Survey

I’m a trustee, get me out of here!

Do you just want to escape from the responsibility of running the pension scheme? Allison Plager surveys the market for derisking

So there you are, stuck in the pensions jungle with lots of other pension scheme trustees. You undertake all the trials that the government and regulators throw at you. You win the loyalty of your members and manage not to get voted out of existence. But in the end, running the scheme gets you down, the worry of keeping going and being able to pay the promised benefits gets too much and you shout: “I’m a pension scheme trustee, get me out of here!”

But who is going to rescue you? Not Ant or Dec on this occasion, but perhaps instead you have in mind an insurer who will purchase the financial responsibility from you. The derisking market is not new, but has gained increasing popularity with schemes which are no longer able or wish to bear the liability of running the pension scheme.

Competition between providers
There are several options available to trustees who wish to adopt a derisking strategy. The Box provides a brief explanation of the main routes. Buyouts were in the ascendant in 2008 and are the ultimate in derisking as the trustees and sponsoring company divest themselves of all responsibility for the scheme. However, they have declined in use and instead buyins and longevity swaps have developed over the last year.

In June 2009, Lane Clark & Peacock (LCP) published Pension buyouts 2009 in which it predicted: “The market for transferring pension scheme risk to an insurance company will fall to £4bn this year as the full force of the financial crisis hits home.”

However, this did not mean that the buyout market was dead. Charlie Finch of LCP noted: “There is no let up in demand for eliminating pension risk. For many pension schemes, it is not a question of whether they will buy out, but rather a question of when” and suggested the market would gradually grow as the year progressed.

However, the report perspicaciously foresaw growth in the longevity protection market – which transfers the financial risk should members live longer than expected – following the Babcock International longevity swap for £300m with Credit Suisse, the first by a UK pension scheme. Mr Finch said the longevity protection market would “help larger pension schemes take a key risk off the table with six FTSE 100 companies having already obtained longevity quotations. Competition between providers seeking to establish themselves means that many larger pension schemes can purchase longevity protection at limited additional cost relative to present funding plans”.

Progressive decline
The decline in pension scheme buyouts in 2009 was confirmed in Aon Consulting’s second quarter buyout survey which found that the insured bulk annuity market for defined benefit (DB) pension schemes had continued to fall, with a 32% reduction in the value of transactions carried out in the second quarter of 2009 compared to the previous quarter. Aon Consulting’s Paul Belok put this down to “volatility in investment markets”.

The value of buyouts, buyins and longevity swap deals made during the third quarter of 2009 was around £4bn according to Hymans Robertson. James Mullins said that the quarter was “an important milestone for the longevity swap market” with deals worth more than £1bn possibly being completed in the next few months, “subject to contracts”.

The Royal County of Berkshire Pension Fund became the first public sector pension scheme to conclude a longevity swap. This was made with Swiss Re and covers some 11,000 pensions in payment at 31 July 2009 until the last pensioner dies. The actuarial valuation placed on these liabilities using the scheme’s 2007 actuarial valuation assumptions is reported as approximately £750m, representing 43% of the scheme’s total liabilities.

Recent celebrities
Perhaps an indicator that the buyout market is reviving is the deal completed in February by the trustees of the Liberty International Group retirement benefit scheme and Liberty International with the Pension Insurance Corporation. The latter has insured Liberty’s DB liabilities in a buyout deal worth £61m, comprising £46m in scheme assets and £15m additional company contribution.

Mercer’s Akash Rooprai, who was lead broker for the transaction, said: “This is another example of a FTSE 100 company that has implemented a successful pension derisking strategy in relation to its DB obligations. It demonstrates how purchasing insurance can enable companies to focus on their primary business objectives rather than the management of increasingly legacy pension obligations. I believe that we will see this market continue to grow in 2010”.

Trustees who are looking to derisk should ensure that this would, in fact, be beneficial. Research published in October 2009 by Punter Southall has shown that most pension schemes would be able to run off the liabilities at a cost below the buyout price, if they followed the same low risk investment strategy an insurer would use. Entitled The False Dawn – An update on the UK bulk buyout market and other derisking solutions, the report is concerned that not all market providers have sufficient capital to write more business. However, despite these problems, according to the report, there is sufficient capital available in the buyout market to meet current levels of demand from pension schemes. It is a lack of demand for the buyout option, rather than a shortage of capital, that has led to the large reduction in buyout activity.

