Pension buy-outs: aligning member benefits with insurer terms

In the case of a transfer to a superfund this will occur at the point of transfer - after which the terms of the superfund will wholly replace the terms of the original pension scheme from that point onwards.

Alternatively, in the case of a scheme moving through the process of turning a full buy-in into a buy-out with the insurer, the position is more complicated.

• During the buy-in phase there will be a period of transition and alignment between the scheme’s rules and the terms on which benefits have been insured with the insurer. During this phase, the scheme rules will determine ultimate legal entitlements of members but the insurer’s terms (in the bulk annuity contract) will in practice be the key reference point.
• Once the scheme has bought out, the scheme rules cease to determine members’ legal entitlements to benefits and will be replaced by the insurer’s policyholder documentation, which will have been issued to the members on buy-out.

The job of the risk transfer legal and broking advisers at the time of the buy-in transaction will be to ensure that the terms on which the members’ benefits are insured are consistent with the scheme rules. And where this is not possible, they will need to ensure it will be possible to bring the scheme in line with the terms of the insurance – using a legal process where necessary.

The insurer’s terms will be contained within the bulk annuity contractual documentation. More specifically they will be contained within the insurer benefit specification and any document codifying how the insurer will exercise discretions.

In addition to this there will be the insurer’s standard factors for benefit options, such as early and late retirement and cash lump sum commutation.

What in practice does all of this mean for the pension scheme administrator?

Following the buy-in, as a general rule the administrator would expect the administration of benefits to follow these insurer terms. However, the scheme rules will continue to govern the ultimate legal position. In practice, this is only likely to make a difference in exceptional cases and the administrator’s working assumption should be that the insurer benefit specification and codified discretions document will have become the primary reference point.

As it will not in all cases be possible to insure exactly the same benefits as under the scheme rules, the administrator will need to have details of how the scheme rules have been aligned with the insurer terms.  

This is best illustrated by some common examples:

• General benefit structure – for a range of reasons the benefits which are insured in the buy-in transaction may be different from those under the scheme rules. This is not a problem from a legal perspective when the benefits that are insured are more generous. This may, for example, be due to limitations on what the insurer is prepared to insure, or to reduce complexity – such as if there are multiple historic membership categories - or because the trustee and sponsor agree to insure a benefit improvement. The administrator will need to be made aware of this and, in particular, the date from which any change relative to the position under the scheme rules will apply.
• Discretionary cases – as part of the process leading up to the buy-in transaction, the trustee - and in some cases the sponsor - will need to agree how any discretionary benefits are codified or “fixed”. This would apply to benefits where the entitlement is subject to the exercise of a trustee, or sponsor, discretion - such as eligibility for an early or late retirement pension or determining the recipient of benefits payable on death. Again, the administrator will need to be made aware of this since, other than in exceptional cases, the insurer’s table setting out the codified discretions will determine how the benefits should be administered.
• Actuarial factors for member options - as part of the buy-in transaction the insurer’s actuarial factors, for example, for early and late retirement and commutation will be adopted by the scheme. Given that during the buy-in phase the scheme rules will still govern the position, there will be a need for the trustee to obtain advice and check these factors are reasonable. However, the general rule will be that the administrator will need to proceed on the basis of the insurer’s factors – and in any case will be likely to be relying on the insurer’s benefit calculations for processing member benefits.
• Tricky benefits to insure – it can be the case that under the scheme rules there are benefits which it is not possible for the trustee to insure at the buy-in stage and which therefore cannot be bought out. Examples of these include: money purchase underpins to defined benefits and GMP underpins to money purchase benefits as well as service linked benefits, such as enhanced ill health benefits or final salary links. Often, once the buy-in has been transacted, there will need to be a process to bring the scheme rules in line with the terms of the insurance. This may require a legal process to remove the tricky benefits to insure. The administrator will need to know the outcome of this process and when that benefit will have ceased to apply under the scheme.
• Benefit options – a decision may be taken at the buy-in transaction stage not to insure certain member options. This may be in order to simplify matters or simply because of what it is possible to insure. Common examples of this include, bridging pensions and dependant’s pensions by surrender. Where the trustee has taken a decision that these options are no longer available under the scheme as they have not been insured, the administrator will need to be made aware of this and member communications updated.