I was sifting through the pensions press the other day – well, it provided a brief escape from Brexit and I still need my CPD! – and I noticed with some surprise that L&G had completed a £35 million buy out for the Edwards Wildman Palmer Scheme. The surprise was that L&G would buy out a scheme as small as this, given that they had recently carried out the largest ever buy out of £4.6 billion for the Rolls Royce Pension Fund* (overtaking their previous biggest of £4.4 billion for one of the BA Schemes).
It was nevertheless a pleasant surprise, because it must be tempting for them to concentrate on the larger schemes in such a busy market. A market, indeed, where demand is currently exceeding supply, despite record breaking levels of transactions (over £24 billion in 2018 and a prediction of £30-40 billion in 2019).
Having carried out some more research (and not just for CPD!), it turns out that there is increasing scope for smaller schemes to try and buy out (or buy in) their members’ benefits. Indeed, my colleagues at Dalriada, who have been actively involved in such exercises, have informed me that L&G and other insurers are prepared to consider transactions for schemes as small as £10m.
There is no doubt, however, that trustees and sponsors of smaller schemes are at a disadvantage compared with their counterparts in larger schemes. Nevertheless, it’s not a complete lost cause and there are some useful guidelines for small schemes wanting to wind up, and some new developments which may provide alternative solutions.
Resolving the issues
As I mentioned above, there are a number of areas where small schemes will struggle when compared with larger schemes, the main ones being:
- There are likely to be fewer insurers with the appetite to quote for smaller schemes.
- The insurance premium is likely to be a higher percentage of the assets, as there is less spreading of risk and the insurer has proportionately more work to do.
- The insurers are likely to be less accommodating or flexible with smaller schemes.
- The expenses incurred by the smaller schemes in preparing for buy out will be proportionately much higher than for larger schemes.
- The governance and administration of smaller schemes may well be of a lower standard, resulting in more data cleansing and corrective actions needing to be carried out before buy out (with corresponding costs).
- The mortality risks may be dominated by a few older and wealthier members which can distort the pricing.
- It is harder for smaller schemes to hedge their investments as efficiently as larger schemes in the road to buy out.
On top of all of the above, there are difficulties that are also faced by larger schemes, namely ensuring the quality of the data and scheme records, checking the Scheme has complied with its Rules and relevant pensions legislation, coping with GMP equalisation and rectification etc.
And resolving all of these issues comes at a price of course, which, when combined with the heady buy out premiums even in today’s market, means that only a relatively few small schemes will be in the same position as the Edwards Wildman Palmer Scheme.
Getting ready for buy-out
However, if your scheme is able to resolve the main issues outlined above then it is well worth seeing if you can buy out with an insurer. Before doing so, you’ll want to make your scheme as attractive as possible:
- Ensure that the sponsor and the trustees are both committed to the buy out and that they jointly demonstrate this to the insurer. When there are no doubts about the willingness of the two parties to engage in the process the insurer will be much more attracted to the scheme.
- Have a clear pricing target which you can communicate to the insurer, who will then be able to see if that is in line with their rates.
- Involve experienced and knowledgeable advisers and administrators, preferably ones known to the insurer.
- Provide clean and complete data, as the insurer will not transact until that is the case. One area that schemes often overlook in this process is the spouse’s and dependant’s data, so this should be obtained before making the approach.
- Get your scheme invested in a way that makes it easy for the insurer to take on the assets. As previously mentioned, this can be more difficult for smaller schemes, so early dialogue with the insurer is advisable.
- If your scheme’s mortality is weighted towards a few wealthy members, it may well be worth getting them medically underwritten. This is because the insurer is likely to assume that they are very healthy individuals – to protect their insurance reserving requirements etc – when quite often such members are not as healthy as assumed and the buy-out premium can be reduced accordingly.
By taking some or all of the above steps, your journey to buy out should be relatively smooth and less costly.
That said, always expect hidden or unforeseen problems and make a conservative allowance for the time and costs incurred in getting through the process. This should minimise any unpleasant surprises on your journey – and you might even be pleasantly surprised!
If your scheme is not ready or able to buy out all of its benefits, then all is not lost, as there are some alternative approaches that can be investigated, namely:
- Consolidating your scheme with other schemes of the same employer. This will require agreement between the various trustees and probably some extra funding for the less well-funded schemes, but the consolidated scheme may be able to secure a buy out that the individual schemes could not.
- Consolidating your scheme with other schemes of different employers. This approach has been pioneered by at least one actuarial consultancy firm and can have the same effect as the consolidation approach outlined above.
- Enter into agreement with one of the new consolidators, e.g. Clara or Superfunds. The terms of these consolidators are still being ratified (and they are causing concerns with the insurers apparently), but assuming they become available and are acceptable to a scheme’s trustees and sponsor, then they will be a potential vehicle for obtaining a high level of security – not quite as high (or as expensive!) as a buy out – for the members’ benefits. This may be a suitable approach, for example, for a sponsor who cannot afford a full buy out cost – now or in the future – and whose covenant and trading position are unlikely to improve. (It should be added, however, that as previously stated, the terms of the consolidators are not yet available and it may be that smaller schemes will not be offered this facility, at least in the early years.)
- Enter into an “Insured Self Sufficiency” arrangement, such as that offered by Legal and General. Under this arrangement, schemes can achieve a lot of the benefits of a bulk annuity, but at a more affordable price. It is effectively an interim step to buy out, whereby the provider shapes the scheme investments towards ultimate buy out (for a premium) and underwrites the buy out if an extreme event (e.g. a 1 in 200 type of loss) occurs.
- Insure the mortality risk through a longevity swap. This type of hedging is obviously not as secure as a full buy out, but it does remove one of the main risks for a scheme and is increasingly becoming available for smaller schemes (c£50-100 million).
As you can see, there now various options that can be considered by smaller schemes approaching their “end game”. With the right advice, and the right approach by both the sponsor and the trustees, a greater degree of security at a more affordable cost can be achieved for the scheme members.
And for those of you who are not in a position to take advantage of these options, you can at least claim some CPD for reading this!
(* The L&G deal for then Rolls Royce Pension Fund was beaten on 26 September, when Rothesay Life agreed a £4.7bn buyout of the GEC 1972 Plan.)