Why insured buyout?
Buy-in and buy-out volumes exceeded £30bn in 2020. Whilst 2021 has seen fewer ‘mega-deals’ which contributed a significant proportion to the overall volume last year, transaction volumes have remained high.
What are the main advantages of securing benefits with an insurance company? And what are the key actions schemes should be taking at various stages along their journey to buyout?
The Pension Scheme Act 2021 introduces new requirements for schemes to set long-term objectives. For many, the ultimate objective will be securing member benefits with an insurer via a bulk annuity. Whilst other long-term targets are available, for example DB Superfunds or self-sufficiency, insured buyout is still seen as the gold standard for securing pension scheme liabilities, and will be a particularly attractive route for many schemes for the following reasons:
- Removes reliance on sponsor covenant in place for benefits being provided by a regulated insurer with stringent capital requirements, which typically enhances member benefit security.
- Reduces ongoing running costs, and trustee and corporate management time.
- Removes the risk of additional contributions calls and reduces balance sheet volatility.
As a result, there will continue to be a growing demand for insured buyout in the future. Schemes should be actively planning their journey to buyout, and considering how they prepare for their journey.
Longer term
Even if it’s many years until a scheme is likely to be able to reach its final destination of buyout, it’s never too early to start planning the journey.
The early stages should involve engagement between the trustee and employer to understand the objectives and available resources. Central to planning the journey is understanding what levers are available to move towards the ultimate target – for example, additional contributions from the sponsor, liability management exercises or reliance on investment performance. Clear, well-defined targets should be agreed, documented, monitored and adjusted to reflect progress.
Schemes should be dynamic in nature, so they are able to react to changing circumstances and grasp opportunities should they arise, for example locking-in investment gains.
Medium Term
When a scheme is getting closer to its buyout destination, perhaps within five years, there are further steps which can help pave the road to buyout.
Liability management can be a particularly effective tool for several reasons:
- Improved affordability: benefits can often be discharged for considerably less than the buyout premium.
- Improved insurability of benefits: exercises such as a pension increase exchange can lead to simplification of benefits for which it may otherwise be challenging to secure attractive insurance pricing.
- Increased flexibility for members: allowing them to access their benefits in the way most suitable to their specific circumstances.
In our experience, these exercises are most successful where there is effective member engagement, for example where members are able to view their options and make decisions online, perhaps using a smartphone app if that option is available. It’s also important that members have access to appropriate independent financial advice when selecting any benefit options.
Schemes should also continue to monitor their buyout funding position regularly, to track progress and be ready to move quickly when opportunities arise.
Securing a bulk annuity with an insurer is a big step and requires considerable preparation to ensure the scheme gets engagement from insurers in a busy marketplace. There are some key steps which should be taken to maximise the likelihood of a successful transaction:
- Having a clear and legally signed-off benefit specification.
- Ensuring that appropriate governance is put in place, in particular having engagement between the sponsor and trustee over the approach to the insurance market.
- Considering a member communications exercise to ensure that the data held is complete and up-to-date – information in relation to members’ marital status is likely to be of particular relevance.
Short term
If buyout is within reach in the short-term, schemes should be honing-in on their target and taking steps to ensure a safe passage towards full insurance.
A vital step at this stage is to ensure that the investment strategy does not lead to a deterioration in the scheme assets relative to insurer pricing in the run up to buyout. Key actions are likely to involve:
- Reviewing interest rate and inflation hedging levels.
- Investing in assets which are more closely linked to insurer pricing – for example, assets with an element of credit exposure such as corporate bonds.
- Addressing any assets within the portfolio of an illiquid nature – continuing to invest in these assets may lead to delays to a transaction if the scheme is unable to realise these investments at short notice.
Schemes should be aware that updates to investment strategy may also lead to unforeseen changes elsewhere – for example, the trustees may review the transfer value basis following an investment review, which may lead to additional liquidity demands and reducing savings relative to buyout upon members transferring.
Conclusion
No matter where the scheme is currently in its journey towards full buyout insurance, there are a number of steps which can be taken to help navigate the route. The starting point is for sponsors and trustees to work together collaboratively, and with their respective advisers, to develop a journey plan that all parties are signed up to.
Recognising the key risks, understanding the tools available to bridge the funding gap, successfully engaging with the members, monitoring progress and reacting to changing circumstances will all help your scheme follow a safe passage to buyout.