy life. Females had a life expectancy of 82.1 years, of which 65 years are expected to be disability-free and 65.7 years in good health.
However, the report found those that are currently 65 could expect approximately a further decade of good health. Males aged 65 were projected to live another 17.8 years, with 10.4 of those years disability-free, and 10.1 of those years healthy. Women aged 65 had a life expectancy of 20.4 years, with 11.2 years disability-free and 11.6 years left healthy.
However, of those 65 year olds, 31,000 (8 per cent) of the 374,000 males and 54,000 (14 per cent) of the 393,000 women are projected to live to 100, according to the Office for National Statistics.
So as Friends Life head of corporate benefits marketing Martin Palmer explains, people are living longer and in many cases living with illnesses for longer. “People may live to 90 but it is quite feasible that people could live with quite serious illnesses for a long period of time. So the period of time in a care home may be longer than was previously the case. It’s that double whammy of living longer and longer periods in care creating more problems for people’s funding.”
According to the Association of British Insurers (ABI) pensions and insurance working group report, Developing products for social care, there were 431,500 elderly and disabled people in residential care in 2013, of which 414,000 (95 per cent) were aged 65 or over.
The likelihood of living in a care home increases with age, peaking at approximately 16 per cent for people aged over 85, the report states. Therefore the group who are most likely to enter a care home in the next 20 years are those that have already retired.
To that extent, the ABI has been working with the Department of Health to review how the insurance, pensions and housing markets can help people pay for long-term care.
Its Social care funding: Statement of intent identified that the financial products most likely to develop in the short term to help fund long-term care will leverage the assets that people already have, specifically housing and pensions.
Retirement products in particular will have a major role, because as Standard Life head of customer income Alastair Black says, many people entering care will only have two substantial assets to help finance this: their house and their pension. “And due to the strong emotional attachments to their home, we consider that providing greater scope to access pension savings is a more attractive option for people.”
The statement of intent followed the 2011 Dilnot Commission’s findings that the industry already helps people pay care costs, but under the right conditions can play a larger role.
This can be achieved by improving the flexibility of existing retirement products, the ABI report found. It names a number of ‘quick wins’ that would enable people to use their pension fund to pay for care, or at least remove ‘disincentives’ from the system.
Within capped drawdown, the lack of flexibility in GAD limits means that more money cannot be drawn down to pay for care. To counter this, the ABI suggests the introduction of new GAD limits that allow an increased amount to be drawn down if the person meets disability criteria.
With flexible drawdown, the minimum income requirement of £20,000 means that much of the fund is not accessible to pay for care. The ABI would like a lower minimum income threshold if the person needs care, potentially matched to the general living expenses limit of £12,000. It would also like a greater range of income sources to be taken into account.
Aegon regulatory strategy director Steven Cameron would like to see the tax rules regarding income drawdown changed, as “when you die you are taxed on what money is left. If we want to encourage people to hold back more of their retirement fund to potentially fund higher income needs at an advanced age then having a relatively onerous tax charge on any remaining fund discourages that.”
However, for many people approaching retirement an annuity is the only feasible option.
A disability-linked annuity offers the consumer a reduced initial annuity, say by 10 per cent, but the value will increase significantly, e.g. by 50 to 100 per cent, if the person goes into a care home. To make disability-linked annuities more attractive, the ABI recommends applying the same positive tax treatment as a standard annuity, and would like to see a clear statement in HMRC guidelines clarifying this.
Half of the customers surveyed by Prudential for the ABI review thought that disability- or care-linked annuities had appeal but wanted to know more about costs.
According to the ABI, another area for further exploration is the value protection option, which returns the fund held in annuity, minus any payouts, if the person dies early. Currently early access to this money to pay for care would be classed as an unauthorised payment and be subject to a 55 per cent tax charge. It recommends exploring whether early access for care purposes should be allowed, and looking at the appropriateness of having the tax charge.
However, one beneficial aspect of the status quo, according to Palmer, is that people are increasingly using drawdown or short-term annuities and are not ‘locking down’ that final annuity decision until later in life, “by which time they are more aware of their own health issues”.
