Out-Law / Your Daily Need-To-Know

Out-Law Guide 6 min. read

Achieving a trustee led pension scheme buy-out

Pension scheme buy-outs, where an insurer is paid an upfront premium to take on the ongoing risk of funding and paying members' benefits, are increasing in prevalence and becoming an option for a growing number of trustees and their sponsors.

Achieving a successful trustee-led pension scheme buy-out in the current economic circumstances requires trustees to be alive to market pricing, collaborate with sponsoring employers and take steps in advance of a potential deal to tidy up benefits, update data and manage risk. In this guide we look in more detail at each of those issues.

A buoyant market despite Covid-19

The UK pensions risk transfer market has so far shown remarkable resilience to the economic impact of the Covid-19 pandemic, which is understandably driving cash conservation by many businesses. Market surveys suggested deal volumes for 2020 remained on track to match those from some of the busiest years over the last decade. A major reason for this is the number of full buy-out deals which are coming to the market without the need for a sponsor contribution.

We are increasingly seeing pension schemes at the more mature end of the scale, and which over the last decade adopted prudent liability management and hedging strategies, achieving a funding position within striking distance of achieving this.

de Ferrars Matthew

Matthew de Ferrars


Early sponsor engagement and collaboration will be important, not least to give potential insurers the confidence that the scheme is ready to transact 

The main ingredients for achieving a successful trustee-led pension scheme buy-out

Scheme assets and insurer pricing

It goes without saying that achieving buy-out requires a convergence of scheme asset values and insurer pricing. Trustees' careful management over a number of years of a sound asset and liability management strategy is often the foundation stone for these deals. We are increasingly seeing these strategies, often put in place a decade or so ago, paying off and bringing schemes close to insurer pricing levels for a full buy-out.

With the support of specialist consultancy advice, trustees can monitor pricing so that when financial conditions are right they can move quickly to secure full insurance of their scheme's benefits with a competitive broking process. This is the starting point for trustees to secure a successful buy-out deal without employer contribution, and a central one for consultancy advice. However, it is worth also considering below some of the other ingredients for a successful buy-out project.

Collaboration with the sponsor

In the current uncertain economic environment, for a buy-out deal to go ahead it will often need to be able to be funded entirely from scheme asset and without recourse to the sponsor. However, that is not to say the sponsor does not still have a part to play in the process. Early sponsor engagement and collaboration will be important, not least to give potential insurers the confidence that the scheme is ready to transact.

The end goal of the process will be the winding-up of the scheme and discharge of the trustees from future liability. Typically the sponsor has a legal role to play in starting that process and it is only right that trustees and sponsor should be in agreement about how and when a scheme enters the final stage of its life.

It may seem unlikely in the current environment, but we are also seeing schemes in the fortunate position of having a surplus. In most cases collaboration with the sponsor over the use of any surplus will be necessary – should it be returned to the sponsor or be used to improve benefits for members including through some form of residual risks cover, or a combination of the two?

Trustee governance

Good trustee governance is essential to securing a successful deal. This is not only in order to run an effective process, but also in a very busy market to secure insurer engagement. If the scheme is presented as an attractive package in every respect, which is very likely to transact, it will help to secure insurer engagement and potentially better pricing.

de Ferrars Matthew

Matthew de Ferrars


With support from advisers with market experience, they will be able to focus on the commercial and legal points that really make a difference

Having a professional trustee on board who has a track record of achieving de-risking deals will give insurers the impression the scheme means business. As will the involvement of professional advisers, broking and legal, who are known in this area.

Setting up a buy-out sub-committee will also enable a trustee board to move swiftly, outside the usual trustee meeting cycle, and will allow those trustees on the board with the most relevant expertise and experience to do much of the heavy lifting. With support from advisers with market experience, they will be able to focus on the commercial and legal points that really make a difference. In a very busy and timing-focussed market, it is important to avoid gold-plating the contract because of the execution risk that can introduce to a deal.

Getting scheme benefits and data right

It is important to start early on the process of getting a scheme's benefits and data correct. Trustees should put in place processes to track down missing data and members, and otherwise ensure member data is up to scratch. If data is patchy, insurers may refuse to go ahead or increase the price. Trustees won't want to run the risk of securing the wrong benefits, and incurring ongoing liability after wind-up, because of poor data.

Scheme amendments over time can lead to tortuously complex benefit structures. Trustees need to check that the benefits the scheme administrator believes are payable tie up with what the scheme rules set out. This will usually mean tracking down old deeds of amendment and carrying out a benefit audit. Any mistakes need to be sorted out early. With good professional advice, pragmatic but legally robust solutions can be found.

For those schemes that are still a long way from buy-out, but have this as their long-term objective, it is important that they strive to ensure that decisions they are taking now in relation to benefits and data are compatible with that long-term objective. A good example of this is 'guaranteed minimum pension' (GMP) equalisation, which presents an opportunity to make benefits more efficient to insure, but also a risk of creating ongoing tax obligations which would be unattractive for insurers. 

Tidying up benefits

Pension schemes contain numerous trustee discretions. In some cases there is a need under the scheme rules to involve the sponsor in exercising those discretions. However, insurers do not typically provide discretionary benefits – everything needs to be buttoned down as an agreed and definite set of benefits.

An example of this is the payment of a pension to a dependant on the death of a member. The insurer will use a precise formula for deciding who is and who is not a financial dependant, where trustees will often give individual consideration to cases.

It therefore makes sense for trustees to go through a process of identifying these discretions and working out how they will codify them in way which will be acceptable to insurers. Similarly, pension schemes sometimes contain little-used member options, such as the ability to surrender pension for more pension for a dependant. These can be expensive to insure and in some cases insurers will refuse to insure them. It makes sense to tidy this area up in good time for a transaction.

Trustee liability and protections

The point of a buy-out transaction is not only to remove defined benefit liabilities from the sponsor's balance sheet and safeguard members' benefits, but also ensure that the trustees are fully discharged from future liability. There are several dimensions to achieving this: the statutory winding-up framework, the trustees' protections under the rules of the scheme, sponsor indemnities, trustee indemnity insurance and extra features in the insurance policy with the buy-out insurer, often referred to as residual risk cover. 

Trustees need to ensure that they don't end up paying for unnecessary or duplicated cover and also that there aren't any gaps in their protections. This requires planning ahead. The best way to do this is for the trustees to obtain legal advice on the different areas where they face risk, which may include around historic administration and documentation errors, sex equalisation and GMPs, and how the different protections and insurance cover available will respond to those risks. That way a holistic view can be taken and a plan developed to ensure the right protections are in place and money is not spent on unnecessary cover.

In summary

Despite the pandemic, full buy-out without sponsor contribution is increasingly coming within reach of some pension schemes. Through careful monitoring of insurer pricing and seizing the opportunity to fully insure all their liabilities, trustees can fulfil their first duty to safeguard the security of their members' benefits.

Whilst asset and liability management strategies have been vital for these fortunate schemes to reach this end goal, there are other steps trustees can take to guarantee a successful process from start to finish. Good governance and involving professionals with experience in this area is important, but so too is advanced planning in relation to benefits, data and managing risk.

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