Buy-outs and buy-ins arranged with an insurer have become an increasingly popular method of risk transfer for scheme sponsors and trustees, though they are often expensive and involve significant planning.
Buy-outs are a method of transferring an occupational pension scheme’s accrued liabilities to an insurer in return for a fee or premium. They are usually seen as a de-risking exercise for defined benefit (DB) scheme sponsors and have been increasingly utilised over the last 2 decades. Once a buy-out completes, the liability for paying member pension benefits lies with the insurer. The buy-out arrangement also removes the responsibility of paying benefits from the sponsor and the trustees i.e. the liability has been bought out.
Buy-outs and scheme members
The buy-out offers members the security of an insurance policy to meet their retirement benefits. Tax law also provides that a buy-out arrangement will not impact the relevant scheme’s Revenue approved status notwithstanding any provisions in the scheme’s rules.
Buy-out arrangements are specifically provided for under the Pensions Act (the Act) as well. It provides trustees with a power to buy-out pensioner liabilities without member consent. Section 53B of the Act is designed specifically to allow for contracts of assurance that discharge the liability of a scheme, a buy-out, to cover some or all of the benefits payable to or in respect of a person who, under a scheme, is receiving benefits or has reached normal pensionable age.
A buy-in is facilitated by way of the purchase of an insurance policy and is also a liability mitigation exercise. A buy-in is carried out with the object of removing the risks of investment, longevity, interest rate changes and inflation for the members covered by the policy. A ‘partial’ buy-in may also be done and it will cover a subset of the scheme liabilities allowing for ‘partial de-risking’. For example, a buy-in might be completed to de-risk liabilities relating to deferred pensioners or current pensioners only. Buy-in exercises are also provided for under Section 53B of the Act. Trustees may proceed with a buy-in exercise if the purchase of an annuity is permitted by the scheme’s trust deed and rules or other governing documentation. In most cases the scheme governing documentation will permit the purchase of such an annuity.
Buy-ins and scheme members
While trustees may proceed with a buy-in if it is permitted by their scheme’s trust deed and rules, consideration should also be given to the scheme’s Statement of Investment Policy Principles. Trustees should consult the sponsoring employer on any significant changes to the Scheme’s investment arrangements and enquiries should be made as to whether any portfolio rebalancing or hedging is required to accommodate the purchase of a bulk annuity. However, the Trustees retain ultimate responsibility for investment decisions and the consent of the scheme members is not required before a buy-in exercise can be completed.
Though member consent is not required for trustees to complete a buy-in exercise, the trustees will have to bear in mind the requirements of the Occupation Pension Schemes (Investment) Regulations 2006.
Buy-outs present trustees and sponsors with a useful risk mitigation solution and are usually carried out as part of a scheme wind-up. A buy-in, on the other hand, is a useful investment option to assist trustees in moving toward a goal, which is often a buy-out, by providing immediate cash-flow. As insurance companies face significant capital and regulatory restrictions, buy-out exercises are expensive and trustees should always consider if it is the most cost effective option for the scheme. While member consent is not an issue for a buy-outs or buy-ins, the interests of scheme members should be first and foremost in the minds of trustee and sponsors.
For more information, contact a member of our Pensions team.
The content of this article is provided for information purposes only and does not constitute legal or other advice.