A bulk annuity, sometimes referred to as a bulk purchase annuity, is a contract between a defined benefit pension scheme and an insurance company, whereby an insurance company insures some or all of the liabilities of the pension scheme.
In other words, the insurance company enters into a contract to pay the pensions to the members of the scheme as and when they become due, and in exchange for this the pension scheme pays a premium to the insurance company.
Depending on whether the intention in the short term is to transfer policies into the names of individual scheme members, bulk annuity contracts are referred to as buyouts or buy-ins. In a buy-out contract the short-term intention is to transfer policies into the names of individual scheme members. Once transferred, the trustees and sponsoring employer are discharged of any future obligations to those members. The bought-out pension scheme would then be wound up.
A buy-in contract works slightly differently, in that the policyholder is the trustee of a pension scheme and the buy-in is treated as an investment asset of the scheme. Normally a buy-in contract will only cover some of the members in a pension scheme (often the pensioners or a group of pensioners). A buy-in policy can eventually be converted into a buy-out policy and is therefore often part of a long-term plan ultimately to wind-up the scheme.
Why would a pension scheme enter into such an arrangement?
The answer is easy: to reduce or remove risk from the pension scheme. UK pension schemes are exposed to a number of risks that could result in higher costs of operating these schemes while lowering the chance that they will be able to provide the benefits that they have promised members. The headline risks are investment, interest rate, inflation and longevity.
Over the past few years, a combination of tightened financial regulation, falling interest rates on medium- and long-term government bonds, deteriorating stock markets, improvements in life expectancy and inflationary pressures has seen DB pension liabilities rocket to unprecedented levels. Companies with a DB scheme have faced rising (and in some cases debilitating) funding costs and a huge debt item on their balance sheets. A bulk annuity policy protects the trustees and sponsors of a DB pension scheme from these headline risks. The amount of protection given will depend on whether the bulk annuity is buy-in or buy-out policy.
