Preparing for buyout: Five essential steps to building a benefits specification

30 June 2023

Alison Bostock, Director, ZEDRA Governance explains why having a clear, accurate benefits specification is a crucial step in buy-in and buyout preparation.

According to Barnett Waddingham’s End Gauge index, the average time to buyout for a FTSE 350 scheme is now under six years, based on progress towards their funding target.

No scheme can transact until it has the funds to do so, but there is plenty that schemes can do to make sure they are ready to transact once their funding position improves.

One of the most important projects in the lead-up to pension buyout is creating a benefits specification. Insurers base their quotes on this specification, so it’s vital that it is complete, accurate, and clear.

Here are five essential steps to preparing an insurer-ready benefits specification:

Plan in advance

Trustees can start this process at any point in their buyout journey, if the scheme is closed to future accrual with benefits that are unlikely to change. They will then be better prepared for any unexpected opportunities to transact if there is a sudden improvement in the funding position.

The bulk of benefits specification work is carried out by the scheme lawyer, administrator, and trustee board, so it’s also possible to do this in parallel with other de-risking activity that requires different resources, such as portfolio alignment.

Start by setting a deadline for the benefits specification. There is a fine balance between moving too quickly and missing crucial small details, and taking too long to resolve debates. Typically, three months should be sufficient, so the process could fit neatly between quarterly board meetings. Most member-nominated trustees will only have to go through this process once, so support from advisers and professional trustees with wider industry experience can be invaluable in maintaining momentum.

Check the basics

As a first step, the scheme lawyer prepares a draft benefits specification, based on the scheme rules and documentation. This will include information such as how benefits are calculated and paid, as well as details such as pension increases in line with indexation.

Once the lawyer’s first draft of the specification is complete, the next step is for the administrator to compare it to the reality of how the scheme is run day-to-day. While there should be no major surprises or discrepancies, this can reveal small mismatches between the rules and everyday practices which will need to be resolved.

There will also be areas where the rules are silent – there may be no detail about the day of the month on which pensions are paid, or the date when pensions payments should start to a bereaved spouse.
In a scheme setting, that silence gives trustees flexibility to pay pensions in advance or in arrears in special circumstances, for example. However, an insurer will need absolute clarity about how the scheme operates.

Identify areas of trustee discretion and unusual benefits

Most schemes give trustees discretion over how benefits are paid in certain circumstances. These often relate to sensitive topics such as death-in-service or payment of pensions to bereaved dependants, so taking time to explore these properly is important.

Insurers are unlikely to be able to exercise discretion in the same way as trustees, so the benefits specification will need to set out clear processes for as many different circumstances as possible.

One example that I have encountered related to so-called deathbed marriages. The scheme rules gave trustees the power to withhold the pension if a spouse had married a member less than six months before their death. This may have been put in place to avoid exploitation but could have serious ramifications for individuals, for example if a long-term common law spouse married their partner shortly before their partner’s death. In a scheme context, the trustees had power to override the rule, but an insurer might not be able to do that.

The Finance Act 2004 provides a standard set of dependant definitions, and most insurers will base their processes on those definitions. However, schemes often have more generous or wide-ranging specifications. Again, the scheme lawyer should identify any definitions that don’t match those of the Act and discuss these with the trustees.

Resolve grey areas

Having identified where the scheme rules are silent, offer discretion, or provide unusual benefits, trustees and the scheme lawyer will need to decide how to codify these. Some areas of discretion may be straightforward to resolve or remove and will help to streamline the benefits specification.

However, there may be some cases where the trustees feel it is imperative that their chosen insurer continues to honour a more generous benefit, or has a mechanism for retaining a process such as awarding discretionary pension increases. This can be a determining factor in selecting an insurer, but could also affect the cost of the pension buyout.

Making these decisions can be complicated and even emotive. Professional trustees can help by bringing objectivity, as well as experience of similar situations in other schemes. We also have the power of a professional trustee firm behind us, where we can turn to others for expertise on different nuances and practical points, as well as helping to resolve decision-making bottlenecks.

Seek quotations

Once the benefits specification is complete, trustees can discuss it with insurers as the basis for a quotation. Insurers will be able to explain whether they are able to replicate the benefits specification exactly, or explore other alternatives.

The benefits specification enables insurers to provide a realistic quotation, and will give them confidence that there are no unexpected details or legal red flags that could delay or derail a transaction. With a wealth of experience behind them, professional trustees are perfectly placed to help schemes prepare a compelling offering to attract insurers and smooth the path to pension buyout.

How ZEDRA can help

With the shifting landscape of pensions legislation and regulation, and increasing risks and governance burden, our team is here to help guide you through the regulatory landscape, deliver good governance, and improve efficiency.

Whether you wish to outsource pensions governance and secretariat, appoint us as professional trustees, engage us to carry out adviser reviews, or conduct discrete projects, we can offer as much or as little support as required for Defined Benefit, Hybrid, and Defined Contribution pension schemes.

Contact Alison to discuss your specific circumstances.

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