DE-RISKING Meet your match

With 2017 expected to be a record year for buyouts, schemes can do much to make themselves more attractive to de-risking providers, says editor Stephanie Hawthorne

In a nutshell: 
  • 2017 is set to be a record breaking year for buyouts and buyins
  • scheme trustees and sponsors should prepare thoroughly for de-risking and be ready to seize any market opportunity
  • medical underwriting is set to continue to develop further.

A dramatic change has taken place over the past decade: the pensions of over one million people are now insured through buyins and buyouts. UK company pension schemes have transferred £70bn of assets to insurers, around 5% of total defined benefit (DB) pension assets, as well as a further £60bn through longevity swaps.

And this figure is set to rise even further, as trustees of most DB schemes, burdened by huge deficits and the increasing longevity of their members, want out. Indeed, in 2016 UK pension schemes plummeted to a record deficit of £459bn in August, following the Brexit vote. This improved somewhat: the deficit of the 5,794 schemes in the PPF 7800 Index was £223.9bn at the end of December 2016, with total assets of £1,476.4bn and total liabilities of £1,700.3bn.

Nevertheless, the collective value of the UK pensions industry can oscillate by more than £100bn in a matter of months. So it is not surprising that trustees are looking at ways to cut their risk and volatility.

2017 is expected to be a record year for de-risking. Willis Towers Watson is predicting that over £30bn of liabilities will be insured in 2017, through buyins, buyouts and longevity swaps. Here, pension scheme members see no change in the amount of their pension benefits as a result of a buyin or buyout, but their retirement income is now backed by a regulated insurance company subject to strict capital requirements, rather than relying on their former employer to fund their pension.

Stressed schemes

Many DB schemes are financially stressed and have lengthy recovery periods.

Charles Cowling, director, JLT Employee Benefits, comments: 

“There will be instances where the pension scheme will represent a serious threat to the company’s balance sheet and, in some cases, the company’s ability to pay dividends.

“The tools now exist for an effective de-risking of pension assets and liabilities which, while not promising a silver bullet, do mean that pension problems can be managed and solved in time. Maybe 2017 will be the year when formal end-game de-risking strategies are at last embraced by the majority of pension schemes.”

Charlie Finch, partner at Lane Clark & Peacock (LCP), agrees: “Many schemes have self-sufficiency or buyout as their ultimate target and a series of well-timed buyins can be an effective way of getting there. For example, following the Brexit vote in June, there was a short-lived opportunity for fast-moving pension schemes to purchase buyins at a reduced cost. Both the Aggregate Industries Pension Plan and the ICI Pension Fund were able to lock in to this pricing for their second and ninth buyins respectively.”

Finch continues: “Our optimism for 2017 has three short-term drivers adding to the longer term trend of defined benefit schemes taking action to reduce risk – first, pensioner buyin pricing is currently at its most favourable level for five years for schemes holding gilts; second, insurers are reporting record levels of new enquiries from pension schemes looking to de-risk; and third, insurers have increased capacity available for new transactions. Put these together and 2017 looks set to be the biggest year yet for pension buyins and buyouts.”

The market in 2016

As the Table shows, there are currently seven insurers in the market, compared with nine at the end of 2015. Just Retirement and Partnership merged in April 2016 to form JRP Group (Just), which now targets both conventional and medically underwritten buyins. Prudential has withdrawn from the bulk annuity market, citing to LCP onerous capital requirements under Solvency II. This is in contrast to most other insurers, which continue to have significant appetite. LCP says: “2016 has been dominated by strong competition between Aviva, JRP Group, Legal & General, Pension Insurance Corporation and Scottish Widows, while Rothesay Life was focused on its ‘back book’ transaction with Aegon, and Canada Life had a quiet year.”

Ruth Ward, senior consultant at JLT Employee Benefits, adds: “This time last year there was a lot of speculation that Solvency II would have a big impact on non-pensioner liabilities, but many buyout deals (covering both current and deferred pensioners) have still gone ahead, including L&G’s recent £1.1bn transaction.”

According to JLT, the largest deals in 2016 were the £1.1bn buyout of the Vickers Group Pension Scheme with Legal & General; the Electricity Supply Pension Scheme’s £1bn longevity swap with Abbey Life; and Aon Retirement Plan’s £900m buyin with Pension Insurance Corporation (PIC). Additionally, the ICI Pension Fund has completed a further five buyin tranches this year, including a £750m buyin with Legal & General and a £630m buyin with Scottish Widows. However, smaller pension schemes are not excluded from de-risking, as Ward explains: “Even the very smallest schemes of less than £1m have been able to obtain buyout quotations, allowing them to settle their pension liabilities. The market has become more difficult for such schemes over the last couple of years, but one insurer, Aviva, has developed more efficient processes to cater for this end of the market, while continuing to quote on mid-large deals.”

Timing is not an exact science, but Ward’s view is that “trustees and sponsors should insure their liabilities as soon as they can afford to do so. There is no guarantee that the position will look better in future and, even if it does, it may prove more difficult to get a quotation and execute a transaction.” In practice, this is likely to mean that trustees, for all but the smallest schemes, insure their schemes’ pensioner liabilities (or subsets of these) in the first instance, and cover more members at a later date.

Attractive proposition

There is a lot that pension schemes can do to increase their attractiveness to the market. The experts agree the single most important thing is to prepare thoroughly. Finch recommends that schemes should consider establishing a business case prior to approaching the market: “Insurers tell us that the number one reason for transactions falling over is because a key stakeholder has not understood what is involved or was not bought in upfront.”

