There are two types of bulk annuity – a buy-in and a buyout.
Under a buy-in, the pension scheme buys an insurance policy to secure all or part of all future pensions and benefits due to be paid to members.
The scheme pays a fixed amount up front to an insurer, and in return the insurer takes on responsibility for meeting the insured benefits, along with the interest rate, inflation, longevity and demographic risks associated with those benefits.
The insurer would generally make the payments to the scheme which, in turn, pays the members. End result: the pension scheme holds the bulk annuity policy as an asset and retains the ultimate responsibility for interacting with members and making sure their pensions can be paid (as shown in the diagram below), while the insurer takes on the financial and demographic risks.
Where the bulk annuity policy does not cover all members’ benefits, it would be referred to as a ‘partial’ buy-in. Where the bulk annuity policy covers all future pensions and benefits due to be paid to all members, it would be referred to as a ‘full scheme buy-in’.
Under a buyout, the pension scheme pays a fixed amount up front in order to fully secure all future pensions and benefits due to be paid to members. In most scenarios, this will cover all members of a pension scheme. An insurer receives the payment and takes on responsibility for meeting those liabilities, along with the interest rate, inflation, longevity and demographic risks associated with the benefits. The insurer deals directly with the scheme members (who then become policyholders) as shown in the diagram below.
The end result: the link between the scheme and the members is ultimately severed.
Where a buyout covers all members of a scheme, the scheme can be wound up as it now has no assets, no liabilities, and has transferred responsibility to the insurer for paying the benefits.