News in focus: Nine years after Nortel's international insolvency, trustees of its UK scheme have secured a PPF-plus buyout. Pensions Expert looks back at the steps trustees took to achieve their pricing, and the precedent set when US and Canadian courts awarded them a £1.2bn payout.
The Nortel Networks UK Pension Plan, which had a buyout deficit of £2.1bn at the time, was left to assert its claim among an army of competing creditors over $7bn (£5.3bn) of international assets, held in an escrow ‘lockbox’ over the Atlantic.
Nine years later, a £2.4bn buyout of the scheme and its exit from the Pension Protection Fund assessment period means members finally have some certainty over the extent to which their benefits have been cut.
While the average member will receive around 80 per cent of the benefits originally promised under the scheme, advisers and trustees can point to evidence that they achieved a good deal with insurer Legal & General.
Any options that you can give those members to take their benefits out of the scheme before you go to buyout, those usually will allow you to settle those liabilities at a significantly lower cost
Ruth Ward, JLT Employee Benefits
In fact, lead transaction adviser KPMG said the level of benefits covered by last week’s deal outstrips what could have been secured with the same injection into a commercial consolidator, the very vehicles said to offer a solution for schemes that cannot afford buyout.
The pricing achieved sets a new standard for what can be achieved in the bulk annuity market, and may suggest trustees of other schemes could do more to prepare themselves, according to professionals working on the Nortel deal and others in the industry.
“It’s not easy to do this but if you’re committed to doing it and everybody’s pulling in the same direction you can get really good outcomes,” said Tom Seecharan, a director in KPMG’s pensions practice. “From what I see at the moment the consolidators are kind of benchmarking themselves against a perceived insurer price level, but it’s not really where the price level is.”
Member options drove price lower
Once it had become apparent that the Nortel scheme would receive enough assets from the insolvency process to exit the PPF, trustees and their advisers set about making the benefit structure as attractive as possible.
Some members were presented with as many as seven options about how to change their benefits under the scheme. Those included transferring out benefits, taking early retirement, and offers simplifying complex benefits like guaranteed minimum pensions into an actuarially equivalent form. Insurers were kept up to date with all changes as they were implemented.
On a pension increase exchange exercise, where members were given the option to trade in their inflation protection above statutory minimums (including pre-1997 indexation) for a higher initial level of pension, take-up was around 70 per cent.
Ruth Ward, a senior consultant at JLT Employee Benefits, agreed that changes like those made to Nortel would help secure better pricing from insurers. She said that while changing scheme benefits can be favourable, giving deferred members attractive options to transfer out leads to larger reductions, as these benefits involve significant uncertainty for insurers.
“Any options that you can give those members to take their benefits out of the scheme before you go to buyout, those usually will allow you to settle those liabilities at a significantly lower cost,” she said.
Members must make informed choice
The scheme also embarked on a widespread communication exercise explaining changes in simple terms, and pre-briefed a large independent financial advice firm on the scheme to ensure that members could pick a trusted adviser.
Rosalind Connor, a partner at Arc Pensions Law, who has seen examples of these communications, said: “The Nortel scheme is a classic example of what happens if people think carefully about communications and do them well.”
Connor urged other schemes to take the same approach, and to make steps like cleaning up and securing any extra data needed as soon as possible, in order to show insurers they are committed to the transaction.
I think there’s value in the result we had on Nortel for other situations of that kind
Angela Dimsdale Gill, Hogan Lovells
That demonstration of commitment may be vital in future, as demand picks up for bulk annuities. JLT data showed that total longevity risk insurance is projected to hit £37.3bn this year.
“We’ve been seeing insurers getting increasingly selective on what they’ll quote on,” said Ward, arguing that well-prepared schemes will continue to attract attention even with smaller deals.
Investment moves secured price lock
As benefit changes helped to drive down costs, changes were also made to the scheme’s investment strategy to ensure the transaction was as efficient as possible.
Seecharan described the trustees' aim as ensuring that as much of the scheme’s finite resources went to members, “rather than just end up with the shareholders of Legal & General”.
Trustees moved into a mix of gilts, corporate bonds and swaps that were able to be placed in a clearing house under the Emir-friendly swaps – the type of assets an insurer would hold against longevity risk.
This persuaded Legal & General to lock the buyout price to the value of the scheme assets, and advisers also negotiated an in-specie transfer of assets to pay the premium, avoiding further market risk.
Suthan Rajagopalan, a partner at Mercer, who led investment advice on the deal, said this process is easier for large schemes involved in significant transactions, compared with smaller schemes using pooled funds.
“You tend to be able to negotiate pretty vigorously and hard to get an in-specie transfer and, more importantly, a price lock,” he said.
One of the factors behind improving bulk annuity pricing has been that insurers have begun to match longevity risk against long-dated alternative assets within the confines of the Solvency II regulations, affording them a return above their traditional fixed income portfolios.
Did some members get less than half benefits?
Not all members will receive 80 per cent of their original benefits under the PPF-plus deal agreed last week. As with the PPF’s own benefit structure, wealthier members may have seen a larger proportion of their entitlements eroded under the deal.
Seecharan said trustees and advisers went beyond the schemes rules “to look for what the legislation allows, and actually the legislation allows quite a lot of discretion”.
Actuaries Willis Towers Watson did not respond to repeated requests to ascertain whether any member had lost more than half of their original pension – the limit to dilutions set by a recent European Court of Justice ruling.
Seecharan said legal advice established that the timing of the deal means trustees are insulated from the impact of the ruling. Other schemes may not enjoy such immunity.
“Until the government and the PPF agree on the new funding basis and the calculation methodology, I think anybody going through the process… will have to think about who bears the risk and whether that’s the insurer or the members, or indeed the PPF,” said Adolfo Aponte, director at Lincoln Pensions.
However, LCP partner Clive Wellsteed said schemes should think carefully about whether they want to hang on to alternatives, running the risk that they are not suitable for transfer to the insurer.
“Insurance companies tend to be quite particular about the types of illiquid asset that they would be happy to receive,” he warned.
Court case set important precedent
Of course, the Nortel scheme could not have bought out PPF-plus benefits without a huge injection of cash. The scheme’s £1.2bn payout was secured after nine years of 'scorched earth litigation', in which the scheme’s lawyers successfully argued that Nortel’s high level of international integration meant all claims should be answered on a pro rata basis.
"I think there’s value in the result we had on Nortel for other situations of that kind,” said Angela Dimsdale Gill, a Hogan Lovells partner, who acted for the scheme at the time. She said more and more multinationals operate integrated corporate structures like Nortel’s, offering trustees of those schemes some hope of recovery.
The buyout was welcomed by both the Pensions Regulator and the PPF, with a spokesperson for the regulator saying that the court settlement reached in 2017 “gave the UK pension scheme a fair share of the proceeds from the disposals of the Nortel group’s worldwide assets and was the best outcome in difficult circumstances”.
However, questions remain over the extent to which the regulator can export its powers. Financial support directions against US and Canadian parents were thrown out by courts in their respective jurisdictions.
“It’s always quite a challenge to enforce internationally,” said Connor. “Not unreasonably, most countries’ law is not particularly embracing to money going overseas.”
Connor said small schemes may struggle to afford the same legal resources as Nortel needed to secure its outcome, but welcomed a proposed change in the government’s white paper, moving the burden of FSDs from trustees onto the employer.
