An increasing trend is that of businesses looking for ways to divest themselves of their UK defined benefit pension plan liabilities. This is the result of a number of factors including increasing regulation, increasing administrative costs, such as the introduction of the Pension Protection Fund levy, and increasing benefit costs resulting from, for example, increased life expectancies and the fact that plans will now look to be much better funded than when the UK statutory minimum funding requirement applied. We have reached a stage where for many businesses continuing a defined benefit pension plan or taking one on (for example, by acquiring a company with its own plan) is a deeply unattractive proposition. It is hardly surprising then that so many businesses are looking for a way out of their plans.
While it used to be the case that “buying out” pension liabilities through purchasing annuities was prohibitively expensive, a larger number of providers have now entered into the market, resulting in greater competition and lower costs. A number of different solutions may be offered, depending on the circumstances of the plan. Full and partial buy-outs are discussed below, but there are a number of additional arrangements, such as phased buy-outs, that enable liabilities to be capped to varying degrees.
A potential problem with either a full or partial buy-out relates to counterparty risk. What would happen if your pension plan was still in existence and the annuity provider failed? For this reason it is important to ensure that trustees take advice from an appropriately regulated financial adviser and that they understand the risks involved. The plan sponsor should also consider doing so, since if a plan is not wound up or the counterparty fails, or the annuities bought fail to fully discharge the plan’s liabilities, it is the employer who will ultimately bear the costs of providing the additional funding required.
This solution entails all liabilities of the pension plan being secured by the purchase of annuities in the members’ names. The insurance company providing the annuities will require a considerable payment – all of the assets of the plan plus, usually, a further amount.
The trust could then be wound up, although before this could be completed the actuary and administrator would need to undertake a thorough exercise in checking that benefits, beneficiaries and liabilities are accurately detailed so that the annuities will reflect what would otherwise have been paid out of the plan. This exercise could take a considerable amount of time. Until it is wound up, the plan would still be liable for any rights not otherwise protected by the insurance products bought.
In this scenario, the trustees of the plan secure portions of the plan’s liabilities rather than securing all liabilities at once. Because the buy-out only relates to part of the plan’s liabilities, the trust continues and the corporate sponsor will remain responsible for any liabilities retained in the plan. This solution may work best for businesses who want to reduce their exposure but do not want to pay to fund a full buy-out, and for plans with liabilities so large it may not be possible to find a provider willing to insure the entire plan.
There have been instances of companies being acquired precisely because they have defined benefit pension schemes. The acquirer’s aim is to assist the trustees in managing the assets of the scheme more efficiently and to become the scheme’s investment manager (thereby receiving the associated fees).
There are a limited number of companies for which this arrangement is appropriate. If a holding company, for example, disposed of an insubstantial subsidiary with its own defined benefit scheme in this sort of arrangement (where the acquirer has little or no interest in the business undertaken by the subsidiary) we expect that the UK Pensions Regulator would be concerned. The UK Government has stated in its Consultation Paper on “Amendments To The Anti-Avoidance Measures In The Pensions Act 2004” that such arrangements put the traditional trust model of structuring pension plans under strain. The Government indicated that this may result in unacceptable risk and therefore a higher chance that the Pension Protection Fund may need to become involved in those pension plans.
There are other methods of limiting a pension plan’s exposure to market volatility, such as by buying a longterm bond or bonds. Providers are working to develop more sophisticated products in order to take advantage of this lucrative market. These products do not entirely eliminate risk although assuming that they are an appropriate match for the liabilities of the plan they will go some way to reducing the plan’s exposure.
Any proposal to buy out a pension plan in full or in part will need to have the agreement of the plan trustees, and financial advice must be sought as to the most appropriate provider. The trustees will also need legal advice on the terms of the applicable documentation.