Could you benefit from a buy-in?
Debunking the myths of buy-in
13 Aug 2019 - Estimated reading time: 5 minutes
Many trustees and sponsors incorrectly assume their scheme wouldn't benefit from a buy-in. While it won't be right for everyone, there are a number of misconceptions around buy-in which prevent viable schemes from considering it. I'd like to debunk those myths once and for all!
Myth 1: A buy-in only increases security for the members covered by the buy-in policy
Reality: A buy-in is an asset of the pension scheme. In the event of employer insolvency:
- if the scheme enters the PPF, the buy-in becomes an asset of the PPF and all members receive benefits at PPF compensation levels;
- if the scheme is funded above PPF levels, but has insufficient assets to insure 100% of members’ benefits, then the buy-in can be reshaped and redistributed amongst other members, so that all members receive the appropriate level of benefits on wind-up, irrespective of whether they were originally notionally covered by the buy-in policy.
Of course, with an ongoing sponsor the de-risking benefits of the buy-in will be good news for all members.
Myth 2: If we complete a buy-in, we’ll miss out on future higher asset returns and fund insurer profits
Reality: Completing a buy-in removes investment risk associated with a portion of the scheme’s assets. Some trustees would rather retain the flexibility to invest the assets elsewhere, this approach could lead to higher returns, albeit the risk is greater – the sponsor would need to underwrite the risk that returns are lower than required or members live longer than expected. It is always important to consider how assets used to fund a buy-in could otherwise be invested now or in the future.
In many cases, a buy-in can marginally increase returns on a scheme’s portfolio. It is currently possible to secure a buy-in at a yield higher than that available on gilts. So if schemes exchange gilts for a buy-in policy it would increase the expected return on the portfolio as well as offering some longevity protection.
Myth 3: The buy-in market is too busy, so pricing isn’t very good at the moment
Reality: The buy-in market is certainly busy, with a record volume of business completed in 2018 and this trend has continued into 2019 with total volume likely to exceed £30bn. Pricing has generally risen, but very attractive pricing is still possible. In the current market, insurers can offer good pricing if they can source enough assets on good terms to back the business, and they need to offer good pricing because pension schemes are generally not forced buyers.
However, this does mean that schemes will need to adopt a patient approach, in some cases giving insurers more time to offer their best possible pricing. Schemes that have set clear objectives at the outset will be well placed to assess insurer pricing quickly and objectively consider whether to transact or wait and monitor the market.
Myth 4: I can’t do a buy-in if I haven’t fully cleansed my member data
Reality: Accurate data is important and making steady progress to fully cleansing data over the period to wind-up is very important. The further trustees are along the data cleansing journey will certainly support engagement from insurers.
However, for most schemes the current data is likely to be sufficient to allow you to approach insurers for accurate buy-in quotations. It may be necessary to make some assumptions to start with where data is incomplete, but any changes can be “trued up” at a later stage of the process or, if the impact of data uncertainty is small, after completing the transaction. Some data items which commonly fall under a “true-up” are pensions payable to spouses on death of a member and marital status information.
Myth 5: We’re still a long way from buy-out, so a buy-in isn’t right for our scheme yet
Reality: It is worth noting that we have seen significant improvements in the pricing for non-pensioner members recently which means that buy-out may be more affordable than you think.
For pension schemes where buy-out is still further away, a buy-in remains a relevant asset class for consideration as part of the portfolio. A buy-in forms part of a trustee’s matching assets, it has very low management costs, provides some longevity risk protection and a return in excess of gilt yields means it can be a more efficient investment.
The considerable uncertainty over long-term buy-out pricing also highlights the potential benefits of completing a series of buy-ins over time instead of waiting and looking to complete one big buy-out transaction when pricing could be unfavourable.
If you face a barrier we haven't mentioned, or would like to discuss anything further, please don't hesitate to get in touch.