Pension scheme buyouts can be a boost to members

Thousands of employees have seen their final-salary schemes sold off in buyouts over the last year, mainly to insurance companies.

In the last month alone, mining company Lonmin and life office Friends Provident have offloaded their final-salary scheme liabilities.

According to a report from PricewaterhouseCoopers, more than a third of all firms with final-salary schemes are considering following suit.

Employers are increasingly reluctant to commit long-term to final-salary schemes because the funding needed to keep them going grows as workers live longer.

"It's not surprising that employers are looking for greater certainty and instead of abandoning the schemes entirely they are selling them to insurers or buyout companies and so offloading their liabilities," said Malcolm McLean, chief executive of the Pensions Advisory Service.

Companies see buyouts as a way of reducing the risk to their own profitability that increased longevity poses.

And with the credit crunch putting more pressure on the bottom line, the market has mushroomed in the last year, according to Damian Morrish, principal for employee benefits at Punter Southall Financial Management. "The market is swamped with quotations for buyouts and providers are not able to deal with the volume of inquiries, which have probably trebled in the last 12 months," he said.

So with hundreds of thousands of employees potentially affected, what are the implications of pension scheme buyouts?

HOW WILL AN INSURED BUYOUT AFFECT ME?

Exactly who a final-salary scheme is bought out by is the key factor. If your scheme is taken on by an insurer, such as Legal & General, Prudential or Aegon, there is little to worry about, according to McLean.

"Individuals shouldn't lose out because all insurers are regulated and have sufficient reserves behind them. It is simply a transfer of responsibilities and they are just getting their pension from an insurer rather than a company."

In fact, this could even make your scheme more secure, as the capital funding requirements set out by the Financial Services Authority, which regulates insurers, mean insurance companies are obliged to hold greater capital reserves than corporate pension schemes.

"It can be excellent news for members from a security point of view," pointed out Darrel Poletyllo, director of private client and wealth management services at Grant Thornton Scotland. "Generally speaking, the insurer's covenant is likely to be far stronger than that of your employer."

David McCourt, policy adviser at the National Association of Pension Funds, added: "Insurers have robust risk and business models so there would only be an issue if this were not borne out. We haven't experienced any problems yet with funds that have been bought out by insurers."

Pension payouts aren't affected – nothing relating to the scheme changes and members get the same income, but from a different source.

WHEN CAN BUYOUTS BE RISKY?

There are other types of buyouts that the pensions regulator is less keen on, carried out by companies not authorised by the FSA. "These companies take over schemes with a view to making a profit and there's a risk in these scenarios of schemes being abandoned or underfunded," said McLean.

The Trades Union Congress has raised concerns over the protection of benefits in non- insured buyouts.

"The growth of increasingly complex and potentially risky new buyout models could pose a serious threat to pension schemes," said TUC generalsecretary Brendan Barber. "Without better regulation, it would only be a matter of time before we face a scheme disaster."

One of the biggest non-insurer buyout firms is Pension Corporation, which recently acquired the pension scheme operated by Telent, part of former telecoms giant Marconi. The case prompted government misgivings about non-insured buyouts, as it felt that Pension Corporation could potentially expose the Telent scheme to inappropriate investments in order to ramp up profits for its own shareholders.

Pension Corporation has taken steps to alleviate concerns by establishing a subsidiary – Pension Insurance Corporation – that is regulated by the FSA, so giving members greater assurances and protection.

The government has moved to improve protection for members of schemes bought out by non-insurers. The Pensions Regulator is to be given extra powers in an amendment to this summer's Pensions Bill to force employers to top up contributions if the benefits of pension scheme members are at risk, a move welcomed by McLean. "Pension schemes are not commodities to be bought and sold for profit at the expense of members."

DO I GET A SAY?

Members do not directly have a say in how their scheme is run, but trustees who work on behalf of members do. "Trustees have to act in the best interests of their members and they should be involved in any buyout discussions," said McLean.

Because trustees are ultimately responsible for a scheme, they carry out detailed due diligence. For example, if the buying company is not an insurer, they assess its financial strength. If the trustees aren't satisfied with the outcome they can effectively veto a buyout.

It is also their job to keep members informed of any changes to their scheme and explain how their pension is being run. So if you are in a final-salary scheme that's subject to a buyout and want to know more, or you just want to understand how your pension scheme is funded, the trustees are your first port of call.

WILL I BE ASKED TO TRANSFER OUT?

There have been instances of employers offering members incentives to transfer out of a final-salary scheme, generally where the member is no longer employed by the company. "In some instances it might be worth considering but people need to get advice on this, especially if they're offered incentives to transfer from a guaranteed final-salary scheme to a private pension," said McLean. "But there is no evidence that this has been the case with buyouts."

IS THERE A SAFETY NET?

All final-salary pension schemes are covered by the Pension Protection Fund (PPF), which guarantees 90 per cent of members' benefits, up to a maximum of 27,771 a year, or 100 per cent where those members are retired. In the very unlikely event of an insurer going bust, members are also protected by the Financial Services Compensation Scheme, which covers 100 per cent of the first 2,000 and 90 per cent of the rest. In most cases the original employer – assuming it still operates – would make some shortfall payments to make up the balance of the FSCS payments. But while the PPF is more valuable than the FSCS, as it provides a pension rather than an arbitrary one-off payment, its future would be in question if it was called upon in the event of several schemes collapsing at the same time.

WHAT NEXT?

While the number of firms investigating buyout options has rocketed in the past year, for many smaller operations it will be out of their reach. Insurer buyouts are expensive, so if the cost is greater than a scheme's assets, it is less likely to happen.

This could mean smaller firms opt for buyouts by non-insurance companies offering a better price – a riskier prospect. "If the covenant of the company buying a scheme is inferior to that of the sponsoring employer, that is a problem," said Poletyllo.

For big companies that can pay the asking price, however, the buyout route will only become more attractive in a difficult economic environment. "It helps them re-gear, and when banks are tightening their lending criteria, pension fund liabilities can be a drag on resources," said Poletyllo. "Not having a final-salary scheme in place also helps them look leaner to potential buyers."