What is an all risks buy-out and why should you care?
In recent “bumper” years of buy-ins and buy-outs, more and more of these have been done on an “all risks” basis. In this post we cover what an all-risks buy-out is, how it works and things to think about when considering one.
What is an all-risks buy-out?
A traditional buy-in or buy-out will only cover a defined set of members and their benefits. All-risks cover is insurance covering risks that a traditional buy-in or buy-out would not cover, in essence, “unknown” risks. It is provided by the same insurers you would go to if you were looking at doing a buy-in or a buy-out. The scope of cover that may be provided varies and it may be more appropriate to refer to such policies as “residual risk” policies because they don’t cover all risks for a scheme in a literal sense.
Examples of the types of risk these policies might typically cover are:
- benefits for scheme members trustees did not know about (i.e. “unknown beneficiaries”); and
- incorrect scheme data.
Why would a trustee or sponsor care about “all-risks” cover?
Some trustees want to take this out to get comfort these extra risks are covered by an insurer rather than elsewhere (e.g. through a sponsor indemnity) or being left uncovered. Sponsoring employers may also like residual risk policies as they provide greater certainty for them by removing more risks than with a traditional buy-in or buy-out. As always, there is a price for this additional cover which will need to be paid. There is no obligation on trustees to take out this type of cover and not all trustees do.
What is important to understand about this type of cover?
The residual risks cover that insurers offer will never cover all the possible risks the trustees are exposed to. It is important trustees understand what risks exist, whether they are covered and any risks that are left behind. Each insurer will often have their own standard carve outs to residual risks cover and also may have identified in their due diligence on the scheme some issues they are not willing to provide cover for. Risks that often remain include:
- defence costs and litigation costs for claims brought against the trustees;
- issues identified through the insurer’s due diligence, for example after reviewing the scheme’s historic rules, the insurer may be unconvinced that the Barber window was closed properly and be unwilling to cover the risk that a member claims higher benefits as a result.
How are the risks covered?
An insurer will provide cover through an insurance policy. This can be part of the bulk annuity policy for a buy-in or buy-out or a separate policy. In theory residual risk cover could be provided by a different insurer than the insurer providing any buy-in or buy-out but it is typically the same insurer. If you are thinking of doing a buy-in, it is helpful to consider whether at some point you may want residual risks cover and asking the insurer about it at the time of the buy-in.
Where a scheme is looking at winding-up, it is worth considering how the residual risks cover will operate post winding-up when the trustees are out of the picture, for example, how claims will be dealt with and if needed, enforced by potential recipients.
What is the process of entering into a residual risks policy?
It is a similar process for a traditional buy-in or buy-out. The trustees can go out to tender to the relevant insurers. This will usually be at the same time as a buy-in or buy-out. Before entering into any residual risks policy, the insurer will perform due diligence on the scheme. Due diligence involves reviewing the scheme’s trust deed and rules, data, administration and scheme governance processes. Trustees and their administrators will need to provide the insurer with access to the scheme’s administration systems and records. After the due diligence is done, the insurer will decide what risks it is and is not willing to cover. Trustees may try and do something to get more risks covered, for example, find any missing documentation. The trustees and insurer will enter into an insurance policy covering the agreed risks.
What about the risks left behind?
We will cover in a later blog post what can be done about the remaining risks. There are options to deal with them including (even more) insurance and looking at the defences available on any claim.
Our key message is we recommend trustees understand what risks exists, what, if any, cover trustees would like for these and what risks are excluded from that cover.
If you are unfamiliar with any terms used in this post, you can access our “De-risking Jargon Buster” by clicking here.