How to conduct a pensions buy-in

pensions buy-in agreement
  • A buy-in is a contract between a defined benefit pension scheme and an employer that removes longevity, market, interest and inflation risks.
  • The parties involved include a sponsoring employer, a scheme trustee, advisers to the trustees and the insurer.
  • If it looks like funding levels are affordable for the scheme against current expected bulk annuity pricing, trustees appoint a consultant to approach the market and insurers.

A surge in bulk annuity deals is anticipated over the next five years, with 86% of defined benefit (DB) pension scheme trustees expecting to approach an insurer in this time period, according to Standard Life’s August 2023 research. With this in mind, what is a pensions buy-in and how is it conducted?

What is a buy-in?

A buy-in is an insurance policy bought by trustees of a DB scheme that covers a proportion or all of a scheme’s liabilities, which include the obligations it has to pay scheme members either now or in the future. It is an exact match to the covered liabilities and is held by the scheme as an asset.

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Charlotte Fletcher, business development actuary at Standard Life, says: “All bulk annuities start in a buy-in phase. A pension scheme will pay a premium upfront to an insurer, who in exchange will commit to pay the monthly payroll pensions back to the scheme, which will pay those benefits onto members.”

A buy-in is designed to help trustees and sponsoring employers to provide long-term security for scheme members and protect pension plans from investment, inflation and longevity risks. If an investment strategy underperforms, it may not generate sufficient returns to pay pensions in the future. If members of the scheme live longer than expected, pensions must be paid for longer.

Under a buy-in, a scheme maintains its relationship with members, while the insurer has no direct relationship with them.

Matthew Dales, director of UK pension risk transfer at Legal and General Retirement Institutional, says: “The trustees and sponsoring employer retain responsibility for meeting members’ benefits, but the insurance policy is designed to ensure that there are always sufficient funds available.”

Who is involved?

When conducting a buy-in, there are several parties involved. These include a sponsoring employer, a scheme trustee, their advisers and an insurer.

The sponsoring employer holds assets in the trust for the beneficiaries of the DB scheme and is liable to provide funding and benefits. it remains responsible for in-house administration.

The scheme trustees will typically be either individual trustees on a board, a corporate trustee, or a professional paid trustee, and act separately from the employer. “Trustees look after members’ best interests, ensure they get paid and act as decision makers on if and when a scheme approaches the bulk annuity market and which insurer to choose after receiving quotations,” explains Fletcher.

They are supported by legal, actuarial and investment advisers, which help the scheme prepare for approaching the market, co-ordinate all required information, and prepare an information pack and request form quotation that summarises the transaction.

Jamie Cole, head of bulk purchase annuity origination at Aviva, says: “Legal advisers will be heavily involved as they complete due diligence of the scheme benefit specification, making sure that the trustee buys the correct benefits via the insurance policy so members get what they are entitled to, as well as deal with contract negotiations.”

A transaction may involve several insurers in competitive tender or just one. They provide terms and pricing tailored to each scheme based on the member data and benefit specification.

“It is the insurer’s responsibility to cover the members’ retirement benefits per the buy-in policy,” says Dales. “Once a request is received, they will examine it and submit a bid to the employer if it wants to proceed.”

Conducting a buy-in

All DB schemes monitor their funding position, which is a ratio of assets held by the scheme relative to the expected value of required future payments, against current expected bulk annuity pricing. If it looks like it will be affordable for the scheme, the trustees recommend advisers look at bulk annuities and appoint a consultant to approach the market and insurers.

Trustees and their advisers then decide which liabilities to insure, and compile quality member data, a legal review of benefit specification, establish governance processes ensuring alignment between the sponsor and the trustees, and ensure their assets are in a form suitable for transfer to an insurer to pay the premium.

“Working closely with their advisers, trustees will consider many factors when selecting an insurer as part of the selection process, including commercial, assessment of the insurer as a counterparty, proposition features, and transition and administration,” explains Cole. “Each scheme coming to market may run multiple pricing rounds.”

Insurers then decide whether to take on the transaction and prepare a bid for the trustees. If accepted, the insurer and scheme enter an exclusivity period where the trustees, advisers and insurers put together the transaction, legal documents, and the price and premium certainty in the form of a portfolio of assets.

“Once signed, the insurer becomes responsible for pension liabilities for the covered members until they die, along with any death benefits,” says Fletcher. “The premium will be paid from the pension scheme to the insurer in between five to 10 business days.”

More DB schemes are closing due to running expenses, with defined contribution (DC) schemes becoming more commonplace. Carrying out a pensions buy-in can help to eliminate this, along with other risks, so employers can ensure their scheme members are protected.