Till death do us part?

Permanent health insurance can be an important tool for recruiting and
retaining senior executives. But beware – the advantages could be far
outweighed by huge penalties if employers fail to heed its hidden dangers. By
James Wilders

Money is often not the only reason an employee (particularly a senior
executive) accepts one job and declines another. The provision of a company
car, for example, is frequently an important consideration in status terms.
Less apparent benefits like life assurance and private medical insurance are
often also essential elements of the remuneration package.

Another important attraction for many employees is permanent health
insurance (PHI). Usually this is taken out by an employer on a group basis. The
employer will enter into a contract of insurance with an insurance company
under which it is insured against any of its employees, or specified groups of
staff, being prevented from working by ill-health.

Should any of the employees covered by the insurance become unable to work
because of illness, then the insurer will make a financial payment to the
employer. The payment will be a proportion of the employee’s salary, for
example a half or two-thirds of basic salary. Monthly payments will be made by
the insurer while the employee remains incapacitated. It is then for the
employer to pass on these regular payments to the absent employee.

As with all insurance contracts, the policy will be subject to limitations.
There will be a minimum period for which employees must remain incapable of
working (usually six months) before any benefits become payable. Also, the
insurer’s obligation to pay benefits will cease if the employer terminates the
employment of any member of staff who is the subject of the policy, if the employee
dies, or upon the employee reaching normal retirement age.

Quite separate from the insurance contract, the employer also enters into an
obligation with its employees for each of them to be members of the PHI scheme.
Membership of the scheme will form part of the terms of each employee’s
contract of employment. It is under the terms of the PHI scheme that the
employer will pass on to an incapacitated member of staff the insurance
benefits which the employer receives from the insurer. But in the absence of an
express agreement to the contrary, the detailed terms of the insurance between
the employer and the insurance company are not incorporated into individual
employment contracts. This gives rise to significant potential dangers in the
operation of PHI schemes.

References to membership of a PHI scheme in, for example, a written
employment contract or staff handbook are frequently vague and incomplete.
Often these documents make no reference to the limitations on the insurance
cover imposed by the insurer. So while providing this kind of benefit can
assist the employer in attracting the best quality staff, and retaining
existing staff with a valuable and often reassuring perk, those advantages can
be outweighed by the huge penalties for getting it wrong. Employees can end up
with far greater rights against the employer than the employer has insured
against.

Rights survive termination

The starting point for understanding the pitfalls facing employers is the
fact that only existing employees are likely to be covered by the policy of
insurance. The detailed terms of such policies include a definition of those
employees in respect to whom the insurer will pay out benefits if one of them
becomes incapacitated. The definition will limit those who are covered to
individuals who are existing employees. This interpretation of such a policy
was confirmed by the Court of Appeal in an unreported decision called Bastick v
Yamaichi (15 January 1993).

Often an executive’s service agreement will include detailed provisions
allowing the employer to dismiss in the event of prolonged incapacity. However,
this does not supersede the employee’s rights arising under any PHI scheme. In
the case of Aspden v Webbs Poultry & Meat Group, 1996, IRLR 521, the
contract of employment contained both a general power to terminate the
contract, and a specific power to dismiss Aspden in the event of him being
unable to discharge his duties, for a total of 183 days in any 12 consecutive
calendar months.

Aspden had been employed in a managerial position since December 1978.
Following a management buy-out, a generous PHI scheme for directors and senior
managers was introduced in the early part of 1985. Aspden was included in the
scheme. The cover was three-quarters of annual salary payable after 26 weeks’
incapacity and ending on the employee’s death, or retirement date, or the date
on which the employee ceased to be an eligible employee (which included
dismissal).

Aspden fell ill with angina. The managing director thought he was
malingering. Aspden was dismissed. In consequence he ceased to be an eligible
employee under the PHI scheme and lost his entitlement to PHI benefits. He
claimed damages for wrongful dismissal. The High Court held that
notwithstanding the express provision allowing the employer to dismiss Aspden
for prolonged incapacity, a term would be implied into his employment contract,
that the provisions for dismissal would not be operated so as to remove
Aspden’s entitlement to benefit under his employer’s PHI scheme, of which he
was a member.

The significance of the decision in Aspden is this. Even if an employee
becomes so ill that it is apparent he or she will never be able to return to
work, the employer must not dismiss, but must keep the employee "on the
books" if he or she is to remain covered by the employer’s PHI insurance.

