Pension buy-ins and buy-outs

A pension buy-in is an investment where a pension scheme purchases an insurance policy to cover the benefits payable to some or all of its members. This means that the insurer takes on the responsibility for paying the pensions of those members to the scheme, effectively transferring the risk from the pension scheme to the insurer. The scheme retains the legal responsibility for paying the pensions, but the insurer is responsible for funding the scheme so the payments can be made. The scheme transfers assets to the insurer to the meet the buy-in price.

Pension scheme trustees may choose to “buy-out” some or all of their scheme’s expected future benefit payments by purchasing a bulk (ie one covering many individuals) annuity contract from an insurance company. The insurer then becomes responsible for meeting pension benefits due to scheme members (effected ultimately by allocating an individual annuity contract to each scheme member). Following a full buy-out, (ie one covering all scheme members) and having discharged all of the trustees’ liabilities, the pension scheme would normally be wound up.

A longevity swap is an agreement between two parties (typically a pension scheme and either an investment bank or insurance company) to exchange streams of payments; one of which is “fixed”, based on a pre-agreed set of demographic and other assumptions and the other of which is variable, or “floating”. Typically, the pension scheme will receive the floating stream of payments (which corresponds to the pension payments it is obliged
to pay based on its actual experience) and the bank/insurer receives the fixed stream. The floating stream of payments will continue until pension payments cease, regardless of how long the members covered by the swap actually live. As a result, the longevity swap eliminates the risk to the pension scheme that members covered by the payments live longer than expected. Of course the pension scheme will be worse off (compared to not entering the swap) if scheme members do not live as long as predicted under the longevity swap.

A superfund is a type of pension scheme designed to consolidate multiple defined benefit (DB) pension schemes into a single, larger fund. This approach can be used when a pension scheme has no realistic prospect of securing a full buy-out with an insurer in the foreseeable future.