This post will be of interest to employers who have a defined benefit pension scheme.
Defined benefit (DB) pension schemes were once the pension arrangement of choice for paternalistic employers seeking to provide competitive benefit packages for their employees.
In more recent times, however, difficult investment environments, increasing life expectancy, low gilt yields and in many cases shrinking company size, have left companies with expanding DB pension schemes burning a hole in their balance sheet. Sound familiar? It is unlikely you would have missed the press coverage surrounding BHS and Tata Steel, and the issues that those companies faced.
Removing risk – buy-ins and buy-outs
There are a number of risk transfer options available to DB pension schemes, attractive to employers and trustees wishing to protect against the risk of increasing liabilities. Two of the most common are buy-ins and buy-outs, commonly referred to as bulk annuity policies.
These are insurance contracts entered into between a pension scheme and an insurance company. In exchange for the payment of a premium, the insurer agrees to pay whatever the eventual liabilities are in respect of the insured members. With a buy-in, the policy covers a particular set of members, normally some or all of the pensioners. With a buy-out, the policy covers the entire membership. The key differences are set out below.
What do you need to consider? – the key differences
|Implications for the scheme||Treated as a scheme investment. The scheme otherwise continues on unchanged and employer contributions continue (where necessary).||Precursor to a scheme winding up. No more employer contributions.|
|Which members does it affect?||A particular group of members||The entire membership|
|Cost||Cheaper option||More expensive option|
|Who pays for it?||Scheme may have sufficient funding to pay itself.||Likely to require capital from the employer unless scheme in surplus.|
|Balance sheet implications||Scheme remains on company balance sheet||Scheme removed from company balance sheet|
A buy-out is an aspirational "end-game" for most DB pension schemes, however it remains unaffordable for most in the short term. A buy-in is a popular and more easily attainable means of removing a significant amount of risk from your DB scheme, and which is frequently used as a stepping stone to a full buy-out in the longer term.
How can we help?
The volume of business in the pensions risk transfer market is currently at an all-time high. Mayer Brown's UK Pensions Risk Transfer Group advises on buy-ins, buy-outs and longevity swaps and we would be very happy to discuss with employers any proposals they wish to present to or have received from the trustees of their pension scheme(s).
February 19, 2020
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