10 Things Pension Schemes Should Know about Buy-Out

The UK’s defined-benefit pension schemes are financially stronger than they have been in years. Many sponsors and trustees are taking this opportunity to revisit their endgame. Should they transfer their obligations to an insurer in a buy-out transaction, or is the scheme better placed to run on, managing its own obligations?

At Goldman Sachs Asset Management, we believe a case can be made for both options, and the decision depends on a scheme’s specific situation. While the finality of buy-out may makes it an attractive option for many schemes, trustees should consider a range of issues before proceeding down this road. Here are 10 things sponsors and trustees should consider as they map out a long-term strategy for their scheme.

Scheme Governance Considerations

1. Getting Ready

Given the continued strong demand for buy-outs, pension schemes planning to pursue this option need to make all aspects of their operation transaction-ready. This process can be costly and time-consuming. It encompasses everything from governance and funding to data cleansing. 

2. Covenant Strength

Trustees need to consider a scheme’s relationship with its sponsor. Where the sponsor’s covenant is seen as volatile, as in cases of potential insolvency, trustees may prefer to move toward buy-out to bolster the security of members’ benefits.

3. Funding Strength

The premium demanded by insurers in a buy-out transaction means pension schemes need funding levels beyond the level sufficient to meet their obligations. This demand for additional funding can be seen by considering the aggregate funding ratio across the UK defined-benefit pension industry. The Pension Protection Fund estimates that the aggregate ratio reflecting the full cost of buy-out stood at just over 94% as of March 31, 2024. Compare this with ratio of 123% using the so-called Section 179 calculation, which does not fully reflect expected increases in member benefits or the cost of an insurance transaction.¹

Investment Strategy Considerations

4. Endgame Alignment

In our view, trustees who are charting a course toward a buy-out agreement will also need to be sensitive to how insurers invest, taking into account solvency capital, regulatory and accounting considerations, and other inputs to target better risk-transfer pricing.

5. Pre-Existing Buy-ins

Schemes may have an existing insurance policy that covers the benefit payments for a portion of their membership, an arrangement known as buy-in. In these cases, trustees should check that the buy-in can be integrated into a full buy-out transaction.

6. Illiquidity Hurdles

Private-market assets such as property and private credit in a pension scheme’s portfolio can slow the buy-out process. Insurers typically prefer transactions involving easy-to-sell assets because of the more onerous capital treatment they can face for illiquid asset classes. Schemes planning to secure a buy-out generally seek to wind down illiquid allocations efficiently.

7. Investment Partner

Trustees may find that outsourcing their investment strategy and/or execution can make sense to help them navigate the challenges of preparing for buy-out. An outsourced chief investment officer (OCIO) or fiduciary management arrangement, typically with an asset manager, potentially allows schemes to tap into the investment expertise of the external manager and free up trustees to spend more time on strategic planning.

Insurance Market Dynamics

8. Insurer Capacity

With so many schemes in a strong financial position, the long-term trend toward de-risking strategies accelerated in 2023 to a record total of 226 buy-in and buy-out transactions.² As more schemes pursue buy-outs, the capacity of insurers to conduct these transactions could potentially affect the speed with which schemes can bring them to completion.

9. Buy-out Cost

This can vary based on the specifics of the transaction and the market’s capacity, but we estimate that the assets transferred in a buy-out are 10% to 30% above what is required to prudently meet a scheme’s obligations. Insurers require this premium to cover their own costs, including capital requirements, and to enhance the profitability of the transaction.

10. Selecting the Right Insurer

It is important for schemes to conduct a competitive tender process, assessing insurers’ financial strength, pricing, service levels, administrative team and track record in delivering buy-outs.

¹ “The Purple Book 2024,” Pension Protection Fund. As of December 5, 2024. The PPF updated its methodology for calculating the value of schemes’ assets and liabilities for this publication. The changes include using more granular asset allocation data and applying a wider range of market indices in its asset roll-forward calculations. The PPF also began to take account of cash flows in and out of schemes, particularly benefit payments.

² “Buy-outs, Buy-ins and Longevity Hedging – H2 2023,” Hymans Robertson. Data as of December 31, 2023.