Lucida PLC

A "buyout", or "bulk buyout" as it is sometimes known, involves the trustees of a defined benefit pension scheme transferring the risks of the scheme to an insurance company in return for the payment of a premium. Buyouts normally involve a three-stage process:

1. An insurance policy is purchased in the trustees' name. The liabilities of the scheme are then insured, but the trustees and employer continue to have legal responsibility for the scheme. From that point on the insurer has responsibility for paying pensioner benefits.
2. The scheme winds up. This can take several years, especially if the member data is incomplete. However, with good project management, this process can be completed within a year. The trustees can then be properly discharged of their responsibilities.
3. The trustees' insurance policy is replaced by individual policies in the members' names and those members become policyholders with the insurer. The trustees and employer then have no further responsibility for the scheme, and the insurer takes full responsibility for the payment of benefits to scheme members.

The key difference between a buy-in and a buyout is that a buy-in does not involve the closure of the scheme or the trustees and employer transferring their responsibilities to the insurer. A buy-in involves an insurance policy being set up to cover the risks presented by either all the scheme members or by certain subsets of members where a partial buy-in is used.

Some schemes decide to buyout only part of the scheme, which could be older pensioners, all pensioners or certain deferred members. Phased buyout 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 paid from the fund.

Buyout can offer the advantage of a 'clean break' for both trustees and employers. A buyout enables trustees to ensure they have fulfilled their duties to members completely, without having to wait until the last beneficiary dies.

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.

A buyout is attractive to closed defined benefit schemes with a surplus or a small deficit and where the employer is able (and prepared) to pay to bridge the gap between the buyout price and the scheme assets. Some insurers will be prepared to take on both deferred and pensioner liabilities, but pensioners are easier to place and for this reason pensioners are often bought-out first.

A buyout may not be appropriate for schemes with a very strong employer covenant or where the employer is willing to offer suitable contingent assets or place funds in escrow to cover risks.

A buyout is a concept that is used with defined benefit pensions where the risks are held centrally by trustees and the employer, allowing them to minimise their exposure to risk. It is not appropriate for defined contribution pensions.

Insurance through a buyout or buy-in helps to guarantee that member benefits will be paid. Payment of benefits by a defined benefit scheme is dependent upon the scheme's funding and on the strength of the employer covenant. Contrary to popular belief, payment is not guaranteed.

With an insurance policy provided by a UK regulated insurance company, members have the security of knowing that benefits are being provided by an FSA regulated company. The FSA ensures that insurance companies hold adequate capital against the benefits they are providing. In a worst case scenario where an insurer becomes insolvent, members have the security of the Financial Services Compensation Scheme, which covers 90% of benefits.

With strong financial backing and a highly experienced and expert team, Lucida is one of the leading insurance and buyout specialists in the UK's highly competitive marketplace. Lucida offers a flexible approach, committed to finding the very best tailored solution to meet the employer and trustees' specific objectives.

To achieve the best possible bespoke solution, Lucida seeks early and direct contact with pension scheme managers, trustees and their advisers looking to reduce risk in their scheme.