Schemes warned of pitfalls in approaching buyout

LCP’s latest Pension Buyouts report – published last week – showed certain forms of derisking, such as pensioner buy-in, are currently at their most affordable since 2008.

Defined benefit schemes viewing buyout or buy-in as part of an endgame strategy have been urged to ensure they are fully ready to transact if market conditions turn favourable so they can get the best deal for their sponsor and members.

Last month, schemeXpert.com reported just one-third of all buyout quotations lead to transaction, revealing the wasted costs and resources in negotiating a failed deal.

Consultants and providers have isolated a number of projects schemes can work on to make sure they are ready to transact when pricing is most favourable. These include:

• setting up an execution sub-committee;

• dealing with guaranteed minimum pension (GMP) equalisation;

• determining an approach to discretionary practices;

• agreeing the final approach with the sponsor; and

• using a trigger-based approach to achieve the desired market timing.

“All of those things require thought, decision-making and discussion between the employer and the trustees,” said Emma Watkins, director of business development at Metlife Assurance.

“You want to be doing that when you’re off the clock, before you go through the transaction process.”

Watkins said while having member data in good order was important and could make a 2-3% difference in price, the most important factor was market timing.

She said the same 2-3% difference in price could also be achieved through a mere 0.2% change in interest rates.

Charlie Finch, partner at LCP, added: “Markets move quickly, so if you don’t move quickly you could miss out on the pricing opportunity.”

Affordable market

The LCP report showed transactions for pensioners typically cost 0-5% above the funding reserve, which is the most affordable the market has been since 2008 and the onset of the financial crisis.

LCP put this movement in pricing down to well performing pension scheme assets, which improved funding levels

Another reason has been the changing relationship between swaps and gilts.

Pension schemes mainly measure their liabilities with gilt yields, while insurers price using swaps. Last year swaps yields were uncharacteristically higher than gilts and so derisking was relatively more expensive.

But that has since reversed, meaning buy-ins and buyouts are now more affordable for schemes.

Insurers are also a lot more confident in their pricing. The fall-out from the financial crisis meant many insurers were looking to bolster their balance sheets and cash was in short supply to write annuities.

There was also concern about how Solvency II requirements would affect their cash requirements. But a lot of that caution has now dropped off and insurers are prepared to be more competitive with their pricing.

Derisking checklist

Schemes looking to take advantage of the favourable market conditions are urged to set up execution sub-committees prepare for transaction.

Duncan Howorth, chief executive of JLT Benefit Solutions, said he always advises his clients to set up such committees, which would include trustees, sponsor representatives and advisers.

“It’s a big corporate transaction and therefore there is a large amount of detail to go through,” he said. “In some cases they may be meeting daily.”

Watkins said one of the major stumbling blocks for schemes failing to transact was them having failed to decide how they would equalise their GMP benefits before the deal.

She also advised schemes to make sure they had closed their Barber Window – the period between May 17, 1990 and equalisation, during which time both sexes must get benefits on equal terms.

Another error schemes often make in the derisking process is failing to work out their approach to discretionary practices, such as discretionary increases to pensions.

They need to make sure they have decided whether such elements are hard-coded into their agreement with the insurer or not. And if not, how they are dealt with.

Schemes are also advised to ensure they have a full agreement with their sponsor over the final transaction, its cost and its benefits to members.

Providers have reported a number of deals since 2008 which collapsed at the last minute due to poor communication between the scheme and sponsor.

Finally, LCP advocates using a trigger-based approach to transacting. This involves agreeing a price matrix with the sponsor and being ready to go through with the deal as soon as market conditions and provider appetite make the price achievable.

Finch advised schemes make sure contracts are in place with the provider and their data are already in the provider’s system before the transaction goes through to enable an efficient process.

Watkins added: “You need to be prepared to hit the button as soon as all your stars are aligned.”