Pension Funds Online

Route to Buyout: Preparation is the Key to Success

In 2009, trustees and employers are expected to give careful consideration to the range of pension risk transfer solutions available. Following the rapid growth of the bulk annuity marketplace in 2008, both in the number and the size of pension scheme buyouts and buy-ins transacted, the majority (54%) of trustees surveyed advised that they were still planning to opt for a buyout regardless of recent market volatility.* However, as any trustee who has been through the process knows, this option should not be entered into lightly and those schemes which invest the time to prepare for this journey will reap the greatest rewards.

• Importance of Good Data

One area worthy of considerable focus is the accuracy of the information held by a pension scheme. The quality of member data is crucial throughout the life of a pension scheme as poor record keeping can lead to significant additional costs in a number of areas including administration, inaccurate actuarial valuations and even claims from disgruntled members. In a buyout deal, it will also play a crucial part in the quote process.

The Pensions Regulator has commented on this in its Record-keeping Guidance Note, noting that a buyout is an event that gives rise to an urgent need to review record-keeping. However, in MetLife Assurance’s experience the due diligence stage is likely to be too late for a data audit to have any real benefit. To understand why this might be the case, it is vital to understand the effect poor quality data can have and to highlight that additional data may even have a positive impact in a buyout process.

It is a well recognised fact that all pension schemes have some data issues, with problems ranging from basic errors in data files such as members’ details not being recorded correctly, to whole member records being incorrectly deleted. Where the quality of data is poor, an insurer may have to add a risk premium to the quotation to account for the additional costs this is likely to lead to. The size of the risk premium will directly correlate with the size of the data issue.

In addition, the costs of any deal are based on a number of actuarial assumptions. If the scheme’s experience can be shown to be more favourable, the buyout costs may be reduced in respect of, for example, mortality assumptions, the proportion of members married on death and the ages of spouses.

Data cleansing can help with these issues if it fills in gaps such as dates of death, marital status, spouse’s dates of birth and even simple issues such as postcodes. Data cleansing could also reduce the likelihood of expensive surprises later, such as having to pay additional contributions for previously unknown benefits at a time when funds are not readily available.

• Importance of an Appropriate Investment Strategy

The latter part of 2008 bore witness to stock markets around the world recording massive falls, spreads on corporate bonds soaring in response to ongoing concern about the stability of the financial system, and longer term concerns about worldwide economic conditions. In this climate of dramatic market volatility the reasons to adopt a de-risking strategy have become even more convincing. 

The major thrust of de-risking is to match assets to liabilities and to understand the scheme’s risk profile. Critical risks include exposure to changes in inflation expectations, interest rates, credit spreads, and property and equity markets. Liability-driven investment strategies, for instance, focus on creating a pool of return-seeking assets which is well matched to the likely cash outflows of the pensions.

For those trustees or employers looking to de-risk by way of a buy-in or buyout, adopting a de-risking investment strategy early is an important step to driving a competitive process which will inevitably lead to driving down prices and injecting greater certainty into the process. Indeed, despite the ongoing stock market volatility, many trustees who have adopted this strategy are still fully intent on completing a buyout transaction over the next twelve months.

A secondary benefit of this investment strategy can be the ease of asset transition to the insurer. The scheme’s advisers, or in some cases, the preferred insurance provider, can help identify the types of assets, counterparties and structures that are more easily transferred, and that helps reduce the potential price volatility to the scheme or their corporate sponsor.

• Importance of Stakeholder Involvement

Although the trustees are the primary decision makers in the move to securing scheme members benefits through an insurance contract, the process should seek to achieve a consensus among all key stakeholders. The corporate sponsor is a particularly meaningful stakeholder, especially if additional funding is required to facilitate the insured solution. Planning the route to buyout, however, is likely to include a number of other parties, such as trade unions, scheme administrators and investment advisers to name but a few. Critically, all stakeholders should know the purpose of the buyout and the impact of the change on their own responsibilities.

A key consideration for all stakeholders going through such a process will be the insurance company covenant. Working with their scheme actuaries and employee benefits consultants, trustees and plan sponsors need to know as much as possible about the insurer who will be assuming the risk of their funds following a buyout. Factors to focus on include capital strength, solvency, stability, administrative capacity and long-term commitment to the business.

• Importance of Shaping the Process

In a traditional buyout, an insurer is usually selected as the potential buyout provider following a tender exercise. Negotiations then commence to agree the policy conditions. Assuming all progresses well, liability transfer and asset transition would subsequently occur over the following three to four weeks. However, one risk associated with this process, which is particularly acute in today’s environment, is that as the negotiations progress the quote becomes out-of-date due to large changes in market conditions.

Trustees need to consider the level of volatility in pricing and asset valuation that the traditional process poses and determine if this is acceptable. One innovative strategy which can deliver a better outcome for trustees and employers is a ‘same-day transaction’, which delivers certainty on premium cost, asset values and legal framework.

With a ‘same-day transaction’, most of the groundwork is done in the weeks prior to the transaction day including all contract negotiations. On the morning of the deal, an up-to-date quotation and asset values are provided. The price is then guaranteed for that day which means there is now no need to recalculate the premium. At a meeting set up for this purpose, the trustees or representative(s) decide whether to proceed with the deal. Following agreement, final documents are signed, liabilities are taken on by the insurer and the assets transferred all on the same day. 

There are two main challenges of the traditional process that ‘same-day transactions’ overcome. Firstly, whilst it may be possible to fix the price associated with a scheme’s liabilities, using for example hedging instruments, the value of a particular asset portfolio is not fixed and would move in line with market conditions. Being able to offer an asset valuation at the same time as pricing provides certainty. Secondly, the legal issues are overcome by negotiating the terms of the contract before agreeing the final deal price. The contract language used is clear from the outset to help ensure that clients fully understand what they are entering into. This is good business practice and helps to create greater client satisfaction.

In summary, there are a number of steps that can assist in the lead-up to a buyout including data cleansing and investment de-risking. Certainty in the buyout process can also be improved by introducing a same-day transaction to limit market volatility risk. Current market experience shows that there is still strong demand from schemes for buyout quotes. Those schemes which understand and take action to prepare will achieve better quotes and can enter the buyout process with greater certainty.

* Metlife Assurance Ltd. surveyed 96 trustees at the NAPF Annual Conference & Exhibition 2008 held on 8th - 10th October 2008.

www.metlife.co.uk/metlifeassurance 

Emma Watkins is the Business Development Manager at MetLife Assurance Limited.  She is responsible for developing and securing new business within the bulk annuity market through the development and management of ongoing relationships and enhancing MetLife Assurance's profile within the industry.  Emma has over 10 years experience in the pensions arena, where she has held positions with ACE Europe as trustee liability insurance product manager and prior to that with Hazell Carr Pensions Consulting and Prudential, where she had operational and client management responsibilities for multi-disciplined operational, defined benefit administration and pension technical areas. Emma is holds the PMI Retirement Provision Diploma and is an Ordinary Member of the Institute (MPMI).