At each phase of a defined benefit (DB) pension scheme buy-in, buy-out and wind-up, it is important for sponsors to take a strategic approach, work in partnership with the trustees and take advice on sponsor-specific issues that might otherwise be missed.
If a buy-in, buy-out and wind-up is the chosen option for a scheme’s endgame strategy then there will be lots of work for trustees to get the scheme ready including working out how to insure tricky benefits, discharging DC assets and deciding how to use any surplus on buy-out, among many other issues to work through. However, there are important strategic issues that sponsors of DB schemes also need to think about and take advice on at each phase of the process.
The buy-in phase
The buy-in is the first key step in a process that could take several years to culminate in a scheme’s winding-up. Sponsors should take stock and work with trustees to decide aims and objectives for the project at this initial stage. Thinking through the issues as early as possible can enable sponsors to get a clear vision of what the overall aims should be and put in place a strategic project plan to achieve those aims.
It is good practice for sponsors and trustees to enter into a framework agreement setting out how both parties will approach buy-in, buy-out and wind-up. This will be to agree points specific to the scheme upfront, such as whether a post wind-up indemnity will be provided by the sponsor and agreeing other key issues like when wind-up will be triggered.
Sponsors will secure better outcomes if they receive strategic advice about risk transfer and the endgame at an early stage before buy-in. There are certain issues in different strategic areas, including funding, illiquid assets, surplus and contract negotiations, that sponsors should consider before or during the buy-in phase.
Funding
Sponsors should be closely managing scheme funding in the run-up to and during the buy-in. They should gain an understanding of where the balance of powers lies under the scheme’s rules and start thinking about how to avoid a trapped surplus.
Illiquid assets
If the scheme has illiquid assets, sponsors have various solutions for dealing with illiquid assets, including the sponsor acquiring the assets and putting in place a sponsor loan.
Surplus
If there will be a surplus in the scheme, sponsors will need to take advice on the scheme’s rules regarding use of surplus.
Buy-in contract negotiations
A key issue for sponsors during the buy-in phase will be the terms of the bulk annuity policy. The bulk annuity policy is an investment of the scheme and trustees are responsible for insuring scheme benefits on the best possible terms with insurers. However, sponsors should not take a backseat when trustees are negotiating the bulk annuity policy as there are certain key terms relevant to sponsors.
The buy-out phase
During buy-out, a key issue for sponsors will be the timing of any buy-out, as the quicker trustees can buy-out scheme benefits the lower ongoing costs there will be in running the scheme.
Other issues that sponsors face during the buy-out phase will typically be whether and what level of liability insurance cover, often referred to as run-off cover, the trustees may seek. This may require sponsor consent under the rules of the scheme or the sponsor to pay either the full premium or an element of the premium as certain insurance cannot legally be paid for out of scheme assets.
Sponsors that pay for ongoing scheme expenses may ask trustees and their advisers to prepare budgets and, if necessary fixed fees, so that greater certainty can be obtained as to the remaining costs in getting the scheme ready to wind-up.
The wind-up phase
The scheme wind-up raises important issues for sponsors, and many issues will have been planned for and dealt with appropriately at an earlier phase of the project including under a framework agreement. However, there will be issues that will be addressed at the end of the project and the most important for many sponsors is ensuring that no further scheme liabilities arise.
In practice it will be impossible for a sponsor to be certain that it will have no further obligations associated with a wound-up scheme. However, there are steps that can be taken to reduce the risk of liabilities arising in the future. These will be particularly important where the sponsor is being asked to indemnify the trustees for any liabilities that arise after the end of the winding-up. Where liabilities do arise, sponsors could put in place conduct of claims arrangements with the trustees to ensure any complaints or claims are dealt with appropriately whether under any indemnity or run-off cover insurance.
The steps the sponsors should consider to minimise liabilities arising once the scheme has wound-up include:
- asking trustees to formally release any sponsor guarantees;
- obtaining a section 75 debt certificate from the scheme actuary evidencing that the sponsor has no further liability towards the scheme under section 75 of the Pensions Act 1995;
- winding-up the trustee company if the trustee is a corporate trustee.
Sponsors will also need to ensure the trustees have put in place sufficient data storage and data protection arrangements post wind-up. For many schemes this will involve the sponsor taking over scheme documents and agreeing the terms of storage in a separate agreement.
Co-written by Josh Potter of Pinsent Masons.
Read more on pension buy-outs:
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- 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: 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: making the decision to fully buy-in
- 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
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