Permanent Health Insurance – the employment benefit which causes HR headaches
Permanent health insurance (PHI) is the employment benefit which breaks the rules. It can outlive employment, restrict an employer’s ability to dismiss, and expose businesses to liabilities lasting decades. The Court of Session’s recent decision in McMahon v AXA ICAS Ltd – confirming that PHI payments may be recoverable as wages after dismissal – brings those risks into sharp focus.
What is PHI?
Permanent health insurance (PHI) – also known as group income protection – replaces a proportion of an employee’s salary (typically 50-75%) where they are unable to work due to long-term illness or injury. Payments are not generally made directly by the employer; they are secured via third party insurance. Payments generally begin after a deferred period of 26 to 52 weeks, and most schemes require the employee to remain employed to receive the benefit. That requirement is where the tension arises.
Express contractual right to PHI
PHI is usually provided as an express contractual benefit. Well-drafted clauses should:
- Make clear that PHI is an insured benefit, subject to insurer rules, scheme terms, and reasonable premiums
- Confirm there is no obligation to provide a replacement benefit if cover is unavailable
- State that the employer’s role is limited to passing on insurer payments
- Address director resignation where relevant
- Clarify the interaction with holiday pay
- Confirm that the provision of PHI does not prevent dismissal
Even with careful drafting, however, PHI risk cannot be fully eliminated.
The Aspden Implied Term and the Tesco v USDAW Parallel
There is an inherent tension with PHI: it only kicks in where an employee is too ill to work, but employment generally needs to continue for the benefit to survive. Aspden v Webbs Poultry established that a term will be implied into an employment contract preventing an employer from dismissing an employee on capability grounds where doing so would extinguish PHI entitlement. The implied term operates even where the contract contains an express right to dismiss on notice for ill health.
That principle has gained renewed significance following the Supreme Court’s decision in Tesco Stores v USDAW, which confirmed that an implied term can prevent an employer exercising an express contractual right where the purpose is to defeat a valuable entitlement. The parallel with PHI is direct.
The Aspden implied term does not prevent dismissal for good cause, even where it would deprive the employee of PHI benefits. Subsequent cases have confirmed that ‘good cause’ includes genuine redundancy and misconduct dismissals. However, an employer who dismisses an employee in receipt of PHI on ‘good cause’ grounds is taking a significant risk. Get it wrong, and you are writing a blank cheque for ongoing PHI payments – which, once the insurance ends on dismissal, fall directly on the employer.
Holiday entitlement during PHI
Retaining an employee on the payroll to preserve PHI entitlement raises the question of accruing annual leave. An employee cannot be required to take annual leave while off sick, and PHI payments are usually less than normal pay. The first instance decision in Souter v Royal College of Nursing Scotland addressed this by holding that holiday pay for someone receiving PHI should be calculated at the reduced PHI rate.
Given the uncertainty around Souter, some employers top up PHI to the employee’s usual pay during holiday periods. This encourages holiday-taking and creates a clear record – but at a direct cost not covered by the insurer.
Employers should pick an approach and apply it consistently, with contracts addressing holiday accrual and calculation during PHI receipt explicitly.
What happens if cover is discontinued
Cancelling the insurance policy does not cancel the contractual obligation. If PHI is a contractual benefit and an employer fails to maintain cover, it assumes direct liability for the payments the insurer would otherwise have made. Depending on the employee’s age and salary, that liability can run to retirement age.
McMahon v AXA: Wages as well as breach of contract
Aspden makes clear that employees dismissed for ill health can bring a breach of contract claim for loss of PHI cover. McMahon v AXA ICAS Ltd has widened that exposure materially. The Court held that PHI payments can constitute ‘wages’ even after dismissal, allowing an unlawful deductions claim for ongoing post-dismissal payments. The Court rejected the argument that termination automatically extinguished the entitlement.
The result is that a wrongly dismissed employee may pursue both a breach of contract claim and an unlawful deductions claim – routes with different limitation periods and compensation rules that, together, significantly widen the window of exposure. Crucially, there is no duty to mitigate on an unlawful deductions claim, so an eligible employee would be entitled to the full amount with no reduction.
Four practical steps
- Audit alignment – Ensure contractual PHI entitlements match current insurance cover. Any gap is a direct liability.
- Pause before action – If an employee is approaching PHI eligibility, take legal advice before initiating capability processes.
- Review drafting – Check contracts clearly address insurance dependency, dismissal rights, and scheme limitations.
- Protect continuity of cover – Treat policy renewals as critical. Even a short lapse at the wrong time can create substantial liability.