Moreover, should the employer dismiss, then it may be faced with a
substantial claim for damages. Those damages will be assessed to represent the
PHI benefits the employee would have received had the employer not dismissed
him in breach of the implied term which was established in Aspden. There is no
limit on such damages so that in the case of a young employee on a high salary
who has no prospect of returning to work but who will survive until his or her
retirement date, the damages could be very substantial.

It should be noted that insurers may consent to the termination of an
employee’s employment and agree to pay insurance benefits direct to the
employee rather than through the employer. In those circumstances, the
employee’s dismissal may not be in breach of the implied term under Aspden.
However, the employer would still have to consider whether the dismissal could
be unfair and/or discriminatory on grounds of disability.

No restrictions for employee

The rights of employees under PHI schemes were further defined in the
subsequent case of Villella v MFI Furniture Centres, 1999, IRLR 468. Villella
ceased working due to ill-health. After six months of absence, he received
benefits in accordance with the PHI scheme. Subsequently the insurers told the
employer that the medical evidence no longer supported the continuation of
benefits. They then ceased paying benefits. Later the employers dismissed
Villella.

Villella sued his employers for benefits under their PHI scheme. The
employer argued that Villella ceased to be entitled to benefits when his
employment was terminated. It submitted that his contractual entitlement could
be no greater than the employer’s own entitlement against the insurers under the
insurance policy (with Villella ceasing to be covered by the policy when he was
dismissed), and that he was bound by the restrictions in the policy which were
incorporated into his employment contract by implication. The High Court held
that the restriction in the insurance policy which stipulated that entitlement
to benefit would cease on the employee leaving service, did not form part of
Villella’s contract of employment. He was therefore entitled to continue to
receive benefits from his employers. The employer’s argument that Villella’s
rights under his employment contract could be no greater than the its own
rights under the insurance policy was wrong. In this case MFI’s arrangements
with its insurers were irrelevant.

How, therefore, can the employer avoid having to pay out PHI benefits to an
incapacitated employee after the insurer has declined to pay?

– Identify the detailed terms under which employees enjoy membership of the
PHI scheme. Those terms may be recorded in the employment contract. There may
also be references to the scheme in employee handbooks. Alternatively they
could be included in an explanatory booklet or guidance note, memo or other
document.

– Bear in mind that in the event of a dispute, the Court would have to
decide how any vague references in such documents to the PHI scheme should be
construed and would imply any other terms necessary in order to make the scheme
workable. The cases described above show that the Court will be inclined to
interpret the PHI scheme in the employee’s favour.

– Ensure that your obligations to staff under the PHI scheme are no greater
than the cover you have taken out with insurers. If necessary, steps should be taken
to amend the PHI scheme so that it more closely reflects the insurance cover
available.

– Consider seeking the express agreement of all employees to any changes to
the scheme. Earlier cases in the context of mobility clauses are quite clear
that where a variation to an employment contract has no immediate practical
effect, the employee cannot be taken to implicitly accept the variation by
simply staying silent and not raising any objection. It may therefore not be
simply enough to notify staff of changes to the PHI scheme. Instead those
changes should be properly documented, preferably with each employee signing a
consent.

James Wilders is head of the employment department at Dickinson Dees in
Newcastle

Warning: choose your insurer with care

Any discussion about PHI schemes is not complete without a note of caution.
Like all diligent and prudent insurers, the insurance companies who specialise
in providing this kind of cover to employers will only admit claims after they
have fully investigated the condition of the affected employee.

I acted in one such case for a quantity surveyor. In March 1993 my client
developed the symptoms of a severe heart condition. He was a member of his
employer’s PHI scheme which was underwritten by one of the market leaders in
the field, Unum. These insurers accepted the severity of my client’s condition.
However they declined his claim on grounds that he could perform sedentary
work, and that the physical demands of his job were minimal.

Despite the medical evidence, Unum continued to resist the claim, even in
the face of requests and representations from my client’s MP. There was
therefore no alternative but to sue. Two weeks before the trial my client died.
Despite this Unum continued to resist the claim until a few days before the
re-arranged trial when they accepted that my client was indeed incapable of
working. Such was Unum’s conduct that on behalf of my client’s widow I pursued
an application at trial for them to pay my client’s costs on an indemnity basis.
The application was successful.

Employers should therefore be warned. One of your staff may have a
persuasive claim for PHI benefits. However, if insurers decline the claim then
the employee will be entitled to sue you for those benefits. In order to recover
against the insurers you will have to join them as a third party to the
employee’s claim. In my late client’s case, the insurers did not capitulate
even after my client had died and only accepted that he was incapacitated
virtually on the doorstep of the court.

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