What happens to life cover when an employee leaves?

As an employer, you can provide death-in-service benefits to your employees in two ways. A group life scheme uses group life cover, and you can also buy a relevant life policy. You can buy both policies to work together or choose one. Whichever option you choose, you pay the premiums, and the policy pays a lump sum upon an employee's death.

Group life insurance

A group life insurance policy pays a lump sum to an employee's beneficiaries when the employee dies while employed by you. Their death doesn't have to be work-related. Your insurance company calculates the lump sum based on a multiple of an employee's usual salary. The multiple is usually between 2 and 4 times their salary, and you can choose the one that applies.

Relevant life cover

A relevant life policy works in the same way as a group policy: it pays a lump sum, equivalent to a multiple of your employee's salary, to their beneficiaries should the worst happen.

The main difference between a relevant life policy and a group life scheme is that you can buy relevant life cover if you don't qualify for a group policy. Group life policies typically require a minimum number of employees, so one-person limited companies or those with a small team aren't usually eligible.

A group life insurance policy only covers your employees when they're employed by your business when they die. If they've resigned or retired, their coverage ends. There can be some grey areas, for example, if an employee resigns and is placed on gardening leave during their notice period. It's a good idea to get legal advice to find out where you stand.

The position with a relevant life policy differs from group life insurance in that an employee's coverage doesn't necessarily end when they leave your company. However, they must usually act to make changes.

There are three main options available, and it's worth discussing them with your team.

Coverage ends

The most straightforward option is for an employee to leave and have their policy coverage end the same way as it would under a group policy. Employees who change jobs may have death-in-service benefits with their new employer, a personal policy, or both, meaning they don't need continuing coverage.

They can transfer the policy to their new employer

A relevant life policy can include continuation or conversion options that allow employees to transfer their policy to a new employer or change it to a different policy type. If the new employer offers generous death-in-service cover, your employee may not need to transfer their policy. Transferring the policy is also possible only if the employer agrees to the switch.

They can change the policy to provide personal cover

A conversion option lets an employee change the policy to provide personal coverage when they leave your company. The coverage continues uninterrupted, and the employee agrees to pay the premiums themselves. This can be a good choice for an employee who is leaving employment to take on contract work or other self-employment. Alternatively, they may be joining a new company and want to supplement the life cover provided by their employee benefits package.

As we've discussed, a relevant life policy can be transferable to a new employer, but how does this work in practice? There are a few factors to consider, which will be relevant to your staff when they leave, but that will also influence whether you accept transfers when recruiting new staff.

They may already have generous death-in-service benefits

When starting a new role, employees should consider whether the death-in-service benefits included in their package are adequate for their needs. This will vary depending on their financial circumstances and requirements. They may be able to keep the policy by funding the premiums themselves or seeking a transfer if this isn't possible.

However, a transfer likely won't be necessary if the life cover offered by their new employer is already generous.

The new employer may refuse the transfer

As an employer, you choose your insurance provider and policy with care to provide cost-effective and generous life insurance for your team. Administering the scheme, including carrying out policy renewals with your broker, ensuring employee records are up to date and appointing or replacing scheme trustees when necessary, all take time and effort.

If a recruit wants to transfer their relevant life policy from their previous employer to you, this will require administering an additional policy that may be with a different provider. If several employees request a transfer, this may create significant additional work that your HR and accounts staff would rather avoid. Equally, their new employer may be unwilling to accept a transfer for similar reasons.

The sum assured may be unsuitable

The multiple that relevant life insurance policies pay is based on an employee's current salary. When they leave for a new job, they may attract a higher salary and a higher death-in-service benefit, which makes the payout seem inadequate or render a transfer unnecessary. Alternatively, they may switch to a part-time job with lower earnings to accommodate a change in their personal circumstances, making the sum assured and the associated premium excessive or unaffordable for their new employer.

The employee needs to act promptly

Transfer options for relevant life cover typically include a specified time period for changes, typically up to 90 days after an employee leaves your employment. The employee must exercise the option to transfer the policy, which also requires securing their new employer's agreement. If they fail to act promptly, or if their new employer delays making the decision or completing the necessary paperwork, the option could lapse.

From an employee's perspective, it's worth checking the approach their new employer will likely take at an early stage.

