In May of this year, we looked at “The Changing End-Game for Defined Benefit Pension Schemes”. It has become clear that the options for trustees to discharge their pension scheme obligations are expanding. Every trustee hopes to be able to secure the benefits promised to their members using a buy-out (insurance policy). Many employers will also want to remove the burden of running a defined benefit pension scheme but for various reasons, this isn’t always as simple as putting in a lot of cash (which they may or may not have).
Whilst it is often the case that companies do not wish to pay a premium to the insurance company for them to take on the risk of the scheme benefits, for some companies it is the impact on the corporate accounts of providing this additional funding that can be the real barrier.
One idea, gaining ground in the industry, which can help resolve this issue is to create a “captive” company. This company will be wholly owned by the scheme’s sponsor and will work with an insurance company to secure the benefits of the scheme.
For trustees and members, this arrangement looks just like any other buy-out. The trustee selects the (agreeable) “primary” insurance provider, buys-out the member benefits and winds up the pension scheme. It is the “captive” company, owned by the scheme sponsor, which then reinsures the liabilities.
Reinsurance is commonly used to spread the risks taken on by the primary insurance company in any buyout. In this case, if the captive company is the reinsurer of its original scheme’s benefits it will retain some/all exposure to the various demographic characteristics of the members (mainly longevity) and potentially some of the exposure to the investments used to fund the liabilities. This gives the captive the opportunity to realise the potential profit against solvency funding provisions. Retaining the exposure to the benefits through this subsidiary also largely “solves” the accounting reporting issues.
The downside is that there are no guarantees in the reinsurance market, just expectations; and the Company will also need to run a reinsurance company, potentially for decades. From the trustees’ perspective, there could also be the perception by members of retaining a reliance on the original sponsor which whilst not technically true is something the trustees would want to take into account.
I certainly find this a captivating idea worth exploring in the right circumstances, and the additional fees involved tend to mean this is an option limited to the larger schemes. Whilst in theory such an arrangement will be relatively simple from a trustee perspective (as all of the advice on the “captive” needs to be taken by the company) the trustee board will still want to understand the implications for their members. As with so many other governance, regulatory, and specialist projects or even ongoing matters, having a professional trustee on the board can help to bring comfort to the membership and the employer, ensure compliance and ease administration in running the scheme.
For additional information on how Pi Pension Trustees can help your pension scheme work towards a successful buyout of liabilities contact us at enquiries@pipg.co.uk.
Sarah Marshall is a Fellow of the Institute and Faculty of Actuaries who now focuses on providing professional trustee services and is an Accredited Trustee through the Association of Professional Pension Trustees. Sarah now acts as Chair, Co- and Sole Trustee to several Defined Benefit and Defined Contribution schemes. Her combination of technical knowledge and pragmatic approach adds value both to trustee boards and specialist project work.
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