Pension buy-outs: residual risks cover for winding-up pension schemes

For this reason, trustees may wish to prepare a list of their requested contractual terms (RCTs) for the residual risks cover, in much the same way as for the main buy-in policy. The sponsoring employer may also want to comment on the RCTs from its perspective.

If the trustees are in discussions with several insurers about residual risks cover, this will help them understand if they are comparing like with like. The process also has the advantage of flushing out areas that are likely to require further negotiation and work. The trustees can then decide how best to approach these and adapt their wind-up plan accordingly.

Strategically, trustees planning to buy-in/buy-out and wind-up their scheme should bear in mind that they’ll probably have more leverage to secure favourable terms if they can present the main buy-in, which will carry a larger premium, as conditional on satisfactory residual risks terms being offered.

Below, we set out some of the questions trustees should ask themselves to help inform their preparation of their RCTs and wind-up plans.

When should the residual risks cover apply from?

Whilst residual risks cover is often perceived as a protection that applies from buy-out, trustees may also feel it’s particularly valuable during buy-in. This is because there may be a higher risk during buy-in of a change in law requiring the trustees to uplift benefits, or of member complaints and claims arising, perhaps prompted by wind-up communications sent to members. On the other hand, if cover is to apply from buy-in, the insurer may not allow the trustees to complete full data cleansing after signing as this might increase the risk of claims the insurer is responsible for. Trustees would need to decide whether this works for them.

Who will bear the costs of the insurer’s residual risks due diligence?

The insurer will wish to conduct due diligence on the scheme and exclude from the cover any specific issues this reveals. The costs of this due diligence can be significant. Trustees would ideally want the insurer to bear these costs, even if the trustees do not go on to sign the buy-in/residual risks policy.

Do the trustees want cover to be all-encompassing or for specific risk items?

Trustees might be attracted to insuring only those risks they are particularly concerned about. However, they should note that insurers will not necessarily let them pick and choose from a menu of risk items. This is because it can be difficult to truly separate out and price different types of risk which are often interconnected – for example,  the boundary between data and legal risk can be blurred.

Will there be an overall cap on the insurer’s liability under the residual risks cover?

The insurer and trustees may agree that an overall cap is to apply to the insurer’s liability under the policy. If the trustees are happy with this in principle, they’ll wish to make sure they properly understand how the cap operates, including any mechanism for reducing the cap over time and calculating the remaining headroom in the cap following a claim.

What will the scope of any missing beneficiary cover be?

Trustees may want to define the covered ‘missing beneficiaries’ as beneficiaries they are not actually aware of having made certain specific enquiries of their current administrators. They will want to avoid having to make more onerous checks of historical records for details of beneficiaries.

How will a beneficiary’s claim to a higher benefit entitlement be substantiated?

The trustees will want certainty on this point under their residual risks policy. Where one beneficiary has substantiated a claim, they will want to know that the insurer is obliged to proactively identify and address the position for other beneficiaries affected by the issue even if they have not brought a claim.

If there are additional liabilities to be settled, how will any arrears due be dealt with?

The trustees will, for example, need to clarify whether the insurer is allowed to treat benefits as forfeited if they have remained unclaimed for a particular period or apply limitation defences, and the rate of interest to be applied to arrears during any period of underpayment. They’ll want to consider how the terms here dovetail with their scheme’s rules. 

How will the residual risks cover work post wind-up?

The trustees will typically want to see a clear obligation for the insurer to adjust the cover under individual buy-out policies to address any claims substantiated after buy-out. They’ll want to check if there is a suitable route for enforcing this obligation, either via the trustees, if the trustee body still exists; the sponsoring employer, if the trustee body no longer exists;, or potentially by giving beneficiaries third party rights under the residual risks policy.

After buy-out, the trustees will generally want to know that no further input or documentation is required from them before the insurer will address a claim. This is because the trustee body might no longer exist at the relevant time.

What are the ‘no-digging’ restrictions on the trustees?

Insurers will generally want to include a ‘no-digging’ clause that limits the trustees’ ability to take steps that crystallise risks the insurer is covering. The trustees will need to carefully consider this and satisfy themselves that the clause allows them to conduct their business-as-usual activities and comply with any overriding legal obligations they may have. 

What risks will be excluded from the cover?

Trustees need to understand the scope of any exclusions regarding liabilities that flow from their own conduct, or which would have been revealed by any documents/records they failed to disclose to the insurer. They’ll want to be sufficiently confident these exclusions will never bite in practice. 

They will also want to confirm any standard exclusions relating to liabilities the insurer is simply not willing to cover as a matter of policy – for example, relating to the invalid execution of documents, defined contribution benefits, or a failure to obtain required actuarial certifications when amending contracted-out benefits – and check these are satisfactory. Different insurers may have different standard exclusions.

If the insurer is proposing scheme-specific exclusions, trustees will want to check that these are justified based on due diligence and that the exclusion wording in the policy is no wider than it needs to be to cover the specific issue identified. This will often be one of the more time-consuming aspects of negotiations over the cover – so anything trustees can do to pre-empt insurer concerns will be helpful.

What is the sponsoring employer's perspective?

The sponsoring employer may be particularly interested in whether residual risks cover is worthwhile when compared to other forms of protection, especially if the employer has other potential uses for the funds used to pay the premium. An RCT process may help the trustees reassure the employer they have conducted a robust process to secure favourable residual risks terms that represent good value. The employer may want to comment on the RCTs and the buy-in/residual risks policy from its perspective – trustees should factor this into their wind-up plan.