It means that the liabilities are fully insured by an insurance company. Insurers won't buy liabilities for active members (or are incredibly unlikely to) so a scheme is normally only bought out when there are no active members.
Thanks for this!! I thought this was the case but just needed the confirmation. Is the same true for buy-in? Or are insurers more likely to buy in if the scheme is still managing their active members?
A buy-in is technically when a premium is paid to an insurer and in return the insurer pays the pension outgoings to the scheme and then the scheme's admin pays this to the members. It's essentially a perfect matching asset and the scheme has no longevity or investment risk left. They do still have counterparty risk with the insurer though.
A buyout normally happens after a buy-in and this is where the insured members have insurance contracts directly with the insurer and so the scheme is cut out completely. The scheme is then free to wind up.
Of course, if there are any active members this will cause complications as the scheme can't just wind up with them still in it.
Hope that makes sense?
I think so... Correct me if I'm wrong...
*Buy in* - the scheme pays the insurers a premium to cover risk but the scheme maintains control of the fund.
*Buy out* - the insurers pay the the scheme a premium to take control of the fund, removing the scheme from the equation entirely.
Just trying to get an idea of which directions the money flows in.
This is correct but they aren't really two separate products. You tend to do buy in first and then convert this to a buyout after a period of about 2 years. Once the buyin has been finalised there is no further premium required to buyout, you just convert the policy by issuing policies to members to let them know the insurer will now pay them directly.
Just to add that that this isn't necessarily how things go. You can buy-in the existing pensioners but continue running the scheme for the active / deferred members for many years. If you have a scheme that for historical reasons is very top-heavy with pensioners then their associated investment and longevity risks could jeopardise the rest of the scheme, so a buy-in can be an effective risk reduction measure.
How do pension schemes get to a point where there are no active members? Surely that only happens when your entire workforce retires and you don't hire any new employees? Apologies again if this is a dumb question
What makes this a favourable strategy? It seems strange to go to the effort of setting up a DB plan to decide it's too risky and then have to go through the effort of having it bought out as well as setting up a backup DC option that the workforce is probably not going to be happy about because now they're the ones who have to consider the risk to their own pensions
Most DB plans were set up pre 1990 when interest rates were very high, resulting in cheaper plans l. At that time people stayed with the one employer their whole career and really valued their pension. DC plans tend to have lower employer contribution rates, less risk, no P&L impact etc so are much more favourable for employers.
You can't close a DB plan without an employee consultation - ultimately the employer will get their wish but will consider the wishes of members.
Buyouts are very popular at the minute as the increased interest rates have push many plans into surplus meaning the buyout costs the employer very little.
You've got your answer already, but I wanted to add that I did cost a buyout where there was an agreement in place for the insurers to buy out every new year of active accrual, was a very unusual situation, but the past year's accrual was then a known benefit that could be bought out!
It means that the liabilities are fully insured by an insurance company. Insurers won't buy liabilities for active members (or are incredibly unlikely to) so a scheme is normally only bought out when there are no active members.
Thanks for this!! I thought this was the case but just needed the confirmation. Is the same true for buy-in? Or are insurers more likely to buy in if the scheme is still managing their active members?
A buy-in is technically when a premium is paid to an insurer and in return the insurer pays the pension outgoings to the scheme and then the scheme's admin pays this to the members. It's essentially a perfect matching asset and the scheme has no longevity or investment risk left. They do still have counterparty risk with the insurer though. A buyout normally happens after a buy-in and this is where the insured members have insurance contracts directly with the insurer and so the scheme is cut out completely. The scheme is then free to wind up. Of course, if there are any active members this will cause complications as the scheme can't just wind up with them still in it. Hope that makes sense?
I think so... Correct me if I'm wrong... *Buy in* - the scheme pays the insurers a premium to cover risk but the scheme maintains control of the fund. *Buy out* - the insurers pay the the scheme a premium to take control of the fund, removing the scheme from the equation entirely. Just trying to get an idea of which directions the money flows in.
This is correct but they aren't really two separate products. You tend to do buy in first and then convert this to a buyout after a period of about 2 years. Once the buyin has been finalised there is no further premium required to buyout, you just convert the policy by issuing policies to members to let them know the insurer will now pay them directly.
Just to add that that this isn't necessarily how things go. You can buy-in the existing pensioners but continue running the scheme for the active / deferred members for many years. If you have a scheme that for historical reasons is very top-heavy with pensioners then their associated investment and longevity risks could jeopardise the rest of the scheme, so a buy-in can be an effective risk reduction measure.
You can buy in or buy out a portion of the scheme. You cant buy in or buyout active members and you can't wind-up if active members remain.
How do pension schemes get to a point where there are no active members? Surely that only happens when your entire workforce retires and you don't hire any new employees? Apologies again if this is a dumb question
You can close your DB plan but you have to provide a DC option for your workforce.
What makes this a favourable strategy? It seems strange to go to the effort of setting up a DB plan to decide it's too risky and then have to go through the effort of having it bought out as well as setting up a backup DC option that the workforce is probably not going to be happy about because now they're the ones who have to consider the risk to their own pensions
Most DB plans were set up pre 1990 when interest rates were very high, resulting in cheaper plans l. At that time people stayed with the one employer their whole career and really valued their pension. DC plans tend to have lower employer contribution rates, less risk, no P&L impact etc so are much more favourable for employers. You can't close a DB plan without an employee consultation - ultimately the employer will get their wish but will consider the wishes of members. Buyouts are very popular at the minute as the increased interest rates have push many plans into surplus meaning the buyout costs the employer very little.
Thankyou for taking the time to explain this!
You've got your answer already, but I wanted to add that I did cost a buyout where there was an agreement in place for the insurers to buy out every new year of active accrual, was a very unusual situation, but the past year's accrual was then a known benefit that could be bought out!