Lucida PLC

Engaged Investor, round table questions.

Jan 01 2008

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What exactly is meant by “bulk buy-out “and how does it work?

Lucida Answer: Bulk buy-out means many things to many people. Basically, by paying a premium to an insurance company, the trustees transfer the risks of the scheme to that insurer. Bulk buy-out is normally a three-stage process:

1. An insurance policy is purchased in the Trustees’ name. The assets are now insured and therefore guaranteed, but the trustees and employer continue to have legal responsibility.
2. The scheme winds up. This can take several years, especially if the member data is poor, but with good management, can be completed within a year. The trustees can then be properly discharged.
3. The trustees’ policy is replaced by individual policies in the members’ names and those members become policyholders with the insurer. The trustees and company have no further responsibility.

There are many different ways to achieve buy out, including simply taking an insurance policy as another asset class. Some schemes decide to buy-out only part of the scheme, which could be older pensioners, all pensioners or certain deferred members. Phased buy-out may start with older pensioners, while the trustees contract to transfer the remaining members over a number of years. In some cases, trustees insure longevity risk, for example, to limit the duration of pensions from the fund, including insuring against the risk of pensioners surviving beyond the age of 90.

How can trustees be sure members will still be guaranteed their pensions – and still get the same level of service they were used to?

Lucida Answer: Insurance is the best method of guaranteeing member benefits. In reality, benefits in a final salary scheme are not guaranteed at all, despite everyone thinking they are – they are simply a promise subject to the assets or an employer with assets being available to pay them at the given time. With an insurance policy provided by a UK regulated insurance company, members have the security of the Policyholders Protection Act, which is considerably more generous than the compensation offered by the PPF. UK insurers must hold reserves to more than cover their liabilities and they are required to use prudent assumptions in valuing those liabilities. The credit risk in an insurance company is considerably lower than that inherent in most employing companies.

Insurance companies are not at the top of the polls for member service, but by selecting the buy-out insurer wisely, the trustees could actually see an improvement in the quality of service to members.

Why is the “buy-out” level of funding so much higher than FRS17 and other funding measures which many trustees already consider rather conservative?

Lucida Answer: Schemes do not yet have to reflect realistic longevity assumptions and improvements, whereas insurance companies must. The gap between buy out and FRS17 is already narrowing because of the current competitive insurance landscape, but also because schemes are beginning to allow for the impact of longevity. Pensions promised will cost what they cost at the end of the day, regardless of the assumptions schemes choose to adopt to spread that cost over the long term. There is already pressure on schemes to tighten up assumptions and investment strategy.

What are the advantages of bulk buy-out and what are the risks the trustees are running by continuing to manage the pensions scheme themselves?

Lucida Answer: Bulk buy-out can offer the advantage of a “clean break” for both trustees and companies. Trustees take their role seriously and are anxious to do the right thing and ensure that members receive their entitlement. Trustees are under considerable pressure. We tend to forget that trustees are only required to be reasonable people, not pension experts. A bulk-buy out enables trustees to ensure they have fulfilled their duties to members completely without having to wait until the last beneficiary expires.

Continuing to run the scheme means that trustees continue to be exposed to risks over which they have little control, like longevity, inflation and credit risk. In addition, the cost of running a pension scheme is high and increasing at a rate of 10% a year. It can absorb anywhere between £30 and £350 a member each year and that does not include the price of errors and bad data.

What should trustees say to pension scheme members who feel that under buy-out the company and trustees are simply trying to get rid of their responsibilities?

Lucida Answer: In my experience, trustees always take their role seriously and in fact, often bend over backwards to protect member benefits. Buy-out is a way to ensure benefit promises are met and instead of getting rid of their responsibilities, trustees are buying the kind of security members could never get from the scheme. Members should applaud the trustees for such action.

How common is buy-out at the moment and do you expect the number of schemes who buy-out to grow?

Lucida Answer: Although there were plenty of wind up buy-outs, 2007 saw slow growth in buy-out activity among solvent schemes for a number of reasons, including unwillingness of trustees to be first to try out something relatively new. Other reasons include the improvement in funding leading to an enhanced sense of security and a general feeling that buy-out prices would fall with increased competition. In fact, competitiveness and improved funding have narrowed the gap to buy-out and this is the optimal time to make such a move.

The number of transactions recently announced, especially the larger deals, will encourage others to follow suit. Some of the solutions available are excellent and this has only been made possible by new players coming into the market with new money and new ideas. Most schemes will buy-out between now and the next twenty years. The next couple of years will see a boom in schemes wanting to take advantage. Of course, increased demand brings the risk that the price of buy out will be less keen than today.

Margaret Snowdon is Operations Director at Lucida plc
She can be contacted on 020 7647 1610, or at
margaret.snowdon@lucidaplc.com