In this respect, Punter Southall’s Richard Jones said: “The key consideration when assessing the merits of buyout is how much risk is actually being removed and how likely it is that the buyout price will exceed the expected cost of providing the benefits through the pension scheme. Our analysis shows that if a pension scheme adopts a similar investment strategy to that used by an insurer, in around 84% of scenarios the pension scheme will be able to run off the liabilities at a cost below the buyout price” – thus only the “most risk averse of finance directors who should consider transferring liabilities to an insurer to represent a good use of shareholder funds”.

To jump or not
The fact is that because so many DB schemes have a substantial deficit, the buyout option is not an option for them. Investment losses have had a detrimental effect on the funding levels of schemes and, until the economic climate really begins to improve, few companies will want to pour more cash into the pension scheme to allow a buyout to take place. As Aegon’s Tony Read, says: “Prevailing market conditions have had the effect of reducing the number of buyouts taking place, since many companies are unable to afford to (or do not want to) derisk their pensions in one transaction”. He adds that buyins, and more recently pensioner buyins, have grown in popularity and also mentions the emergence of longevity swaps. He feels that the latter are “more appropriate for bigger DB schemes” and does not envisage them having much of an impact on small/ medium sized schemes.

In terms of volumes of business written, Hugo James of Legal & General says: “The bulk purchase annuity business has historically always been ‘lumpy’ and we expect new business to continue to be volatile, but overall the market is expected to keep growing. This is partly due to larger scheme transactions and we believe the attractiveness to companies and trustees of derisking DB pension schemes, especially in the form of buyins and longevity-only protection, will continue to increase.”

It was the Lehman Brothers debacle that changed the approach to risk in the asset market used to back buyouts, says Nick Johnson of Aviva, but adds “that approaches by insurers to investment risk have grown more cautious”.

He believes that “with innovation and risk taking prevalent in the larger part of the market” the buyout market will grow in 2010 and anticipates “13% year on year growth for at least the next five years”. He says that that increasingly companies are looking at ways to manage risk within their DB pension schemes and “this will encourage buyouts for those who can afford it, but for those trustees who cannot, there may be other attractive options to help manage towards buyout for a limited set of members, through longevity swaps, enhanced transfer values and diversification of investment strategy”.

It is not just pension schemes which are holding back in terms of buyouts. Mr Read says that “Solvency II is an issue for many UK insurers and this may cause levels of new business transacted to be put on hold until the impact of Solvency II is fully clarified”. Similarly, Myles Pink of Paternoster says “2010 is set to be an exciting year, with a number of high profile deals being completed”. But he feels that Solvency II is a factor and that once greater clarity regarding it has been provided, additional capital will “be deployed to meet growing demand”.

Fresh appearance
The buyout option may be particularly attractive to small rather than large pension schemes, due to the fixed expenses associated with running a pension scheme and the increased longevity risk which small schemes face. Ben Shaw of Occupational Pensions Trust (OPT) says that schemes of £20m upwards are “more suitable for the traditional buyin/buyout market”, adding that OPT “can take on the small schemes”. The Table provides a list of some of the providers in the bulk pensions annuity market and includes a guide as to the size of schemes that each is likely to consider.

What will certainly be important to all insurers is that the schemes are “well funded and have clean data” says Mr Pink. Thus it will be important for companies to ensure their pension scheme data is up to date and clean.

Overall it seems that 2010 is likely to see a lot of demand for buyouts and derisking solutions, after a year that began quietly but saw the development of longevity swaps. Perhaps this year will be the one to scream: “I’m a pension scheme trustee, get me out of here!”

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

Definitions
Buyout
The pension scheme’s liabilities are transferred to an insurance company and it no longer has any responsibility for them.
Buyin
The company buys an annuity contract to cover some or all of the pension scheme’s liabilities, often those relating to pensioners in payment. The liabilities continue to be the responsibility of trustees of the scheme.
Longevity swap or hedge
The company purchases an investment to reduce the risk faced should beneficiaries of the scheme live longer than expected.