The Pension Schemes Act 2021 has put in place the legislative framework for the new defined benefit (DB) scheme funding regime, which includes the requirement for trustees to set a long-term objective (LTO) for their scheme (see our article on LTOs and the new scheme funding regime here).

Typically, there are two main options for DB schemes: buy-out or low dependency (similar in concept to self-sufficiency). Some newer variations have surfaced in recent years, such as consolidation within a superfund or master trust (see our article on superfunds here) but, for many trustees, the LTO will still mean buy-out.

What is a buy-out and why might trustees choose this route?

Two of the most common risk transfer options available to DB pension schemes are buy-ins and buy-outs, commonly referred to as bulk annuity policies.

These are insurance contracts entered into between a pension scheme and an insurance company. In exchange for the payment of a premium, the insurer agrees to pay whatever the eventual liabilities are in respect of the insured members. With a buy-in, the policy covers a particular set of members, normally some or all of the pensioners. With a buy-out, the policy covers the entire membership. For the purposes of this article, we take a look at the process of going straight to buy-out although, in practice, many schemes will often complete a buy-in first before moving on to a buy-out.

Buy-out involves transferring all the scheme's assets and liabilities to an insurer (for a premium) and taking the scheme off the sponsoring company's balance sheet. This removes not only all investment-related risks, but also longevity risk, the need for trustee oversight, ongoing sponsor covenant reliance and the costs of administrating the benefit payments.

As the buy-out market has continued to develop and expand, the size of schemes for which buy-out may be realistic has moved from small-to-medium-sized schemes to larger schemes, with transaction sizes now reaching in excess of £4 billion.

Collaboration with the sponsor

In the current uncertain economic environment, for a buy-out deal to go ahead it will often need to be able to be funded entirely from scheme assets and without recourse to the sponsor. However, that is not to say the sponsor does not still have a part to play in the process. Early sponsor engagement and collaboration will be important, not least to give potential insurers the confidence that the scheme is ready to transact.

The end goal of the process will be the winding-up of the scheme and discharge of the trustees from future liability. Typically, the sponsor has a legal role to play in starting that process and it is only right that the trustees and sponsor should agree on how and when a scheme enters the final stage of its life.

For schemes in surplus, collaboration with the sponsor over the use of any surplus will be necessary – should it be returned to the sponsor or be used to improve benefits for members, including through some form of residual risks cover, or a combination of the two? See our article considering the issues around trapped surplus here.

"All risks" buy-out

Collaboration with the sponsor will also be key in respect of buy-outs to be done on an "all risks" basis. A traditional buy-out will only cover a defined set of members and their benefits. All risks cover is insurance covering risks that a traditional buy-in or buy-out would not cover – in essence, "unknown" risks. The scope of cover that may be provided varies and it may be more appropriate to refer to such policies as "residual risk" policies because they do not cover all risks for a scheme in a literal sense.

Some trustees may want to take this out to get comfort that these extra risks are covered by an insurer but trustees may need the sponsor to agree to pay for such cover or to provide an ongoing indemnity before agreeing to do the deal as there are risks that the insurer will not be taking on as part of the buy-out.

When should trustees start preparing?

It is never too early. Even two to three years from buy-out, schemes should look to start discussions with insurers to understand the process and begin to plan for the endgame. Insurers want to help make the process as smooth as possible for both trustees and sponsors, and will be keener to work with those that come to them early in the process.

Moreover, trustees and scheme sponsors need to ensure that the scheme-specific information issues are all resolved and that everything within their control is "buy-out ready". Insurers have detailed requirements regarding the quality and description of data and the nature of the assets held in the scheme's portfolio.

What follows is a review of those issues that are within the control of the trustees and sponsor and which, once resolved, will ensure the scheme is primed, buy-out ready and able to capitalise on market opportunities. We also take a quick look at the buy-out market and the process trustees typically go through to secure an annuity.

Missing and poor-quality data

Whilst it is important that trustees follow the Pensions Regulator's issued guidance on record-keeping, they should not stop there if they want their scheme to be buy-out ready, as the data requirements of insurers are a little more demanding. When pricing a buy-out, insurers will make prudent assumptions about any missing data items. The most common include:

  • marital status and spouses' existence;
  • spouses' dates of birth; and
  • postcodes.

It is possible for trustees to source and verify this data using tracing services that are both reasonably priced and non-invasive. Doing so could materially lower prices by cutting insurers' margins for prudence, although in a small number of cases it could increase the cost (for example, if spouses are found to be much younger than members). Regular member existence checks are also important. Tracing and verification can take time and are worth undertaking earlier rather than later to prevent them acting as barriers to transacting a deal quickly and at a good price when an opportunity presents itself.

Poor data quality can not only affect buy-out prices, in some cases it can also put insurers off quoting at all. The other danger is that trustees secure a mismatched bulk annuity policy due to inaccurate member records, which can then cause headaches a few years down the line when they have to correct benefits before they can wind up the scheme. To be buy-out ready, it pays for trustees to collect and correct data now and keep it up to date.

Guaranteed minimum pensions (GMPs)

Certain schemes (that were previously "contracted out") have some guaranteed benefits – GMPs, that are effectively a replacement for earnings-related state pension benefits. For many schemes, particularly those with fairly high average pensions, the GMPs form a small part of total scheme benefits. Even so, they require careful treatment.