Partnership director of product development Nigel Barlow agrees that as people are working longer, “sometimes close to the point where they need care”, so they have a better idea of what their financial needs will be. As people tend to go into care with an illness, “annuitising close to this point means that they would likely qualify for an enhanced annuity, providing a higher income to help fund care costs”.
Another way that a pension could pay for care is by ring-fencing a portion of the pension pot at decumulation to fund care if required. Prudential’s research also looked into people saving additional money into their pension plan, using that extra money to cover care costs. It found that 42 per cent of people agreed the proposition had appeal, particularly as the extra payments would benefit from tax relief and any money not used would be included within the individual’s estate. However costs and a loss of control were cited as concerns.
While the pensions market will have a key role in paying for care, this is expected to be in conjunction with other saving products. For instance equity release products, enabling people to release their housing equity without selling their home, are expected to be major contributors towards care costs. Hargreaves Lansdown head of corporate research Laith Khalaf suggests the “humble ISA” as another tool to build up a care fund. “If you save up to your annual ISA allowance each year you can enter retirement with a tax-efficient war chest to help cover the costs of any care,” he says.
Platform solutions can help with this, enabling individuals to view their assets in one place and determine the best approach to fund care.
Instead of using existing assets, another option is the purchase of a care annuity. For a lump sum an insurer will pay a regular income to the care home for the entirety of the person’s stay. Just Retirement has recently entered this market, as “new rules are set to come into force in England in two years’ time, which will ensure everyone except the very poorest will have to pay towards their own care”, group external affairs and customer insight director Stephen Lowe explains.
“It could be a catalyst for huge growth in the sector, particularly as research suggests six or seven times more people could benefit from immediate needs annuities than currently buy one.”
However, the ABI expects that new products for care saving may only initially reach a small market.
“The issue with care annuities is that the money is tied up, it cannot be used for anything else. For younger people the cost may be acceptable but they would not see the need, while for older people they may see the need but the cost would be too prohibitive,” Barlow explains.
Instead, the ABI recommends growing awareness around the costs of care, and exactly what the government will and will not provide.
From April 2016, the Local Authority will take on all care costs once the £72,000 cap has been paid by the individual. However the cap is based on the Local Authority’s assessment of care needs and costs. So for instance if the individual chooses to live in a care home more expensive than the Local Authority’s allocated cost, they would have to pay the difference even after the cap had been reached.
Also, food and accommodation costs, up to £12,000, are not regarded as care costs so are not included in the cap. However the government has said that this figure should be broadly in line with the single-tier state pension, potentially enabling people to use that to pay these costs.
As the ABI report states that 114 weeks (801 days) is the average length of stay in a BUPA care home, with £536 per week the UK average annual fee in 2012 for a single room in a private residential home, the cost to individuals for care can still greatly exceed the £72,000 cap. According to the Department of Health, 16 per cent of older people will have care costs of more than £72,000.
To increase understanding of this, the ABI recommends a government-led public initiative, along with amendments to the Care Bill to improve access to regulated advice, and to guidance.
However, Cameron says: “Most of the educational material that has been talked about has been focused on those about to go into a care home, with the Local Authority having to refer people to where they can get advice. If you are coming up to retirement you are not necessarily going to ask your Local Authority for information in case you need long term care in 20 years’ time.”
Therefore this initiative will need to be complemented by the pensions industry, and other relevant parties. “You have lots of people who are experts in retirement products and financial services. You have lots of people who are experts in the provision of care, instead of the funding of it. But there are not many people who are experts in both. So for this market to take off I think the number of experts need to increase, or the dialogue between the two needs to improve,” Cameron adds.
The pensions industry’s efforts in encouraging people to save generally for retirement also have a role to play. According to Barlow, it is already difficult to get people to save for retirement despite most thinking they will retire, “so to add saving for care on top of that is an even more difficult message, as hardly anybody believes that they will need long term care”.
“If we can’t get people to think about their retirement before it happens we will struggle to get them to think about care. The whole area needs better communication,” he adds.
The Department of Health and the ABI will be reviewing the progress made in helping people afford long term care in the first half of 2014. Therefore, it seems the relationship between retirement saving and funding long term care is only going to increase in importance.
Laura Blows is editor of Pensions Age