There may be differing terms and conditions

Having a single insurance provider for your entire workforce creates consistency and promotes fairness. Insurers apply different definitions to death in service and terminal illness cover, which may mean that introducing a policy from a different provider results in employees being treated differently. For example, insurers list the conditions covered by critical illness or terminal illness cover, with some covering more conditions than others, or paying out sooner. Refusing transfers and providing the same cover options for all staff avoids perceived unfairness.

Even if an employee has death-in-service benefits, an individual policy can be a wise choice. It can provide an additional safety net to their loved ones and ensure ongoing cover during any breaks in employment. Let's consider the practicalities.

No additional medical underwriting

There will often be a medical underwriting process when an employee first joins your company's life insurance scheme. Insurers will examine their medical history, age, lifestyle, and hobbies during their risk assessment. When they convert this policy to provide personal coverage, they can often keep the same terms and conditions without additional medical underwriting. By contrast, when buying a new individual policy, they'll go through the underwriting process again. They may end up with different terms and conditions, additional policy exclusions or a higher premium.

The term and sum assured remain the same

When buying a policy for employees, you choose the sum assured and policy term, usually setting the end date to coincide with an employee's anticipated retirement date. If an employee leaves and transfers the policy, the lump sum payment and policy term remain the same. This is fine if the policy still meets their needs, but it could cause issues if their circumstances have changed. Shopping around and getting comparison quotes from a broker could help them find a more affordable policy with coverage that meets their requirements.

Employees must pay the premium themselves

Your employees may not have realised how much cover they need or how much it costs, since you were paying the premiums for them. Converting the policy means they must fund the premiums themselves, which could cause financial difficulties. Premiums for individual policies are often calculated differently from group policies. Some apply higher premiums as you age, so employees must consider how these increases will impact them.

Ensuring the policy is in a trust

When a business invests in a relevant life policy, it's typically set up to pay into a trust and supervised by trustees. However, this doesn't happen automatically with individual policies, and your employee may need to request this during the transfer. If they don't have a trust in place, this can have inheritance tax implications.

What are the inheritance tax implications?

A policy that’s held in trust pays into the trust and doesn’t form part of someone’s estate when they die. Individuals have different tax-free allowances, and the amount of inheritance tax they pay depends on the value of their assets, what their estate includes and who the beneficiaries are. Paying the lump sum into a trust means it doesn't form part of the inheritance tax calculation, which can be more tax-efficient. The money is often paid to their loved ones more quickly, as it doesn’t have to go through probate.

We've discussed some of the pros and cons of transferring a relevant life policy, but there are circumstances in which it may not be possible.

In most cases, life cover is only available to UK businesses and employees resident in the UK, even if they work overseas. If an employee plans to move abroad permanently, either during their retirement or for work, the policy exclusions will likely prevent them from taking the policy with them.

Transferring a policy to a new employer is only possible if the new employer agrees to accept it. However, there may be circumstances when an employee doesn't have a new employer in the traditional sense. They may plan to take on fixed-term contract work, meaning their employer changes regularly. Alternatively, they may plan to become self-employed.

If an individual registers a one-person company with Companies House, they may still be eligible for a relevant life policy. However, if they become a sole trader without a limited company, this won't apply, and they must convert to an individual policy or buy a new one.

Communication is key to helping your team make informed financial choices and ensure they have the right life insurance coverage for their needs. Sharing information can support existing employees and those who choose to leave.

Here are two ways you can support the process.

Promote access to independent advice

Ensuring your employees have access to independent advice helps them manage their finances in multiple ways. Staff training can cover a range of financial topics, including how to manage your money and find a trusted advisor. An insurance broker can provide information on your life insurance coverage and terms and conditions, so employees can seek comparison quotes when arranging additional coverage or considering transferring their policy.

A resource library with links to information from reliable sources can also be useful.

Provide an Employee Assistance Programme (EAP)

An Employee Assistance Programme (EAP) can be a standalone service or come as part of your employee health insurance. An EAP provides access to counselling for mental health concerns, but most also include financial and legal telephone helplines. These can provide general guidance and signpost staff to professional financial advice for tailored support.

Choosing the right group life policy or relevant life cover is the first step in protecting your employees’ financial future. An independent insurance broker can help you find the best life insurance policy for your staff and provide resources to keep them informed about their coverage. Contact us for tailored advice to help you find the best policy for your needs.