Pension pointers
3 Nov 08
Buy-outs are increasingly tempting to companies seeking to simplify staff bene?t processes, and Iain Talman offers some guidance for trustees
by Iain Talman
An increasing number of trustees are looking to transfer the risk of their pension scheme by paying a premium to an insurance company.
There is a range of increasingly flexible and innovative offerings, and some sources estimate that the value of the pensions buy-out market may reach £12 billion by the year-end. This speculation has been fuelled by Cable & Wireless’s landmark deal with Prudential. A buy-out could be a wise move for companies considering restructuring and seeking to protect staff retirement benefits.
The rates for bulk buy-outs are good but it is unlikely this will last. Yields on corporate bonds have risen significantly. The higher returns are enough for insurers to ask for lower up-front sums when they take on pension liabilities.
Many employers are keen on them as part of a pension scheme strategy, given changes in regulation, and increased life expectancy and disclosure requirements.
Trustees will be influenced by the employer but they must invest the scheme funds in accordance with the statement of investment principles on which the employer has to be consulted. Other, possibly cheaper though more risky, options ought to be considered, for example, liability-driven investment or, with all due caution, use 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 for a buy-out. Trustees will also need to consider whether a full or partial buy-out is the most suitable. Next, they will need to obtain quotations from insurance companies.
Trustees may consider holding an auction, which allows insurers that have quoted to adjust their offer. However, they must ensure that they are comparing like with like on benefits.
The preferred insurer’s policies may not always qualify for the Financial Services Compensation Scheme but where possible, it would be advisable to ensure that they are covered.
Schemes should also check out the financial probity of the insurer and be satisfied that it will maintain effective communication with scheme members
Trustees must choose between an insurance-based product, which is more heavily regulated, and a non-insurance-based one. If a non-insured buyout is chosen, the provider takes over the role of the employer. If an insured product is selected, however, liability to meet benefits passes to the insurer. Insurers are regulated by the FSA.
There is a view that current buy-out prices are neither profitable nor sustainable and will need to rise. It seems likely that demand will continue while supply will remain fairly static. Pension schemes may be unable to afford the prices quoted by insurers.
Recently, I have heard reports of clients waiting for months for quotations. The actuaries’ view is that opportunities will end soon, possibly before 2008 is out. So schemes must act fast.
It is the trustees’ duty to act in accordance with the law and in the interests of scheme beneficiaries. They must also take precautions to prevent things going wrong in the first place and avoid claims by “missing beneficiaries” after the buy-out, incorrect claims calculations or claims of maladministration.
Trustees should also take precautions to avoid personal liability and are advised to take legal advice on this. The Pensions Management Institute has said that trustees might still find themselves liable after a buy-out but this seems to be a misunderstanding. In summary, if the trustees have acted in accordance with the trust deed and legal requirements, and have, with proper advice, chosen an apparently reputable insurer, they can be discharged even if the insurer subsequently fails.
The requirements of the Financial Services Compensation Scheme are much more difficult and require study in each individual case.
Trustees must decide what is best for their scheme and not just follow the herd. They should follow advice from an expert and authorised broker. Buy-ins leave liabilities (and covering policies) within the scheme with effects on accounting and Pension Protection Fund levies and plays havoc with statutory winding up priorities. Buying individual policies outside the scheme must satisfy preservation and contracting-out requirements and needs a thorough communication exercise.
See also ICAS guidance for pension trustees