Prepping for buyout: How the current derisking market affects your scheme?

That record was set despite a sharp fall in long-term bond yields, which serves to increase both the value placed on pension scheme liabilities and the prices charged by insurers to take on the risks. 

Despite the falling yields, attractive annuity pricing exists, particularly where schemes have well-matched bond portfolios to back their liabilities.

For most defined benefit schemes, executing a buyout with an insurer is the end game.

However, for many schemes this is a medium to long-term aspiration given the impact of quantitative easing on pension scheme liabilities.

Yet, it is possible to begin taking meaningful steps towards buyout that will benefit members in the interim.

Accurate data is a win-win

One such step is to ensure the data for the pension scheme is as accurate and complete as possible. Specific examples include ensuring high-quality data regarding spouses/civil partners, marital status and member postcodes more generally.

This clearly has relevance for the day-to-day scheme operation of delivering the agreed benefits, but is brought into sharp focus when a buyout is being considered. 

Accurate and complete data allows insurers to price the buyout with additional confidence and without having to include in their calculations additional reserves for data issues.

This, in turn, reduces the buyout premium that assists sponsors in funding the transaction.

In any event, better data leads to more efficient operation of the scheme and less time spent correcting administrative errors, or worse, resolving incorrect payments.

Member security is important

An often-overlooked aspect of the current market is the member security offered by different providers in the buyout market – not all insurance providers are the same. 

In the US, the equivalent of trustees (fiduciaries) are required to conduct an objective and thorough analytical review and purchase the annuity from the 'safest available' annuity provider. 

In the UK, the system operates differently with the prime focus on determining, usually through an intermediary, the best price (ie typically the cheapest) for the buyout premium.

Once a provider has been selected it is often only then that some – typically relatively light – due diligence is done to confirm the suitability of the provider.

In effect, a lot of reliance is placed on the UK regulatory environment and the intermediary procuring the buyout to ensure member security is not compromised in the process.

While no buyout provider has as yet failed, a number of players that were providing buyouts in 2008 were subsumed into other providers, showing how things can evolve.

The keenest price might be from a provider offering a lower standard of benefit, and on a like-for-like basis may actually be more expensive than alternative providers

When the time comes to move to buyout, trustees should ensure member security is not an afterthought, but a key factor in the selection process.

Discretionary benefits

It may be obvious, but insurance contracts cannot apply discretion and will provide a certain level of benefit in specified circumstances.

As such, trustees will need to look at 'hard-coding' any discretions within their scheme rules before they eventually buy out, so that they and the insurer will know precisely what is going to be provided following the winding-up.

The keenest price might be from a provider offering a lower standard of benefit, and on a like-for-like basis may actually be more expensive than alternative providers.

As we all know, the governance processes for DB schemes means determining a consistent approach to apply with respect to discretionary benefits may take a lot longer than one might think, and is something that can usefully be done in the preparatory phase for buyout.

Darren Redmayne is head of Lincoln Pensions