UK: Window Of Opportunity – Trustees Must Be Aware Of The Discussion On Buy-Out Options

Last Updated: 13 November 2008
Article by Iain Talman

Iain Talman explores the issues for trustees and how to manage the buy-out process whilst minimising risks.

Some sources estimate that the value of the pensions buy-out market could reach £12bn by the year-end. This speculation has been fuelled by C&W's landmark deal with Prudential and more schemes will probably follow suit. In the current climate, it could be a prudent move for companies considering a restructuring and seeking to protect the retirement benefits of staff.

The rates for bulk-buyouts are good but it is unlikely that they will last. Unsurprisingly, an increasing number of schemes are taking advantage of the competitive offerings now available that are more flexible and innovative than ever before. Insurers have seen yields on corporate bonds rise significantly. The higher returns are enough for insurers to ask for lower upfront sums when they agree to take on pension liabilities.

The temptation for trustees to follow the herd is strong but this is not a decision to be taken lightly. Many employers are keen to buy-out as part of a strategy to manage pension scheme liabilities given changes in pensions regulation, increased life expectancy and disclosure requirements. Trustees have the unenviable task of being responsible for the future of their schemes but their decision will be influenced by the employer. Trustees must invest the scheme funds in accordance with the Statement of Investment Principles on which the employer has to be consulted. Other, possibly cheaper (although more vulnerable) options ought to be considered for example, liability driven investment or use of derivatives.

Trustees need to check the terms of their trust deed and rules and take investment advice as to whether this is an appropriate time to buy-out or not. For practical purposes, liability for actives cannot be bought out. They will also need to consider whether a full or partial buy-out is the most suitable. Next, they will need to obtain quotations from various insurance companies, consider these in detail and then manage the whole buy-out process carefully to avoid exposing themselves to risk or claims from beneficiaries. 

Trustees may consider holding an auction, which allows insurers who have quoted to adjust their price. However, they must ensure that they are comparing like with like benefits and are satisfied that the insurer will maintain effective communication with scheme members in the future.

The preferred insurer's policies must fall within the Investors Compensation Scheme. Even if they are covered by the Financial Services Authority, it would be prudent to clarify this. Schemes should also check out the financial probity of their insurer before proceeding. Trustees must make a choice between (more regulated) insurance-based products and non-insurance.

Some say that current pricing levels in the market are neither profitable nor sustainable. Prices will need to rise for buy-out firms to get the return on their equity. It seems likely that demand will continue whilst supply will remain fairly static. Pension schemes may be faced with being unable to afford the prices quoted by insurers. Recently, I have heard reports of clients waiting for months to receive quotations. The actuaries view is that opportunities will end soon, possibly before 2008 is out. So schemes must act fast to take advantage.

It is the trustee's duty to act in accordance with the law and in the interest of the scheme beneficiaries. They must also take active precautions to prevent issues going wrong in the first place and avoid claims being made by "missing beneficiaries" after the buyout is complete, claims that are incorrectly calculated or claims of maladministration. Trustees should also take precautions to avoid personal liability and are advised to take legal advice on this.

Ultimately, the trustees should decide what is best for their scheme and not just follow the herd. They should follow advice from an expert and authorised broker to ensure that the correct annuity is taken out for the correct liabilities. Buy-in leaves liabilities (and covering policies) within the scheme with consequent effects on accounting and PPF levy numbers and plays havoc with statutory winding up priorities. Buying individual policies standing outside the scheme needs to satisfy preservation and contracting-out requirements and needs a thorough communication exercise.

Iain Talman is head of the pensions team at Scottish law firm, Biggart Baillie LLP. Iain is accredited by The Law Society of Scotland as a specialist in pensions law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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