Sammy Cooper-Smith, Rothesay Life, suggests establishing “a robust process for the transaction, with a clear indication of the target price and timetable. Engage trustees and ensure key decision makers understand the impact of the transaction on: the ongoing technical provisions/funding basis; the residual asset portfolio and how it will be invested; and the accounting impact for the sponsor.”

He advises: “Make sure there are no ongoing issues regarding funding and appoint pension scheme advisers experienced in pension insurance. Do provide clean and comprehensive data for quotation purposes (long term experience data, information on spouses, etc).”

He concludes: “A transaction is more likely to conclude successfully if the pension fund holds liquid investments for the transaction.”

John Towner, head of origination at Legal & General, adds: “The more complete and accurate your member data is, the better the insurance company will understand your scheme and this will come through in the pricing offered.”

Jay Shah, chief origination officer at Pension Insurance Corporation, says de-risking companies prefer to deal with schemes that have a well thought through de-risking plan and that have taken advice from consultants with significant experience in buyins and buyouts.

It is also helpful to have “realistic expectations in terms of buyin or buyout pricing and to have good decision making processes in place to execute transactions if these targets are met”.

Market conditions, such as the level of interest rates and credit spreads, can impact the price of the insurance quote. Sponsoring companies should build monitoring into their schemes’ journey plans to enable them to execute when market conditions are favourable. Legal & General’s £750m buyin with the ICI Pension Fund in July 2016 is an excellent example of this principle, as the trustees were able to leverage favourable market movements, following the EU referendum, which significantly narrowed the gap between the funding basis and the buyin premium.

Another way that pension schemes are driving affordability for themselves is by looking at liability management exercises. Examples of this are transfer value exercises and pension increase exchange offers. Towner says: “These exercises can help the trustees and the sponsoring company achieve their objectives, while giving members the freedom and choice to shape their pensions in a way that best suits their needs.”

Smaller schemes

While the market is buoyant for larger schemes, the smallest schemes are struggling to get firm quotes from a large number of insurers. Indeed, Shah says: “Several insurers will be interested in transactions over £50m. Interest is much lower below £20m.”

Finch agrees about the market for small schemes: “Getting insurers to quote and put forward competitive pricing can be challenging, with so many other competing transactions. It is more important than ever to prepare carefully before approaching the market and avoid approaches that insurers will view as complex.”

Medical underwriting

JRP Group (rebranded this year as “Just”) is the pioneer of medical underwriting for de-risking and this area continues to develop. Indeed, Stephen Lowe, group communications director at JRP Group, says “all major employee benefit consultants have now been involved in a medically underwritten transaction”. He expects that medical underwriting will continue to be used for schemes with the right characteristics, such as schemes with a high concentration of high liability in a small number of members.

Perfect partner

2017 looks like a good year to begin or continue the de-risking journey, with existing providers allocating more resources to this market. New entrants are expected, bringing possibly more competitive tension among the existing providers in this market. The key message is to do your homework and get an experienced adviser.

Be prepared – then you will find the perfect partner and that DB burden will be gone forever.

Buyins need not restrict a scheme’s flexibility

As an insurer providing de-risking solutions, we are aware that many trustees are concerned that their decision to secure some of their liabilities with an annuity contract may prohibit their flexibility to manage their liabilities in other ways. Over the past few years, trustees have been keen to explore all options to manage their own risk and provide their membership with as much flexibility as possible. This might include:

  1. Transfer exercises where members are offered the opportunity to transfer their present value of their future annuity to a defined contribution (DC) pension where they will have greater flexibility to manage their pension assets either through drawdown or through the purchase of an annuity which better matches their own position (non-increasing pension or a single life pension).
  2. Trivial commutation exercises where members of the scheme with a pension of less than £1,500 a year are offered a one off cash lump sum in exchange for their future pension.
  3. Pension increase exchanges (PIE) where members can forego future inflation increases in return for a higher starting pension.

  Recently, one such pension scheme insured a portion of its pension liabilities with us, reducing the funding volatility for both the trustees and company. Its aim was to insure the greatest proportion of itsliabilities with a fixed contribution from the sponsor which would cover the strain between the technical provisions and the cost of the annuity. 
   Shortly afterwards, the scheme wanted to offer its pensioner members a PIE. Working with the trustees, we agreed a methodology to reshape the insurance we provided to reflect the change in liabilities. This reshape allowed us to offer the scheme a refund, as the new liabilities were cheaper to insure due to the lower associated hedging costs. The value created through the PIE was then used to cover the strain between technical provisions and the annuity cost on a further buyin contract.
   Working together, we increased the total liabilities insured by 50% with no additional funding strain for either the scheme or the sponsoring employer. As such, many concerns trustees have with annuities curtailing their options can be mitigated by working closely together.
Sammy Cooper-Smith is co-head of business development at Rothesay Life


Stephanie Hawthorne has been editor of Pensions World since 1989. An honours law graduate of King's College, London and winner of 10 first and second prizes for pensions, property and insurance journalism, Stephanie has been a journalist for 25 years. Starting her financial career as a researcher/marketing specialist for a national independent financial adviser and subsequently a leading life office, she then moved on to Insurance Age, Planned Savings and Financial Times' Money Management (deputy editor). Stephanie has contributed articles to the Financial Times, Mail on Sunday, The Times, The Sunday Times, The Sunday Telegraph and The Observer, as well as numerous magazines. Among her other editorships are Counsel: The Journal of the Bar of England and Wales (from 1997 to 2007) and Charity World (managing editor, 1993 to 1997).