My company pension is moving to an insurer – what happens if it goes bust? STEVE WEBB replies

I’ve just been notified that my company pension will be transferred to an insurance firm via bulk annuity.

I understand that many companies seem to be taking advantage of the increase in gilt yields to do this.

My questions is if the insurance company were to fail would my pension be taken over by the Pension Protection Fund as would be the case if the company failed?

I’m sure many readers would like your opinion on this.

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Steve Webb replies: More and more company pension schemes are transferring their assets to insurance companies which then take on responsibility for paying pensions in a process known as a ‘buyout’.

I’m happy to walk you through the process and how this might affect the security of your pension.

Let’s start with the situation before a buyout transaction takes place.

As things stand, your pension is safe as long as your employer (or former employer) continues in business.

This is because your company is required to put in place plans to make sure that the scheme has enough money to pay the pension promises which have been made.

If the funding position worsens for some reason, the scheme has to have a ‘recovery plan’ to put things straight.

As you will appreciate, even the strongest companies can sometimes go bust, so this means that there is some risk to your pension if this happened at a time when the scheme was not sufficiently funded to meet all pension promises.

I should add that trustees and companies take a lot of measures to manage this risk, including investing in lower risk assets as schemes become more mature.

Another example would be where a company gives the pension scheme first call on certain company assets in the event that the company were to go bust.

But if the worst happens and your company goes bust when the scheme is not fully funded, you would have the security of the Pension Protection Fund.

There are two main scenarios. The first is that your scheme is seriously underfunded, in which case the assets would transfer to the PPF and it would then pay you ‘compensation’.

In simple terms this is something approaching the pension you would have received, but with certain cut-backs. Your can find more details on the PPF site here.

A second scenario is where there’s not enough money to secure full pensions, but there is enough to pay more than PPF compensation.

In this situation, the assets of your pension scheme would go to an insurance company who would pay a set of benefits that were better than PPF compensation but short of full scheme benefits.

The key point of all of this is that even in your current situation there is some risk of your pensions not being paid in full, and the key uncertainties are whether your company goes bust and the level of scheme funding if/when that happens.

Turning now to the ‘buyout’ scenario, here it is an insurance company which takes on responsibility for paying your pension for the rest of your life.

The good news is that insurance companies are heavily regulated, notably by the Prudential Regulation Authority.

This is to make sure that these major financial institutions are well run and can cope with the ups and downs of the economy.

One way that this is done is to require all insurers to have minimum levels of what are called ‘capital reserves’.

In simple terms, these are a kind of buffer so that the insurance company can absorb shocks – such as the recent turmoil in financial markets.

The kind of firms who provide buyout deals for pension schemes tend to hold relatively high levels of reserves.

My colleagues at LCP have estimated that a typical buyout insurer on average currently holds nearly double the minimum amount of reserves that are required by law.

This provides additional peace of mind to policy holders.

A second source of reassurance is that because insurance companies are so heavily capitalised, regulated and monitored, it is generally considered to be unlikely that there would be a sudden or unexpected failure which might put your pension at immediate risk.

Instead, there is a graduated process of regulation so that steps can be taken if an insurance company starts to get into difficulties.

To give a simple example, if an insurance company starts to look less financially secure, the PRA could require them to stop paying dividends to shareholders so that more money is retained in the business.

If things were to get more serious, the PRA can use its powers to facilitate a transfer of parts of the business to another insurer in a more robust financial position.

In short, although nothing is ever completely guaranteed, and it’s possible that an insurer could go bust, this is unlikely and there are a series of protections and safeguards in place to avoid getting into that situation.

If the worst were to happen, and the insurer were to go bust, then in principle your pension would be covered by the Financial Services Compensation Scheme (rather than the PPF).

However, in a world where a major insurer has gone bust it’s quite possible that there’s a lot going wrong in the wider economy, that other financial institutions have gone bust, and that there could be much wider claims on the FSCS.

We haven’t been in that scenario to date, and it’s hard to make definitive predictions about what would happen in that case.

But, of course, in that kind of nightmare scenario it’s quite possible that your own company might be in financial difficulty and your pension might not have been safe if you were still depending on your company to stand behind it.

One final piece of reassurance is the role of trustees in all of this.

A board of trustees is responsible for making decisions about how best to ensure that your company pension pays out what you are entitled to.

When considering whether to transfer to an insurer, a key issue that the trustees will have weighed up (and taken expert advice on) is the relative security of your pension where they continue to rely on your employer as against relying on an insurance company.

If they have decided to go for a full buyout, this is likely to mean that they consider the prospect of your pension being paid is at least as good (if not better) if backed by an insurance company.