If the scheme has not already done so, then GMPs will need to be equalised as part of the buy-out process, and so insurers expect to see an understanding from trustees of the likely costs of doing a GMP equalisation exercise and the additional liabilities that will result from it.

Promised benefits

It is easy to think that the benefits provided by a pension scheme are clear and unambiguous, but reality can be somewhat different. Some schemes have a single benefit basis that has hardly changed over the years, with minimal impact from legislation. However, most schemes do not fit this simple model.

A review of the promised benefits will result in a full benefit specification setting out definitively what each class of member is entitled to under the scheme rules. Such an exercise will often reveal issues where the administration of the scheme in the past has not reflected the correct entitlements. Particular problems have arisen with equalisation – for example, where the scheme has equalised retirement ages incorrectly and further work is required to put this right. In some cases, normal pension age is misstated for some members and changes have to be made and often backdated. It is important to iron out these issues at an early stage.

Discretionary benefits

Pension schemes contain numerous trustee discretions. In some cases, there is a need under the scheme rules to involve the sponsor in exercising those discretions. However, insurers do not typically provide discretionary benefits – everything needs to be buttoned down as an agreed and definite set of benefits.

An example of this is the payment of a pension to a dependant on the death of a member. The insurer will require direction on deciding to whom payments will be made on death, whereas trustees will often give individual consideration to cases and exercise their discretion.

It therefore makes sense for trustees to go through a process of identifying these discretions and working out how they will codify them in a way which will be acceptable to insurers. Similarly, pension schemes sometimes contain complex benefits or little-used member options, such as the ability to surrender pension for additional pension for a dependant. These can be expensive to insure and, in some cases, insurers will refuse to insure them. It makes sense to tidy this area up in good time for a transaction.


As well as checking all the data issues and ensuring a full appreciation of the promised benefits, trustees also need to give due consideration to the asset side of the equation, in particular:

  • price movements on the bulk annuity quotation compared to scheme investment performance in the period leading up to the transaction;
  • liquidity; and
  • the mechanics of paying the premium to the insurer.

Matching annuity pricing

The way in which a buy-out operates means that the final premium to be paid is not usually known until the settlement date – the date the payment is actually made. Typically, how this works is that a price is agreed based on market conditions at an earlier date and this price is then rolled forward in line with daily returns calculated using a formula specified in the annuity contract – this can be based on a reference portfolio or on specified indices.

To reduce the risk of the price increasing by more than the scheme assets over this period (or falling by less), trustees should ensure that assets to be used in the transaction are invested in asset types that provide a reasonable "match" for annuity prices – in other words, assets which change in value in a similar way to the change in annuity prices. Examples could include corporate or government bonds.


Similarly, trustees should review the liquidity and marketability of their assets to ensure they are able to settle the bulk annuity premium within the timescales agreed with the insurer. In practice, the importance of this will depend on the transaction mechanism.

For a full buy-out, insurers typically look for certainty around assets being sufficiently liquid and aligned to liabilities (typically gilts and cash by the very end), so it is important that trustees have a plan in place to transition to this type of portfolio over time. This will also influence the type of assets held in the portfolio now – for example, if the scheme is a few years from buy-out, trustees should steer clear of illiquid assets. The same goes for certain types of LDI positions, such as LPI swaps, that are highly illiquid (see our article on LDIs and the recent gilt market volatility here).

Paying the premium

Rather than requiring the premium to be paid in cash, some insurers are prepared to accept some or all of the scheme assets for the transaction in settlement. This is called an "in specie" transfer. This can be more cost-effective since trustees would otherwise incur the transaction costs of disinvesting into cash, and an insurer would include a loading in their premium for the costs of investing the cash received into suitable assets within its wider portfolio.

The trustees should take appropriate investment advice on the asset transfer/premium payment mechanics.

The buy-out market and the process for securing an annuity policy

The buy-out market has grown significantly over the past few years as the appetite to de-risk pension schemes has steadily increased. To match this demand, the number of providers has also increased and there are significantly more players today.

To summarise, the step-by-step process for securing a bulk annuity is broadly as follows:

  • approach suitable insurers on an anonymous basis to see if they are prepared to provide a quotation;
  • provide insurers with the scheme-specific information (i.e. benefit specification and full set of current member data);
  • insurers issue indicative quotations for the cost of providing the specified benefits;
  • trustees review the indicative quotations and may decide to proceed with a few insurers with the best premiums;
  • the (shortlisted) insurers provide guaranteed quotations (usually valid only for a few weeks). To note, only the calculation basis is secured – the price will fluctuate with market movements;
  • the trustees review the guaranteed quotations (with advisers) and, if they accept a quotation, the corresponding policy is signed and the trustees arrange for the premium to be settled in line with the terms of the contract (usually within five business days). The insurer is now on risk for any changes in membership (such as deaths and retirements); and
  • the data is confirmed and a balancing payment is calculated and paid. The policy is now fully implemented.


Full buy-out without sponsor contribution is increasingly coming within reach of some pension schemes. Through careful monitoring of insurer pricing and seizing the opportunity to fully insure all their liabilities, trustees can fulfil their first duty to safeguard the security of their members' benefits.

Whilst asset and liability management strategies have been vital for these fortunate schemes to reach this end goal, there are other steps trustees can take to guarantee a successful process from start to finish. Good governance and involving professionals with experience in this area is important, but so too is advanced planning in relation to benefits, data and managing risk.