Many DB schemes are now focused on securing their liabilities with an insurer. As trustees work through the preparation needed for a buy-in or buy-out, legacy benefit design can sometimes create unexpected obstacles. One example we increasingly see is the hybrid underpin benefit.

These benefits may take different forms: for example, a DB benefit with a DC guarantee, or a DC benefit with a GMP or DB underpin. Whatever the structure, they can be difficult to insure because they do not fit neatly within a standard risk-transfer model.

For trustees, the key is to identify and address these benefits early. Doing so can make the route to buy-out smoother, improve insurer engagement and reduce the risk of late-stage transaction delays.

Why underpins can affect insurer appetite

A bulk annuity policy is designed to transfer clearly DB risks to an insurer, including financial, inflation and mortality risks. An underpin can complicate that transfer because it may require a comparison between two different benefit structures, often at the point a member retires. That can make the final liability more uncertain and administratively complex. If left unresolved, this can narrow the pool of insurers willing to quote, lead to more detailed due diligence and / or increase the premium required to secure the benefits.

One possible solution: actuarial equivalence

There are options available to trustees to simplify these benefits before entering into an insurance contract. The right approach will depend on the scheme rules, the type of underpin, the profile of the affected members and the employer’s objectives.

One route is to carry out a statutory actuarial equivalence exercise. With appropriate legal and actuarial input, this may allow trustees to replace the dual-nature underpin with a single DB benefit of actuarially equivalent value. That replacement benefit may then be easier to secure with an insurer.

In some cases, actuarial equivalence may instead be used to separate the benefits, effectively de-linking the DB element from the DC element. The DB benefits could then be insured through a bulk annuity, while the DC benefits could be transferred out of the scheme, for example to a master trust.

The process involves a number of formal steps. These include formal certification from the scheme actuary that the replacement benefit has been calculated to be actuarially equivalent to the member’s original accrued rights, member communications and an amendment to the scheme rules. The aim is to simplify the benefit design while safeguarding member outcomes.

Practical steps for trustees

If your scheme has a legacy underpin, it doesn’t necessarily have to derail your endgame plans. However, it is worth dealing with the issue before you are deep into an insurer process. Trustees may wish to consider the following practical steps:

• Understand the underpin: Take legal advice on how the underpin is drafted and what options you may have for simplifying or separating the benefits.
• Quantify the impact: Ask your scheme actuary to assess when and how often the underpin is expected to “bite”, and the likely cost of any proposed solution.
• Think about member expectations: Consider whether affected members are likely to view their benefits as primarily DB or DC in nature. This can be important when selecting the most appropriate solution and designing communications.
• Engage with the employer: If your scheme amendment power is shared with the principal employer, involve the employer early so that any legal, funding and transaction objectives are aligned.

In a competitive insurance market, early preparation can make all the difference. Tackling an underpin sooner rather than later can help trustees avoid last-minute surprises and keep the path to buy-out on track.