Perhaps you are one of the 10.5 million people in the UK with a defined benefit (DB) pension. Commonly referred to as ‘final salary’ or ‘career average’ pensions, private sector DB pensions are rarely available today, although people who worked for companies in the 1990s or earlier may have this type of pension.
Over the past decade, more than one million of these pensions have been insured through pension buy-ins and buyouts – and financial analysts are forecasting that hundreds of billions of pounds worth of DB pensions are set to transfer to insurance companies over the next decade. However, the awareness and understanding of these transactions remains relatively limited.
A pension buyout is a financial agreement that takes place between a DB pension scheme and an insurance company, like Legal & General. In a buyout, the pension scheme pays the insurance company a premium and in return receives individual policies issued to all of the members covering their retirement income. The insurance company takes over responsibility for the payment of these pensions and, typically, also the administration and customer service. Members usually enjoy exactly the same pension benefits that they were due from their pension scheme, although in some buyouts the scheme is able to enhance members’ benefits, and to purchase more pension income for their members from the insurance company.
Completing a buyout accomplishes two main objectives for the company:
By removing the pension liabilities from its balance sheet, the company will not be called on to put more money and resources into the pension scheme and can instead focus on growing its business.
A buyout with an insurance company is usually seen as the gold standard objective for companies and the trustees who run DB pension schemes on behalf of the members. Why? Because it also improves the security of members’ pensions as they move out of the corporate pensions environment and into the regulated insurance regime.
Insurance companies are required by law to hold large reserves (known as capital requirements) to ensure that they can always meet their financial commitments even in extreme economic scenarios. No insurance company in the UK pension buyout market has ever defaulted against its policyholder obligations.
By contrast, more than 2,000 defined benefit pension schemes have required support from the Pension Protection Fund (PPF), the industry lifeboat. This has seen more than a quarter of a million people facing a cut (often 10% or more) to the benefits that they were promised.
A buyout should be viewed as excellent news for members of DB pension schemes as it is an insurance arrangement that protects their retirement benefits. It also means the that they will receive long-term customer care as a policyholder of the insurance company.
Pension schemes pay insurance companies a premium when completing a buyout. Built into the price that the insurer charges will be a level of prudence to protect against different risks – for example, the risk that members of the pension scheme live longer than expected, meaning that pensions must be paid for longer. The price will also take account of administrative costs and other expenses associated with running the pension scheme.
Insurers like Legal & General take the premium that is paid and invest it in a low-risk way in order to back the pension promises that they are now responsible for keeping. This means that the insurance company expects to make a bit more money each month than they need to pay pensions. At Legal & General we are committed to what we call ‘inclusive capitalism’ – improving lives by boosting the economy from the ground up. In a buyout your pension money plays a vital role in this.
We invest responsibly in corporate bonds and in socially and economically useful projects, such as urban regeneration, transport, housing, clean energy, and financing for smaller companies. We believe this will help to plug the UK’s infrastructure gap and encourage the post-pandemic recovery. So far, we’ve invested over £26 billion in these types of projects.