How to secure DB pensions in a crowded market
An insider guide on achieving the best outcome with your insurer of choice
The Pension Risk Transfer (PRT) market has been one of the great success stories of the financial services industry. Over the past five years, more than £140 billion of retirement income in Defined Benefit (DB) schemes, covering hundreds of thousands of members, has been secured through buy-in and buyout transactions with insurers in the UK. Last year alone, the PRT market agreed transactions totalling almost £30 billion.
Demand for PRT is growing, as rising interest rates and widening credit spreads reduce pension deficits and accelerate the journey to buyout for many pension schemes. With more DB pension schemes approaching the PRT market than ever before, insurers are unable to quote on all transactions, prioritising those that give them the best chance of securing a transaction.
At Legal & General, we were unable to quote on around a third of the requests that we received for buy-in and buyout quotes during 2021, and this is set to grow in future as demand increases.
Now, more than ever, it is vital that pensions schemes do not rush their approach to market and can demonstrate that they are well prepared for a buy-in or buyout transaction. Those that have laid the groundwork will be best equipped to gain insurer engagement, when insurers are considering their case alongside scores of other requests, and to take advantage of opportunities that may arise along the way.
However, it is not always clear to schemes what this looks like in practice. To help demystify the process, we have created a simple step-by-step checklist packaged up in a neat acronym: A BADGE.
DB pension schemes need to demonstrate to prospective insurers that they have A BADGE.
A feasibility study conducted by the scheme, with input from specialist de-risking advisors, can help to set a target premium for a transaction and help a scheme to understand whether a buy-in or buyout is affordable.
Demonstrating that this test has been carried out gives insurers confidence that a transaction will go ahead if the target is met.
A legally reviewed benefit specification helps insurers understand the benefits that they are taking on and the risks they’re exposed to; any gaps will create uncertainty. Schemes should also consider any discretionary benefits that have been provided historically. If these are to continue after a buyout the benefits will need to be hard coded in the scheme rules.
Insurers prefer schemes to demonstrate that they’ve considered Guaranteed Minimum Pensions (GMP) equalisation, too, although that doesn’t need to have been completed before a transaction.
As part of understanding affordability, schemes should also work with their advisors to understand how insurers invest the premiums that they receive. Schemes may consider moving into assets that better match those that an insurer invests in – any mismatch could impact on affordability as market conditions change between the time the feasibility study is carried out at the transaction is finalised.
Investing in insurer friendly assets also means that an insurer may be able to accept the scheme’s assets as premium payment, rather than having to sell them first, which introduces risk and transaction costs and will result in a higher premium.
Schemes should also review any illiquid assets they hold. Selling these before a transaction can avoid delays at the end of a transaction process.
A scheme’s data does not need to be perfect, but it helps if a scheme can demonstrate that some data cleansing has been carried out. As is the case with the benefit specification, any gaps create uncertainty for the insurer.
Ideally, schemes should also provide insurers with marital status data and, for larger schemes, mortality experience data, as these additional data items help the insurer to set their pricing assumptions with more certainty.
Schemes should approach the market with clear decision-making criteria, such as considering what factors are important beyond pricing. More and more schemes are considering factors such as administration capabilities, ESG principles, brand and track record when choosing an insurer.
Establishing an efficient and flexible decision making process can also be hugely beneficial to schemes ahead of a transaction process. Opportunities can be short-lived, so it’s helpful if schemes can make decisions quickly.
In the first instance schemes will need to engage closely with their advisors (and in some cases their preferred insurers) to help with each of the steps outlined above.
It is equally important that there are clear lines of communication between the trustees and sponsor stakeholders to ensure that objectives are aligned – we have seen projects fall down very late in the process where those conversations didn’t happen in advance and the trustees and sponsor failed to agree on their preferred outcome once the insurers had provided quotations. This makes it very difficult for such schemes to credibly approach insurers in future.
Insurers know that all DB pension schemes have their quirks but, in an increasingly busy market, A BADGE is a comprehensive and easy to remember checklist that pension schemes can use to ensure they are approaching the market in their best shape to attract insurer engagement.
A BADGE is based on our learnings from more than 35 years’ experience of working with pension schemes and their advisors to secure buy-in and buyout transactions. Pension schemes that follow these steps will put themselves in the strongest position to achieve the best outcome for their members.