Pensions World

Allison Plager, financial journalist, reports on the de-risking options currently available to pension schemes

Remember the good old days? Defined benefit pension schemes used to be – well, maybe not a joy to run, but nowhere near the headache they are now. For a start, the problem was not what to do about the deficit, but how to deal with the surplus (the days of employer contribution holidays are long gone); rather than schemes closing, they opened and were welcomed by employees as a useful, if distant, benefit. Trustees were responsible for the scheme but could never have imagined how complex the role would become.

As readers of Pensions World know, looking after the pension scheme is now a minefield of complications and regulations; as a result, trustees and the sponsoring employers are increasingly looking to de-risk their pension schemes, if not offload them altogether.
However, the economic climate has not lent itself to buyouts and there has also been some hiatus with companies offering such transactions. A recent high profile example is Goldman Sachs’ acquisition of Paternoster in January, resulting in Paternoster now being a 100% owned subsidiary of Goldman Sachs. Already the owner of Rothesay Life, Goldman Sachs intends in the short term to hold both as separate insurance companies. The two will be combined over time. Another provider, Aegon, has pulled out of the buyout market.

Table 1 Buyout/buyin providers

The Table provides information about a selection of current insurers. As to further market movements, the respondents say that more consolidations are always possible, but are generally upbeat about the future. “The future of current providers seems positive,” says MetLife Assurance’s Emma Watkins. She predicts that “2011 will see continuing interest in pension scheme de-risking in general”, and envisages that most “schemes completing a bulk annuities transaction in 2011 will be at the smaller end of the market”.

She adds that, following the trend in 2009 and 2010, “pensioner buyins are likely to remain the most popular solution sought by schemes” and considers any large changes in the market unlikely. Similarly, Lucida plc’s John Smitherman-Cairns feels that “capacity may well become an issue given the more disciplined state of global capital markets” and believes that “there are significant barriers to entry in this market”.

British Airways

The vast majority of pension schemes have “material de-risking as an aspiration and several would like to secure a buyout”, confirms Towers Watson’s Mark Duke. The economic downturn had “slowed progress”, but as the equity market has bounced back and pension schemes’ assets improved in value accordingly, “quite a lot of schemes are examining how they can get on with the next round of de-risking”.

He says there are some relatively inexpensive options that trustees can take initially. These include enhanced transfer value exercises: the trustees make an offer to pension scheme members which makes it attractive to them to take their money out of the pension scheme. This is suitable for members who are not yet receiving their pension and, says Mr Duke, “can represent a big chunk of the scheme’s liability”.

The other option is a pension increase exchange. The trustees trade future increases for higher pensions now by offering pensioners a lump sum or one off uplift to their pension in exchange for future non-statutory increases. From the sponsoring employer’s point of view, such exchanges obviously need to be designed so that the uplift is worth less than the potential future increases given up.

Agreeing that the buyout market has slowed, but that trustees are still focused on de-risking, Martin Bird of Aon Hewitt says that longevity hedging or swaps are proving of interest to some trustees. These transactions allow the trustees to retain the scheme’s assets, but they transfer the risk that members of the scheme will live longer than predicted. It can also be the springboard for tackling extensive de-risking where the company might be looking for a buyout.

Buyins are another means of de-risking which are more affordable for some schemes, in that an annuity is bought to cover part of the pension scheme’s liabilities, usually those for pensioners. A substantial buyin was carried out by Rothesay Life in July 2010, says Keith Satchell of Rothesay Life, when the company “insured £1.3bn of pension liabilities of the Airways Pension Scheme, one of the two defined benefit pension schemes sponsored by British Airways”. He explains that this has been structured so that “the trustees retain ownership of the assets backing the transaction”.

OPT is different from the insurance companies in the survey in that it is a trust based occupational pension scheme providing defined benefits. It operates as an umbrella group beneath which individual company occupational schemes exist as separate entities. Ben Shaw of OPT says this is “much cheaper” than a buyout with an insurance company and, because it is a pension scheme, it is not restricted as to its investments. It has the same wide investment choice as any other scheme.

Flight path to buyout

The question of buying out the scheme may be when rather than if, but even with improved investment returns, for most pension schemes a buyout is an aspiration. “Very few schemes can afford a buyout at the moment,” says Mr Duke, although some may be working towards a buyout in the future.

However, even in 2010, some schemes achieved their buyout ambitions. Emma Watkins says that MetLife Assurance took on the liabilities of 12 schemes during 2010:

“six buyins and six buyouts, valued at a total of £364m”.

So clearly, while some companies are in a position to support a buyout, for most it is a goal. If their aim is a buyout, what can trustees do to bring their pension scheme to a suitable position for this transaction? Emma Watkins’ pointers for how trustees preparing for a buyin or buyout quotation can increase their attractiveness are in the Box – Preparing for a buyout. She says that, when it comes to considering a scheme for de-risking, MetLife Assurance “will review each quotation request on an individual basis, so the provision of additional information is useful in helping us establish a view on each circumstance. For example, the reasons for embarking on such a process and any preparation, ie data cleansing and investment de-risking, the trustees have undertaken prior to requesting a firm quote helps indicate the seriousness with which the trustees are approaching the marketplace.

“If the scheme is not fully funded, an indication of how much the company is willing to provide to transfer risk will also give a good indication of how ‘affordable’ an insured solution is for the scheme and corporate sponsor in question. Details of the asset portfolio can be used to determine whether the value of liabilities is likely to move in line with the asset value, thus demonstrating whether any changes in pricing due to market conditions would be mirrored approximately by the asset portfolio. It also assists in determining the ease with which assets can be disinvested and whether an in-specie asset transfer may be achievable for any particular case. Finally, any deadlines must be agreed in advance.”

Preparation for a buyout must be thorough, but in some cases trustees are looking several years ahead, say five years, so they have time to plan. Planning ahead much longer is harder, as it is impossible to foresee future changes to pension regulations that far in advance.

An expression being bandied about is the “flight path to buyout”. In essence, trustees need to have the governance in place, check that their data is fit for purpose and examine other de-risking options which they can carry out on their way to the buyout. As Ms Watkins says: “If the trustee board is fully prepared, they will get the benefit in the transaction process, with competitive quotes.”

Looking for an exit

Compared with 2008, there are far fewer buyouts today and not many schemes can afford them. However, pension scheme trustees still have de-risking at the top of their agenda and are looking at the various ways they can do this, so the market is buoyant. As Mr Bird says, there is definitely a long term game plan where the goal is self-sufficiency and exit. The question is arranging how to reach that goal.

It is not surprising then that many providers are optimistic for the future. For example, Mr Smitherman-Cairns is “very positive about the outlook for 2011 reflecting the strong underlying demand of pension fund trustees and their corporate sponsors to take pension risk off the table with a full or partial buyout or buyin”. Likewise, Ms Watkins says: “The trend of more schemes de-risking is clear and ongoing and we have every expectation that significant numbers of trustees and corporate sponsors will continue to secure benefits for their members through insured annuities in 2011 and beyond.”

Pension scheme trustees and the sponsoring employers are just as keen to de-risk as they were a couple of years ago, but just as agreeing a buyout has become relatively unattainable for many schemes, other de-risking products are available.

It is important for trustees to ensure that the scheme is in good condition so that they can take advantage of what is available.

Allison Plager is a financial journalist; allison.plager@lexisnexis.co.uk