Top 5 considerations for trustees considering residual risk buyout

One of the trends in this space is the growing interest in a residual risk buyout. Residual risks might, however, not be right for every scheme, and here are the top five considerations commonly seen for trustees who embark on the residual risk journey. 

1. Residual risk does not mean every risk

Even with a residual risk policy, not every conceivable risk is likely to be covered as insurers have never been seen to give blanket cover. Rather, the insurer will scrutinise the scheme documentation and data and decide which areas of risk it is prepared to cover under the policy and exclude others. Common exclusions may include risks related to incorrectly executed documents or specific historic scheme data errors or amendments. 

The path to a residual risk buyout is not always straightforward, and trustees should be mindful of the issues that may lie ahead and take appropriate advice before embarking on a residual risk journey

2. Be prepared for due diligence

In order to achieve the best possible residual risk cover, trustees must get their house in order and be prepared for the due diligence process where the insurer will ‘dig up the drains’ and critically assess everything. This means ensuring all scheme documentation and data are in good order, including being able to confidently demonstrate that all records are reasonably complete and accurate. One area where this can be challenging is historic bulk transfers, where transferring scheme documentation is not always available.

It is also important to ensure the right resources are in place. Going through the due diligence process will require a high level of engagement between trustees and insurer, and as such trustees will need to be prepared and ensure they have the right team of advisers in place to support the process.

3. Residual risk cover is expensive.

The extended cover that residual risk provides comes at an additional cost. The exact amount will differ from scheme to scheme, but in many cases, residual risk cover can cost an additional 0.5 per cent to 1.5 per cent in premium. Before proceeding too far into the process, trustees will need to take advice on affordability and to realistically assess whether the pricing data used for the initial quote will stand up to scrutiny.  

4. Not every excluded risk necessarily falls to trustee liability

Trustees should bear in mind that a residual risk policy is often not the only recourse for any unexpected liabilities. Trustees are often covered by an indemnity given by the principal employer of the scheme, or may already be covered under an existing indemnity insurance policy funded by the employer, and may ultimately obtain run-off insurance as part of winding up a scheme. Trustees will want to consider the interaction between the different elements of protection available when negotiating the residual risk policy.  

5. Consider timings of your residual risk cover

Another decision that trustees will need to make is when residual risk cover will come into effect. Some policies provide cover from the point of buy-in, while others might not cover residual risks until the buyout stage — whether automatically or a gap policy exercisable at that stage.  

When and how residual risk cover could apply is also further complicated in cases where schemes have a tranched buy-in and might want to use different insurers across tranches. In this scenario, the insurers will want parameters around the scope of cover for the members they are insuring, and trustees will need to ensure that they do not end up in a grey zone between two policies.

Therefore, when it comes to timing, trustees will want to consider what is appropriate for their scheme; for example, what the prospective insurers are willing to provide and the intended timing to buyout and winding up.  

In conclusion, residual risk can be a worthwhile option for some schemes and potentially offers an increased level of protection to scheme members. However, the path to a residual risk buyout is not always straightforward, and trustees should be mindful of the issues that may lie ahead and take appropriate advice before embarking on a residual risk journey.  

Maria Rodia is pensions partner and Elaine He is pensions associate at CMS