What you need to know before seeking a buyout or buy-in

Advisers and decision-makers from the employer and trustees should be ready to respond quickly to favourable conditions and to keep competitive tension between insurers

In practice, a buyout of benefits by trustees usually only happens where all members’ liabilities are being secured on winding-up, when trustees should consider insurance protection against future claims by unknown beneficiaries.

Which liabilities?

Trustees, in discussion with the sponsoring employer, should decide which liabilities to buy in (or out) – often it is the pensioner liabilities, as annuities for deferred benefits are particularly expensive. Some trustees annuitise only the largest pensions in payment (‘top-slicing’), on the basis that they represent the greatest risk.

Be prepared

Data that is as complete and up-to-date as possible will help insurers provide more accurate quotations, as well as demonstrating the trustees’ serious intention to trade.

Insurers also need a detailed specification of benefits to be covered: any wrinkles in scheme rules should be ironed out before this is prepared. Consider replacing benefits insurers are reluctant to cover (such as pensions increasing by both an index and a minimum fixed rate) with alternative benefits of equivalent value if scheme rules allow; or, on a buy-in, excluding some benefits from the scope of the policy.  

Guaranteed minimum pensions may need equalising before an insurer will take them on. On a buyout, any discretions in the scheme rules will be lost unless they are hard-coded in the terms agreed with the insurer.

Paying the premium

Whether to fund the buy-in or buyout with existing assets, additional employer contributions or a combination of the two should be agreed with the employer.

Check the practicalities of selling scheme assets, particularly how much notice is required and whether dealing is restricted to certain days. In some cases, a direct transfer of assets (in specie) to the insurer may be possible.

Investment

Trustees should consider whether their investment strategy will remain appropriate both before and after the annuity purchase.

In the run-up to the transaction, hedging against movements in the value of scheme assets, compared with indices used in the insurer’s pricing model, can be worthwhile.

Selecting an insurer

Some insurers may decline to quote for a particular transaction. When choosing from interested insurers, trustees may consider, in addition to price:

• whether to transact with a general insurer that is a household name, or with a less well-known specialist bulk annuity provider;

• how the insurer communicates with existing annuity holders and whether this will be appropriate for their members;

• if the insurer offers 'medical underwriting', with price adjustments determined by members' responses to a health survey (medical underwriting is not always advantageous and can make subsequent non-medically underwritten annuities harder to obtain);

• if the insurer's administration is carried out in-house or outsourced, and can it deal with more complex benefits (for example, pensions which increase on the anniversary of retirement rather than on a fixed day);

• whether the insurer is willing to take on further tranches of liabilities from the scheme in future transactions, and to convert a buy-in policy into individual buyout policies in the members' names in due course;

• the insurer’s financial strength and security. Insurers providing annuities in the UK are regulated by the Prudential Regulation Authority. Individual and bulk annuities are also covered by the Financial Services Compensation Scheme, which provides 100 per cent compensation should the insurer fail. Trustees who need further reassurance may want to commission a covenant assessment on their preferred insurer before committing to the deal.

Market movements can create windows of opportunity – advisers and decision-makers from the employer and trustees should be ready to respond quickly to favourable conditions and to keep competitive tension between insurers.

Jill Clucas is of counsel at law firm Hogan Lovells