A pension buy-in takes place when a regulated insurer takes over financial responsibility for meeting the cost of the pension promises made by a pension fund to some or all of its members. The pension fund will pay a premium to the insurance company, which then secures a stream of income to the pension scheme trustees, perfectly matching the insured pensions. The pensioner remains a member of the pension scheme and the links with the sponsor and the trustees are maintained. The pension scheme is not wound up, but continues.
The Trustees can effect a buy in to cover all the liabilities for members under the scheme, or just a tranche, for example, pensioners.
Such policies can be flexible in changing circumstances to cover different liabilities, e.g. s73 priority benefits on an eventual winding up.
They can also extend to longevity insurance, where the insurance contract fixes the length of time a pension fund will meet the pension payments to its members. If members live longer than the fixed period agreed in the insurance policy, then it is the insurance company that meets the extra cost. Under a longevity insurance policy only longevity risk is insured. This means that there is no up-front premium payment and the pension fund retains all of its assets.
The decision to effect a buy-in is primarily an investment decision made by the pension scheme trustees and will be a perfectly matched investment for all the liabilities that are insured. A buy in is usually a step on the way to fully insuring liabilities, potentially with a view to an eventual buy out where the scheme can be discontinued.
The price paid for the buy-in policy is related to a number of factors, including longevity and fund investment returns. The trustees must robustly conduct due diligence on their scheme data prior to buy in as errors or mistakes which come to light at a future date are usually an issue for the trustees, not the insurer. Some insurers will provide a guaranteed quotation which will show a price and a transparent market-related adjustment mechanism. This allows the trustees to know that insurance capacity is being reserved for them. It may also be possible for an insurer to take on the risks caused by market movements affecting scheme asset values in the period immediately prior to signing the insurance policy, during which the contracts and any outstanding due diligence can be completed. This removes the risk of market volatility and the uncertainty it may cause for both the trustees and the employer, particularly where the employer is liable to provide additional funds to meet any shortfall between the scheme's assets and the insurance premium.
Great care must also be taken with the negotiation of the terms of the policy and buy-in conditions, as many buy-in contracts put the onus for any mistakes and any future adjustments on the trustees (and indirectly the employer) and will usually seek an indemnity from the trustees in respect of any unforeseen adjustments. This can cause issues if the employer is not able or willing to support such an indemnity.
Seeking appropriate legal advice on the terms and conditions supporting the policy and robustly negotiating away or mitigating potentially unfavourable terms will give the trustees reassurance that they have properly covered the members interests and will not be exposed themselves to future demands for further payments which they cannot pay, having handed over the assets to the insurer.
The benefit to the scheme member is that the insurer, unlike the corporate sponsor or pension fund, is required to hold certain surplus assets, known as capital, to support the insurance policies of the members. This provides significant additional levels of security. The Prudential Regulation Authority oversees and monitors these reserves and the capital held by insurers.
This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.