Is buy-out still the panacea it used to be?
5th July, 2022
For many years, trustees like myself have targeted buy-out for the pension schemes we look after. We have worked with sponsors to get the scheme ultimately transferred to an insurance company. From the trustees’ perspective we have done this in the name of security. We were worried that we might not have enough money to pay benefits or that our sponsor may not be around in the long term to keep paying the contributions needed to make sure Trustees can still pay their members.
More recently, improvements to pension scheme funding levels, operational considerations and corporate financial developments are leading to a wider suite of factors for trustees and sponsors to consider as part of the buy-out process. In doing so, I am beginning to feel that the shining star of buy-out is starting to fade.
In addition to the usual never-ending monologue from consultants and insurance companies that we must get our data, investments, members and finances all “buy-out ready”, I now see a further four areas that also need to be considered. These are:
- Is benefit security still such a worry as pension schemes reach self-sufficiency funding or better, where the traditional concerns trustees have had are diminished? After all, the whole point of self-sufficiency, or more, is that there is a high probability of meeting the members’ benefits in full, which is exactly what you achieve with a buy-out.
- Is sponsor covenant still relevant? With higher funding level comes a lower reliance on the sponsor for future support. When you know you have enough money to pay member benefits in full, it is not clear to me why trustees should still need to be concerned with the sponsor’s covenant. There is a flip side to this argument, in that if you have enough money for a buy-out but do not go to buy-out, then you will rely on the sponsor covenant as long as they are around. Once the sponsor is gone, you can then flip to buy-out and rely on the insurance covenant after that. You can get two covenants for the price of one.
- Should sponsors pay away high levels of profit to insurance companies? For a recent buy-out exercise, the adviser was asked to estimate the level of profit the insurance company would make from the premium we were asked to pay. Their response was based on their knowledge of how insurance company management accounts are prepared and how embedded value works. What we were told was that the insurer would expect to make 30-40% return on the premium. This astounded the trustees. Of course, there will be arguments about the long-term and risks (usual comments from insurers) but we all still felt this was a very healthy return for the insurer from the monies our members had paid in over the years.
- Who looks after the members? In my role, I see how difficult it is to provide high-quality pensions administration to members. The pensions industry has sought to make improvements to administration over many years with varying degrees of success. With a buy out, we pass all the administration to the insurer and hope they can do better. My own experience of insurance company administration for their own products is not always great and yet we rely on them to get pensions administration right. This point was recently highlighted to me by a member of a scheme for which I was a trustee and the scheme went to buy-out. She sent me an email to say she was unhappy at how long it had taken to get her benefits into payment after the death of her husband. She had no other income and the delay had distressed her. She asked me to help. Unfortunately there was nothing material I could do as I was no longer in charge of the scheme. This highlighted to me that I had no control over the administration concerns my former members now had.
Buy-out will still be the right answer for most pension schemes. I am not making the above points to diminish the role insurance company buy-outs have in the work that we do. However, I do think it is time that the buy-out tunnel vision world we are living in needs to be sense checked and that broader practical, operational and financial considerations are taken into account. That way, we can be more sure that the decisions we take for our members are the right ones.