Out-Law Analysis 4 min. read
29 Jun 2023, 11:35 am
Pension trustees want an insurance policy which closely reflects their scheme’s benefit structure, as this is critical to obtaining a discharge from liability on buyout and winding-up.
However, some scheme benefits can be difficult for insurers to administer or hedge against, making them difficult or prohibitively expensive to insure. Common examples include defined contribution (DC) underpins, benefits linked to the continuing employment status of the member, and member options which present a selection risk to the insurer.
We are seeing a greater focus on these benefit issues as more pension schemes prepare for a full buy-in and wind-up, with advance agreement to insure these benefits asked for in requested contractual terms (RCTs).
DC underpins raise matching adjustment issues for insurers. There is no magic solution for underpins, but it led to an interesting proposal for one scheme we advised on which identified a number of members with DC underpins shortly before buy-in.
In that case, the insurers had to decide whether to exclude them, with possibility of adding them later, but on a discretionary basis and using a prevailing pricing basis due to Solvency II, or to include them, facing the risk of pricing impact if they were later to be removed on best estimate liability terms.
One solution we have seen implemented is to insure the DC underpins from the outset with a notional pension amount – for example, £1 – meaning any change to that amount could be classed as a data correction, making it Solvency II-compliant.
Where there are tricky benefits, it is important for trustees to understand just how close the insurer can get to replicating the scheme benefits, as they may be pleasantly surprised.
For example, we recently agreed a framework for an insurer to cover enhanced early retirement benefits for deferred members who were unable to continue their occupation due to ill-health. We worked closely with the insurer and the scheme administrators to set clear objective criteria for members to qualify for the benefit, and evidential requirements and protocols which would need to be followed to substantiate the claim. This gave the insurer the certainty it needed to be able to price and insure the benefit on a basis which was very close to that set out in the scheme rules.
Where the gap cannot be bridged, it is important for trustees and sponsoring employers to understand the funding and risk implications for the remainder of the buy-in stage and buy-out. Trustees should also seek legal advice on other possible ways of aligning the scheme rules with the benefits which can actually be insured. This may involve checking the extent of any powers in the scheme rules to insure benefits on different terms and conditions, and how this interacts with laws and rules which protect the benefits that members have already built up.
An area where the alignment of scheme rules before buy-out may be important is member options.
A common option in scheme rules which is problematic for insurance is the option for members to surrender their own pension for an adult dependant’s or greater spouse’s pension. Insurers are generally reluctant to insure options such as these, not least because of the risk of selection against the insurer. The legal question is then one of whether these options can be ignored when it comes to buying out the scheme – and this may hang on whether the member has an absolute right to exercise the option, or it is subject to the consent of the trustees. In practice it will also be relevant whether the option has in the past been communicated and/or exercised by members. Some of these options may only exist in the scheme rules and never have been used in practice.
The complexity of guaranteed minimum pension (GMP) and conversion should not be underestimated, both in terms of the project itself but also the impact that it has on the buy-out documents. Very fiddly changes have to be made to benefit specifications, particularly given insurer requirements.
When advising on a recent buy-out project, we were required by an insurer to present two versions of the same benefit specification – one showing all data cleanse changes other than GMP conversion, then a second version showing the GMP conversion changes – to help them assess the impact on cashflows.
Forfeiture or backpayments can be relevant on any buy-in or buy-out when questions arise of whether a scheme member’s benefits will be forfeited if they do not claim them in time, and whether the insurer will apply a different approach to the trustee after buy-out. This issue also arises where the insurer offers residual risks insurance. If a member can substantiate a claim to a higher level of benefits, so that the insurer has to top up those benefits, there will be a question of how far back in time the insurer should be required to go by the residual risks policy terms.
13 Jun 2023
13 Jun 2023