Bermuda can benefit from pensions restructuring
Bermuda is well-placed to benefit from increased life expectancy rates that have some employers seeking to restructure the pension entitlements of their employee members.
Life expectancy rates of an average 65-year-old have increased 50 percent in just three decades. That has contributed to soaring costs for employers maintaining defined employee benefit pension plans, which generally require employers to make pension payments to its employee members for the rest of their lives.
In some cases, there have been serious concerns whether certain pension plans have the necessary funds to provide defined pension benefits at all.
In the United Kingdom, for example, both UK Coal's and Nortel's pension plans had shortfalls of approximately £500 million and £333 million, respectively. Employee members of those pension plans would not have received their benefits if it were not for bailouts offered by the UK government's Pension Protection Fund.
In Bermuda, the National Pension Scheme (Occupational Pensions) Temporary Amendment Act 2012 enabled 140 pension plans to suspend contributions for a 12-month period. This measure provided some breathing space to employers and employees who had previously been required to make regular contributions to those pension plans.
In the current climate, some employers are looking for alternative solutions as employees live longer — and, as a recent trend would suggest, they are adopting pension buy-outs, longevity swaps and restructuring of their global pension plans.
Bermuda's strength in the global re/insurance market means that it is able to assist employers with pension buy-out or longevity swap arrangements through captive insurance and special purpose company vehicles, which are increasingly being used for pension plan reorganisation.
During 2012, General Motors employed a Bermudian captive insurer — an insurance or re/insurance company that is formed primarily to cover the assets and risks of its parent company or related companies — to enter into a pension buy-out arrangement with Prudential Financial Inc that affected approximately 44,000 employees and $26 billion of pension plan liabilities.
A typical pension buy-out arrangement sees an employer sponsor — such as General Motors — and the trustee of the pension plan pay an insurer a lump sum fee to provide the pension entitlements directly to the members of the pension plan. The objective is for employer sponsors and trustees of the pension plan to be fully discharged from their ongoing obligation to fund and pay the pension benefits.
The use of captive insurance companies gives employer sponsors the opportunity to retain a desired level of the risks associated with the pension plan but transferring the risks into the captive insurer.
A captive also provides the possibility to make use of any surplus contributions not applied toward employee members' pension benefits — something that generally would otherwise not be possible. Bermudian captives are increasingly being used for pension buy-out transactions.
Other employer sponsors may adopt an alternative known as a longevity swap arrangement. A Bermudian special purpose company was employed in 2011 as part of the longevity swap transaction between Deutsche Bank and the trustees of the Rolls-Royce Pension fund. That transaction covered some £3 billion of pension plan liabilities relating to about 37,000 members' pensions.
Typically, in such a transaction, the employer sponsor and the trustee of a pension plan will agree to pay fixed monthly amounts to a financial institution that in return makes variable monthly payments to the pension trustee. The variable payments are calculated based on the pension amounts that the trustee is obliged to pay to the members of the pension plan. In this way, the risk of members living longer than anticipated (and the liability for pension payments subsequently being more than anticipated) now rests with the financial institution.
In the context of longevity swap arrangements, an offshore special purpose company often acts to facilitate the ability of insurance and re/insurance companies to share, and potentially profit from, the financial institution's risk. In such circumstances, the risk for the financial institution is that the variable rate it pays to the pension trustees will ultimately be greater than the fixed rate that it receives from them.
The future is promising for Bermuda to play a significant role in supporting the reorganisation and stabilisation of global pension arrangements.
Lawyer Ashley Fife is a Senior Associate and a member of the Private Client and Trusts Practice Group at Appleby. A copy of this column can be found on the Appleby website at www.applebyglobal.com.
This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.