Over recent months, we have received enquiries from trustees and sponsors of defined benefit (DB) pension schemes that are thought to be fully funded, or close enough to being so, that the parties wish to purchase a bulk annuity policy with an insurance company.
Sounds great! The benefits can be provided in full to members and the scheme can then be wound up – a good job, which benefits all the stakeholders.
Unfortunately, it is just not so easy to complete the buyout and wind-up process and we thought it would be useful to set out a reminder about some of the challenges that schemes might face and what you need to think about before the process gets under way.
Are you really fully funded?
Before you start addressing the challenges, you should pause and consider the following questions. How confident is your adviser that your scheme does have enough assets to meet all its liabilities by purchasing a buyout insurance policy? What was the effective date of the sums that your adviser carried out to establish that this was the case? Given the highly volatile markets over recent months, how has the position changed since that date? These are important questions that require answers and when you have them, here are the challenges as we see them.
The challenges
- The impact a buyout and wind-up may have on the sponsor’s accounts – we suggest seeking advice from the sponsor’s auditor to understand how the sponsor’s P&L and balance sheet would be affected, as some auditors may have differing views on this. If the sponsor does not like the impact, moving directly to a buyout and/or completing the wind-up might not be the best option at the current time. The sponsor might prefer the scheme to consider a buy-in, or just reduce its investment risks, rather than remove all the risks in a buyout and wind-up exercise.
- Considering active members – do any employees of the sponsor still earn benefits or have a salary link under the scheme? If you have such a scheme, then you and the sponsor will need to take some mitigating action.
- Giving members benefit options prior to buyout – if the scheme is moving to wind-up status, there might be members who could be offered immediate lump sums, which can be cheaper to provide, as compared with buying benefits with an insurer. Similarly, some deferred members could decide to take their pension benefits immediately, rather than waiting until the scheme’s normal retirement age, and insuring them as a current pensioner could be more cost-effective than insuring them as a deferred pensioner.
- Finding an insurance broker to work with the buyout insurance company – there are lots of firms that can carry out the broking work. However, how do you select the right broker for you? Is your current actuary or your current administrator really best placed, or should you speak with other firms too?
- Finding an insurance company – although there are lots of brokers, it is widely accepted that there are only a few insurers who will quote for schemes at the smaller end of the market. In addition, unless your broker can demonstrate that it is ready to proceed with purchasing a buyout insurance policy, some of these insurers will be unwilling to provide a quotation, which limits the field further. It will be helpful if the sponsor and trustees can demonstrate that they are working together as regards purchasing a buyout policy. You will need to discuss with your broker what else ‘ready to proceed’ actually means.
- Providing data and benefit details to the insurers – getting complete and accurate membership data into the right format for an insurer is crucial. Also extremely important is preparation of the detailed benefit specification. It is common to ask a pensions lawyer to sign off the benefit specification, as well as the broker, actuary and administrator being expected to cast a critical eye over it.
- Guaranteed Minimum Pension (GMP) equalisation – before you can complete a wind-up, if your scheme has any members who earned GMP benefits between May 1990 and April 1997, it will be necessary to check if any of these members need an uplift to their pension. For most schemes, the size of adjustment for each affected member is not large. However, the sums to calculate these amounts are complex, and there can be data issues, so GMP equalisation is not straightforward. It is possible to carry out an insurance transaction before GMP equalisation is fully addressed, provided you subsequently complete it within a specified period. However, doing the GMP equalisation work after purchasing the buyout policy does increase some of the risks, so it is worth thinking about your options at an early stage.
- Verifying the data and handing the scheme to the insurer – after the buyout policy has been purchased, there is usually a limited period, which is defined in the policy, to finalise the data, and then to hand over to the insurance company the responsibility for paying members. There can be many tasks for the trustees to carry out in this period and it can be expected to take anywhere between 12 and 18 months from completion of the insurance transaction to finalisation of the wind-up.
How did we get here?
It is worth reflecting on the journey that brought you to this place. For some schemes, the current situation has arisen because of what happened to interest rates, and more importantly gilt yields, in the summer of 2022 and later in September of the same year. As you may recall from the significant press coverage last autumn and since then, interest rates went up materially compared with where they had been for many years. However, although there has been a windfall for lots of pension schemes, not all have benefitted from last year’s interest rate change. If you did benefit, then now is the time to take stock and ask yourself if you are fully committed to your current position and if not, are better options now available?
MHM can help you
Help is at hand to meet these challenges and more. MHM has extensive experience completing buyouts and wind-ups. Over many years, our pensions experts have performed these tasks as professional, independent trustees or, where existing trustees remain in the role, we act as adviser or secretary to the trustees.
Whether or not you are a current client of MHM, please do contact us for an informal discussion about how we could help you resolve your wind-up challenges.
Contact Steve Button on 07952 035538 or by email to steve.button@mhmtrustees.co.uk
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