28 November 2020
New research from consultants LCP finds that millions of pension scheme members are set to benefit from greater security in the next five years as increasing numbers of pension schemes are secured with insurance companies.
There are currently 10 million people in Britain with pension rights from private sector Defined Benefit pension schemes. Five years ago, fewer than 1 in 10 members had their pensions backed by an insurance company. New figures from LCP, based on a recent survey of insurers, reveal that around 1 in 6 members have now been insured, and LCP estimates this will increase to 1 in 3 by the middle of the 2020s.
At present, when a worker’s pension comes from a ‘final salary’ type of pension, whether or not the pension gets paid in full often depends on their employer (or former employer) staying in business and being able to make up any funding shortfall. If the employer goes bust at a time when there is a deficit in the scheme, pensions may not be paid in full. The ‘lifeboat’ Pension Protection Fund (PPF) provides a safety net but does not cover the full value of benefits for all members. With insolvencies expected to rise over the next 12 months, and with thousands of pension schemes currently in deficit, many pensioners and workers face the risk that their pensions may not be paid in full.
To provide greater security to members’ pensions, many company pension schemes are entering into what is known as a ‘buy-out’ where all of the pension promises are passed over to an insurance company.
Because the insurance company has to meet strict conditions around the assets and capital reserves it holds, a deal of this nature provides a greater level of security to members than relying on the former employer to continue trading for decades to come. In the current year it is estimated that over £25 billion will be paid over to insurers to ‘buy out’ pensions. (This figure also includes ‘buy-in’ transactions which are an intermediate stage where only some of the liabilities are under-written by an insurer). Schemes which have undertaken such transactions include Asda who last year paid £800m into their pension scheme to allow a buy-out to proceed.
To help members understand the implications of this activity, consultants LCP have produced a new paper: “Will your company pension end up being paid by an insurance company – and should you care?”. The paper explains that when benefits are passed over to an insurance company, the main terms – such as the level of the pension and the annual rate of increase – remain unchanged. But instead of being dependent on the solvency of the former employer, the additional security provided by the insurance regime means that it is likely that all pensions will be paid in full.
And in the unlikely event of the insurer going out of business, pensions are covered by the Financial Services Compensation Scheme.
Some relatively minor features of the pension scheme often change following a buy-out. These include the ongoing administration arrangements and, for those who have not yet retired, the terms to transfer out or take a cash lump sum, which could be more or less favourable than previously.
Commenting, LCP partner and buy-out specialist Imogen Cothay said:
“Millions of pension scheme members are blissfully unaware of all the activity that is going on to make sure their pensions are paid in full. Whilst most company pension schemes will deliver as planned, there is always an element of risk as for salary-related schemes, your pension is dependent on your former employer still being in business and able to make up any shortfall in the fund. The process of buy-out involves securing pension payments via a deal with an insurance company which should give pension scheme members greater peace of mind.
We estimate that by the middle of this decade nearly 1 in 3 members will have their pensions secured with an insurer. If you receive a letter saying your pension will be paid in future by an insurance company, you should regard this as a positive action providing a safe home for your pension benefits.”