Page last updated at 13:15 GMT, Friday, 5 December 2008

Pension scheme buyouts protected

Money Talk
Matthew Furniss
Punter Southall consulting actuaries

Matthew Furniss
Matthew Furniss

An important element of financial protection has been clarified for some pension scheme members.

The Financial Services Compensation Scheme (FSCS) has, at long last, confirmed that it covers both members and trustees of pension schemes where there has been a buy-out, or buy-in respectively, involving an insurance company.

In recent times there has been a growing trend for pension schemes to "buyout" liabilities through the purchase of bulk annuities from insurance companies.

However, with the recent turmoil in financial markets, trustees and members of pension schemes who held these annuities needed to know what would happen if the insurance companies issuing them become insolvent.

A year or two ago, the idea of a major insurance company going under would have been almost laughable, given the high reserves that the Financial Services Authority (FSA) requires each insurer to hold.

The joke though, has begun to fall somewhat flat.

Collapse

Recent events round the world have shown that even the perceived strongest financial institutions are at risk of failing following the shocks in the US.

The FSCS has finally confirmed the compensation that would be available

These included the Lehmann Brothers collapse and the part nationalisation of insurance giant AIG.

Should an insurance company go bust it was hoped that trustees and scheme members would be protected by compensation from the FSA's lifeboat scheme the FSCS.

The FSA rulebook broadly provides for recompense of the first 2,000 of the value of the policy and then 90% of the remainder.

As far as big insurers involved in buy-outs are concerned, the FSCS is so far untested.

Following calls from the industry to confirm this compensation, the FSCS had up until last week not been forthcoming with the required assurance.

However, in the light of growing public unease around this, it has finally confirmed the compensation that would be available under the various circumstances.

Compensation

The term "buyout" actually covers two different type of structure, buy-outs and buy-ins, with both being affected by this issue in differing ways.

Pound coin
The precise level of protection may change soon

Under a buy-out, the insurer takes on the liabilities of the pension scheme from the trustees and has direct responsibility for ensuring that the members' benefits get paid.

In light of this, the security of those benefits depends on the strength of the insurance company.

In the worst circumstance where the insurer actually went under, it had been assumed that the FSCS would pay out to members in the way suggested in the FSA handbook.

The FSCS has now confirmed this is the case, should it be unable to secure continuity of cover by transferring the policies to another insurer for at least 90% of the pre-insolvency benefits.

However, the FSA has recently begun a consultation on whether to scrap the 100% guarantee on the first 2,000 of each member's policy value, in preference for a blanket 90% protection for all benefits.

The FSCS suggests that this is likely to be agreed and cites benefit consistency and administration simplification as the reasons for this change.

The fall in coverage, should it come into force, will be a reduction in the protection available.

Buy-ins

Up until the clarification from the FSCS, there had been far more uncertainty surrounding compensation available to trustees following a buy-in.

This is the area that trustees and their advisors had been particularly worried about

Under this arrangement, the bulk annuities are bought by the trustees of a scheme and are held as a scheme investment.

The trustees - and the company whose scheme they are running - ultimately remain responsible for ensuring that all pensions are paid.

If the insurer that wrote the annuities for a buy-in became insolvent then, if protection were to be provided, the FSCS compensation would need to go to the scheme's assets.

If the compensation was unavailable, this would mean that the annuities might have no value, leaving a big hole in a scheme's funding position.

This is the area that trustees and their advisors had been particularly worried about.

Recent comments from the FSA and FSCS had suggested that compensation might be dependent on various factors.

Among them were how the original transfers were made to the insurers, or the make up of the employer, and whether any money would be recovered elsewhere.

None of these suggested criteria form part of the FSA's Rule Book.

Thankfully now the FSCS has confirmed that the trustees, following a buy-in, will get the same protection as members would following a buy-out.

Risks

Despite the risk of an insurer going bust, without being able to transfer its liabilities to another solvent insurer, being still relatively low, the clarification from the FSCS in these areas is certainly welcome.

It ensures that the risks of buying in or out can now be fully analysed by trustees and their advisors.

Scheme members and trustees of schemes where benefits have already been bought-in will also be relieved as to the security of their assets and benefits.

However, the probable fall in the level of protection for the first 2,000 of value, which has come somewhat out of the blue, is unfortunate for any members that may be affected and progression of the consulting stage of this proposal will be followed with interest.


An earlier version of this story wrongly suggested that the 2,000 limit applied to policy value rather than benefits; the article has been corrected.

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.



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