Pension buy-outs: making the decision to fully buy-in

When deciding whether to enter into a full buy-in, trustees should therefore be thinking ahead to buy-out and wind-up. This will ensure that any potential difficulties are anticipated in advance; reduce vulnerability to any challenges from members; and ensure that trustees are able to demonstrate that they have considered whether the journey to wind-up will be in members’ best interests.

There are a range of issues trustees need to consider when entering into a buy-in with a view to an eventual wind-up of the scheme and buy-out of member benefits.

The decision to fully buy-in

A full buy-in involves the purchase of a bulk annuity policy by the trustee from an insurer covering all members of the scheme, which will initially be held as an asset of the scheme.

A buy-in is an investment decision taken by a trustee under its investment power as set out in the scheme rules. It will therefore be the trustee who takes the lead on implementing the decision.

If there is insufficient funding in the scheme to proceed with a full buy-in of the scheme’s liabilities, the trustee will necessarily be reliant on the employer to provide that funding and it will therefore become a joint decision. In that situation, the employer is likely to have greater involvement in the process.

Even if there is sufficient funding, where the buy-in is a step to an eventual buy-out and wind-up, we would expect the trustees to agree the full-buy in with the employer, given that it is ordinarily the employer’s decision to commence winding-up.

Trustee considerations

Where it is intended that buy-in be followed by buy-out and wind-up, the trustees should also consider at the buy-in stage whether those further steps are in members’ interests.

There are three main issues the trustees will need to consider:

• On buy-out members will lose any discretionary benefits that have not been hard-coded. Trustees will need to weigh the loss of these benefits – in particular, discretionary inflation proofing – against the increased security for members arising from the fact their benefits will be secured with a UK-regulated insurer;
• Where there is a surplus in the scheme, trustees will need to determine whether members will be more or less likely to benefit from the surplus in the event of a buy-in and buy-out. This will depend in part on how the scheme rules deal with the treatment of a surplus;
• Where the trustees have a high level of confidence in the sponsor covenant, they will need to give further thoughts on whether it is still in members’ interests to proceed with buy-in and buy-out.

As well as the above considerations, the trustees will need to give thought to several other issues when deciding whether to enter into a buy-in. These include the treatment of any benefit options or factors that will be difficult to insure; allocation of residual risks; governance, project management and timescales; and member experience with the selected insurer.

Trustee leverage before buy-in

Scheme rules usually provide that the sponsoring employer may trigger the winding-up of the scheme. Trustee leverage will likely be at its highest before a full buy-in as, afterwards, the sponsoring employer may trigger wind-up without the risk of an employer debt falling due.

Given trustee leverage is highest before buy-in, trustees should consider whether the buy-in presents a strategic opportunity to secure other commitments from the sponsoring employer. This might include hardcoding discretionary benefits or obtaining protections for the trustees and beneficiaries in relation to any residual risks, including an indemnity or insurance cover.

Legal input

Trustees should get legal input from the outset. At the buy-in stage, this includes reviewing the scheme rules to ensure the trustees can purchase a bulk annuity policy; drafting any deed of amendment required to allow the trustees to agree to the terms of the policy; preparing a benefit specification to ensure that that there is no mismatch between the benefits to which members are entitled and those secured under the policy; engaging in contract negotiations with the insurer; and discussing any future funding requirements and indemnities with the employer.

Trustees should also ensure that decision-making is appropriately documented throughout the process and that appropriate trustee governance arrangements are in place. This will reduce their vulnerability to challenges during or after completion of the process.

This record trail should also demonstrate that the trustees have properly discharged their duties to members and considered whether the exercise, as a whole, is in members’ best interests. 

Read more on pension buy-outs:

• • Pension buy-outs: trustee liability post winding up 
  • Pension buy-outs: claim limitation periods post winding-up
  • Pension buy-outs: communicating with members about winding-up
  • Pension buy-outs: concluding the winding-up
  • Pension buy-outs: deciding how to use surplus on winding-up
  • Pension buy-outs: discharging DC assets on winding-up
  • Pension buy-outs: endgame issues for sponsors
  • Pension buy-outs: employer indemnities on winding-up
  • Pension buy-outs: incorporating pension scheme trustees before winding-up
  • Pension buy-outs: issuing individual policies using assignment before winding up
  • Pension buy-outs: managing a surplus on winding-up
  • Pension buy-outs: relevance of FCA’s Consumer Duty when winding-up
  • Pension buy-outs: residual risks cover for winding-up pension schemes
  • Pension buy-outs: managing the risk of ‘trapped surplus’ on winding-up