Out-Law Analysis 4 min. read
26 Jun 2023, 9:53 am
With an increasing number of pensions schemes in a position to secure a full buy-in and then wind up, the buy-out clauses in bulk annuity policies are coming under closer scrutiny, trustees will want to understand what the typical provisions governing buy-out are.
Prior to buy-out, trustees should ensure the insured benefits reflect those under the scheme.
Trustees can usually request to amend benefits at the point of buy-out as part of a final data cleanse. The insurer can then review the requested changes and decide whether it will agree to insure them. It will then be important for the insurer to have sole discretion to agree to insure any additional benefits for Solvency II purposes.
From the trustee’s perspective, they may want to use this option to change any benefits to correct them once they have finished their GMP equalisation exercise which may be after the initial data cleanse. The insurer may issue a separate insurance policy – again, for Solvency II reasons – to the trustee in respect of these additional benefits. However, when the scheme moves to buy-out, the member will only receive one individual policy that will incorporate all of their benefits – including any benefit changes that have been insured.
Insurers can be quite prescriptive in their contract about the form of the final data cleanse sign-off. Trustees may need support with the warranties, form of report, trustee resolutions, disclosures, and comfort letters. It is important there is a water-tight legal focus on tracing changes to the benefits secured back to trustee decisions. This will mean there is a clear record-trail that can be relied upon by the trustees if the decision is challenged in the future.
Another area where insurers have requirements is the form of the final benefit statement that accompanies a section 74 discharge notice. These have in the past been quite light touch in detailing all aspects of the members’ benefits, but both trustees and insurers are increasingly taking the view that a very detailed benefit statement provides better protection. This is so that members can review the statement and raise any potential issues before buy-out.
Administration can also be an issue depending on how quickly the insurer can take on payroll. Some insurers are happy to do that before buy-out while others are not. Trustees will need to consider the timetable for when administration will be taken over by the insurer. This is because administration is often a costly process to keep running for the scheme.
In most buy-out projects, the insurer is asked to convert the bulk annuity policy into individual policies in the name of the pension scheme trustee, with the trustee then assigning the individual policies directly to members. This two-stage approach is widely regarded as reducing the risks of pension scheme members losing tax protection for the lifetime allowance. The two-stage approach also protects any members living outside the UK from losing protection from the Financial Services Compensation Scheme (FSCS) if the insurer fails to pay their benefits.
Although this structure adds a layer of complexity to buy-out project plans, it is important for trustees to take reasonable steps to help members retain relevant tax and regulatory protections.
The importance of ensuring that all conditions are satisfied should not be understated. Typically, the conditions include that there are no outstanding payments, that the data cleanse has been completed and that GMP equalisation has been carried out.
Some insurers will have a longer list of conditions that must be satisfied before buy-out, whilst others are more pragmatic. In either case, it is crucial for trustees to be sure that the conditions are met and the insurer agrees that individual policies can be issued before buy-out is triggered. Getting these conditions right from a trustee perspective should be addressed upfront at the buy-in stage as part of the requested contractual terms (RCTs) process.
If any members of the scheme appear on a financial sanctions list, this could put the insurer in legal difficulty if an individual policy is issued to that member. Whilst it is unlikely to apply to most schemes, the insurer will want to be sure that no member is subject to financial sanctions. The contract between the trustees and the insurer may stipulate that the trustee check and confirm that no member is subject to financial sanctions. This may require the trustees to check sanctions lists maintained by HM Treasury and other government organisations in the EU and the US.
Trustees must provide a formal notice to the members to confirm how they intend to secure the members benefits under section 74 of the Pensions Act 1995.
The three main ways of securing benefits are: to arrange annuities with an insurance company; to arrange transfers to another occupational or personal pension scheme and to accept the transfer payment, or; to commute members’ pension entitlements for a cash sum.
Trustees are obliged to provide the members with details of the proposed method to secure their benefits. The section 74 notice can pose as an impediment to buy-out because the trustees must give at least three months’ notice to the member before the section 74 notice is effective in giving the trustees a discharge of liability.
If, at any point before it was abolished on 6 April 2016, a scheme has contracted out of the state pension, the scheme is not allowed to discharge its liabilities until it has reconciled its records in respect of GMPs. The High Court confirmed in the case of Lloyds Banking Group Pensions Trustees Ltd v Lloyds Bank plc that trustees are obliged by law to equalise pension benefits between men and women to reflect unequal GMPs. There is little guidance and consensus on achieving this and, in practice, GMP equalisation is an area that many trustees are still grappling with.
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