Pension Buy-Ins and Illiquid Assets

12 July 2024

A Pension Buy-In (buy-in) is a strategic move employed by pension schemes to manage and transfer risks associated with providing retirement benefits.

Essentially, a buy-in is an investment decision taken by the Trustees of a scheme to provide an insurance policy for its members, managing their liabilities and reducing risk.

We’ve broken down the key features and benefits for you below:

What is a buy-in?

  • A buy-in occurs when a pension scheme enters into an agreement with an insurer.
  • In this arrangement, the insurer assumes a portion or all of the scheme’s liabilities, specifically related to pension payments, either due now for pensioner members, or future pensions for the deferred members.
  • Essentially, the scheme ‘buys in’ by purchasing an insurance policy that covers a defined group of members or the full membership.
  • The Trustees of the pension scheme will enter into a buy-in with support from the sponsoring employer, and after having considered the full range of options available alongside formal advice from appointed professionals.

Risk transfer mechanism:

  • The primary purpose of a pension buy-in is to financially secure the benefits promised to members.
  • Typically, the insurer represents a larger and more secure financial backer for pension schemes, meaning that members are more likely to receive their pension benefits in full and on time.
  • The benefit to Trustees and sponsor is risk reduction.
  • By transferring a portion of the pension liabilities to an insurer, the scheme mitigates exposure to longevity and investment risks.
  • This allows the scheme to secure its financial position and enhance stability.

How it works:

  • The pension scheme pays a premium up front to the insurer in exchange for the insurer contractually committing to pay all future pension payments due to the members covered under the policy.
  • For the members in the buy-in policy, they won’t see any difference in the receipt of their pensions, as the insurer pays the pension to the scheme, who continue to pay the pensioners in the usual way.
  • The scheme can continue to run on whilst having the buy-in policy in place and there is the option to progress to a buy-out, where the member’s benefits are transferred to the insurer and the scheme can be wound-up.

Benefits:

  • Security: Members’ benefits are safeguarded, as the insurer takes responsibility for future payments, whilst the scheme still has the financial backing of the sponsoring employer until the potential of the buy-out and scheme wind-up.
  • Risk Mitigation: The scheme reduces its exposure to uncertainties such as market volatility and changes in life expectancy.
  • Member experience: Many schemes can benefit from taking advantage of an insurer’s financial wellbeing tools and member options, where ordinarily these may not have been accessible within the existing structure.

Overcoming illiquid assets:

  • At the time of transacting the buy-in policy, a payment is made to the chosen insurer, giving the requirement to be able to encash the investments held under the scheme. This sometimes gives rise to issues if the scheme has previously invested in illiquid assets which are not able to be encashed at the time the transaction is made.
  • This can be a common challenge, as schemes may not have necessarily expected to be selling their invested assets quite so soon. However, the current insurance market is attractively priced for pension schemes and a buy-in transaction is very popular.
  • Several insurers allow part of the initial premium to be deferred, giving schemes additional time for the illiquid assets to be encashed or sold on a secondary market if necessary.
  • However deferred premiums typically only go up to 10% of the initial price and even then, these deferred premiums can fluctuate in price until they are settled.
  • Selling illiquid assets on a secondary market can be attractive, but this is usually at a discounted value. In some instances, the discounts or “hair-cuts” taken by sellers could be up to 20%. Just as if you were looking to sell your house; the price offered could be materially lower than your valuation because of a desperation to sell quickly.
  • An alternative purchaser for illiquid assets may be the insurer themselves. They may be willing to take on the asset directly, with a view to selling it in the future. This can support a buy-in transaction, but the deal may also be subject to a discounted value.
  • A final option is, the sponsoring employer may agree to make a payment to the scheme in order to meet the agreed insurance premium and the illiquid assets are transferred to the employer.

In summary

Buy-ins provide a valuable risk transfer mechanism, allowing pension schemes to secure their financial position and protect members’ benefits. Holding illiquid assets is not a barrier to a buy-in, and solutions are available.

How ZEDRA can help

Our risk transfer team have worked with all of the main insurers in the market. We provide full market coverage for schemes of all sizes.

We understand that this is one of the most complex projects for a scheme to undertake, and therefore you need an experienced, resourceful and delivery-focussed hand to guide you through.

Having completed over 60 transactions, we are here to help you meet your objectives.

To find out more, contact Eddie Hopkins or Alan Greenlees to discover how we’re helping clients tackle this challenge.

How Can We Help You?