Buy-outs and Buy-ins… is it time?

With sponsors of defined benefit (DB) pension schemes and trustees now looking to work in a collaborative way, many have a roadmap in place for taking DB liability risk off the table.

Roadmap planning is the most commonly cited priority both for pension scheme trustees and sponsors. There are a number of ways to do this but the most effective method to reduce or entirely remove the liability is through either a bulk annuity buy-out or buy-in.

In simple terms, a pension buy-out is where the trustees of a pension scheme transfer the assets and liabilities of the entire scheme to an appropriate insurer. A pension buy-in is the process by which trustees of a pension scheme buy an insurance policy to cover a group of their members, for example, current pensioners already in payment. The trustees hold the policy as an asset and remain responsible for paying the pensions. The members remain within the original scheme.

The number of DB pension scheme trustees targeting a buy-out with an insurer has increased significantly in the past five years. A report produced by Willis Towers Watson in April identified around a third (32%) of schemes surveyed were targeting buy-out outright, in comparison to only 11% in 2013.

This year has seen some of the most competitive buy-in and buy-out pricing for a decade. Since the start of 2018 there have been a number of high profile companies that have completed bulk annuity transactions for example Marks & Spencer and Menzies, and a number of insurers have reported that they have transacted bulk annuity business in excess of £1bn in the first half of 2018.

Some DB pension schemes may now be closer to buy-out than they know. This may because the insurers' life expectancy assumptions have softened since the last actuarial valuation or because a number of members have taken DB transfers from the scheme.

Consider your own scheme and the impact of these factors. In addition, ask yourself if the funding level improved because the scheme has a higher weighting in equites or is the sponsor now able to call on liquid assets to fund a buy-out which it didn’t have access to 18 months ago.

The Prudential Regulation Authority (PRA) is currently consulting on updating capital requirements for providers that hold equity release mortgages as assets to back buy-ins and buy-outs and these rules will come into effect at the end of this year. In 2019 Insurers holding these assets may become more prudent when pricing new business and so buy-in and buy-out pricing could increase.

Trustees of schemes that are actively considering de-risking should think now about their options, as the PRA's recommendations may result in quotation or transaction delays while insurers digest the proposals.For those schemes that have already completed a buy-in the trustees need to understand whether there will be any potential impact on their chosen insurer's solvency level as a result of a change in capital requirements.

What if you are going through a buy-in and buy-out now?

Schemes could be impacted by an increase in pricing immediately as a result of insurers taking steps to prepare for the new rules, and at each point of the risk transfer journey, whether they are still at the consideration stage or are close to entering into a buy-in or buy-out.

There may be some price volatility so trustees currently investigating pricing or those in the process of negotiating final terms of pricing, should look to secure good price lock-in terms. Deals can take a couple of months to negotiate and at the point of signing, trustees and sponsors don’t want to find they are going to have to pay more for the risk transfer than anticipated.

Trustees and sponsors should therefore engage with their advisers and consult with several insurers to lock in good pricing now.

Smith & Williamson assists trustees and sponsors through the entire buy-out or buy-in process. Please do contact us if you wish to explore a bulk annuity exercise or need assistance on an existing project.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.