TRW Automotive buyout
TRW is one of the world's leading automotive suppliers. The company, through its subsidiaries, operates in 24 countries. TRW Automotive products include integrated vehicle control systems, braking systems, steering systems, suspension systems, seat belts, airbags, electronics, and engine components. Prior to the arrangement it put in place, the TRW Pension Scheme was a UK trust-based pension plan providing benefits to over 46,000 beneficiaries with assets of £3.5 billion (31 March 2014). The scheme closed to all future accrual in 2009.
Increasing affordability and pricing certainty
In July 2014, Legal & General entered into a ground-breaking buyout agreement with the TRW Pension Scheme, covering £2.5bn of liability and 22,000 pensioner members. The arrangement had a number of unique features that enabled the company and trustees to bridge a substantial buyout deficit and achieve meaningful risk reduction.
Both TRW and the company’s UK pension Trustees wanted to reduce risk in the TRW UK pension scheme in a meaningful way. While the Trustees had concerns about the covenant, the company wanted to remove a significant proportion of the pension liabilities from its balance sheet and made available a fixed amount of cash for the Trustees to take de-risking action.
The amount of cash made available for de-risking was relatively small in the context of the size of the scheme and deficit. Only a small amount of risk would be reduced leaving the company with a large residual liability and the associated risk, while the Trustees would not achieve their journey plan objective of getting the scheme to a de-risked position and improving the covenant.
The Trustees and sponsors took a more holistic approach to buyout that brought together wider initiatives, including liability management exercises and active transition management, in an effort to lower costs, increase pricing certainty and ultimately enable the company to discharge a meaningful proportion of its UK pension liabilities and better secure and protect member benefits.
Pension Increase Exchange
The UK pension had a high percentage of CPI linked benefits. CPI linked benefits are more costly to buyout given the lack of hedging products. By offering members the option to exchange their CPI linked benefits for a higher, non-CPI increasing pension (a Pension Increase Exchange (PIE)), members were given more choice about their benefit structure and the buyout became more affordable for the scheme. Since the members who accepted the PIE were cheaper to buyout, the scheme knew they would insure those members. However, they did not know if they could afford to buyout the other members.To accommodate this, the scheme did two things:
- Legal & General named in the PIE communications: To encourage take-up of the PIE, the PIE Communications included the promise of a Legal & General annuity to all members who accepted the PIE. The PIE exercise had a 43% acceptance rate.
- Flexible Buyout Contract: The buyout contract obligated Legal & General to insure an unknown population of members, which would ultimately depend on PIE acceptances and TRW’s decision to buyout additional members.
Other Member Options
To further offset the cost of buyout and remove scheme liabilities, the scheme offered member options in addition to the PIE.
- Winding-up Lump Sums (WULS) to members with small pensions (<£18k): Removed £75m of liabilities.
- Enhanced Transfer Values (ETVs) to deferreds: 13% acceptance removing £125m of liabilities.
GMPs can be converted into simpler, actuarially equivalent, benefits which are more cost-effective to buyout. The scheme decided to convert GMPs, but first needed to equalise GMPs, which is a rare undertaking. However, by keeping in close, open dialogue with Legal & General throughout the equalisation process, they were able to equalise GMPs in a manner consistent with Legal & General’s expectations and thus achieved maximum price efficiency on the buyout price.
Critical to TRW’s strategic objective was obtaining pricing certainty to be able to lock into pricing metrics before the results of the member option offers were known based on the assets held by the pension plan. Legal & General worked closely with the scheme to define an asset portfolio and to assist in the asset transitioning to allow the plan to lock into Legal & General’s pricing and provide price certainty during the 4 month period of member option offered to give the company transparency on the required cash injection for buyout. This also required Legal & General to predefine a pricing methodology on a member-by-member basis.
By working closely with Legal & General to bolster PIE acceptances, convert GMPs, and achieve pricing certainty, TRW was able to turn an £800 million deficit to buyout into a buyout of two thirds of the liabilities (£2.5 billion) for only one £100m cash injection from the company.
|Funding status||ca. 100% at Gilts+50bps|
|Estimated buyout deficit||£800 million|
|Company contribution||ca. £100 million|
|Result||£2.6 billion partial buyout|
|Residual funding status||Same as before transaction|
What does the TRW transaction demonstrate?
- A number of elements, from member options to GMP conversions to transition exercises, can be brought together to deliver cost savings and pricing certainty to the buyout.
- Full settlement (i.e. a buyout rather than a buy-in) can be completed in a comparatively short period of time.
- There is capacity and appetite in the buyout and buy-in market to undertake large transactions.
- Buyouts are not just endgame solutions; TRW was the natural evolution of a multi-year plan of the trustees and company.