Insured Self-Sufficiency Q&A
Jonathan Stapleton, Editor of Professional Pensions, speaks to Russell Lee about Legal & General's new Insured Self-Sufficiency solution.
[Jonathan Stapleton]: Hello my name is Jonathan Stapleton, editor of Professional Pensions. Today I am delighted to be joined by Russell Lee from Legal in General to talk about his firm's new Insured Self Sufficiency solution. So Russell, what is ISS? As a trustee of a defined benefit pension scheme, why would I want to consider such a solution?
[Russell Lee]: So, ISS (Insured Self Sufficiency) brings some innovation to the pension de-risking market. It allows you to achieve a lot of the benefits of a bulk annuity but it's more affordable than that. For people who are a little bit away off their end game (and most schemes are), we would say there's quite a lot of risks along the way, you rarely get the nice steady gilts plus 1% that the actuaries project. Things go down, come back up and come down again; Insured Self Sufficiency gives you some protection against the downside. So, pension schemes are increasingly investing like an insurance company; they have cash-flow match strategy, you’re adopting some of these insurances principles with respect to risk. What they rarely have so far is having reserves to cover the unexpected, and in credit markets you should expect the unexpected. Things go badly in cycles. What Insured Self Sufficiency provides is that reserve to compliment the cash flow match strategy.
[Jonathan Stapleton]: How does ISS achieve this? How does it address some of these issues?
[Russell Lee]: So, first of all there's about four components. We have our cash flow matched investment strategy; we have access from the scheme to an insurance-style risk framework, so they'd get the tap into our expertise; we have L&G's capability to source assets, high-quality real assets; and last of all, we have probation of a reserve to cover unexpected losses. We put that all together, we can achieve a lot of the benefits of a bulk annuity because those are all components of a bulk annuity, but the pricing is maybe 10-15% cheaper.
[Jonathan Stapleton]: Provision of third party capital. That sounds a little bit like consolidation, is it consolidation?
[Russell Lee]: Yes and no. So, we have been developing Insured Self Sufficiency for about two years now and we think our model has some benefits compared to the consolidators that we are aware of in the marketplace. You're right, because we are providing some capital, we are providing some reserve, but we are not replacing the existing covenant, we are enhancing it.
[Jonathan Stapleton]: Russell can you tell me a little bit more about how ISS works in detail? Firstly, who manages the assets?
[Russell Lee]: So it's LGIM that manages the assets, and importantly they are managing them for the scheme, it's not the insurance company that's telling them what to do. However, the insurance company is the one who's writing the cheque if things go wrong.
[Jonathan Stapleton]: And why is ISS so much cheaper than a bulk annuity?
[Russell Lee]: The assets don't leave the pension scheme, they stay there. And so there is some more investment freedom compared to having the assets sitting on the insurance balance sheet, there's some cost-saving in terms of hedging. But also, the way that the insurance that we provide works, it's a limited amount of insurance (when I say limited, it's still a sizeable amount, it's enough to cover a 1 in 200 type of loss), but it’s not forever insurance and that makes it more cost-effective for us and we can pass on those cost savings to the members and the trustees of the scheme.
[Jonathan Stapleton]: So, may I ask Russell, how do you make money from ISS?
[Russell Lee]: So, we expect to receive a premium every year, these are contingent premiums in the structure. So, if the funding level has improved, then that's what triggers a premium payment to us. We only get paid if things are going well. If longevity is getting better for members, then the funding level would deteriorate, we wouldn't get paid. If risk is increasing or assets have done badly, those things also would mean that we wouldn't get paid our premium.
[Jonathan Stapleton]:Can ISS provide a route to buy-out?
[Russell Lee]: Yes, it can. So, the assets are invested very much like we would invest them for our own back-book as an insurance company. And so you get lots of the benefits in terms of converging to buy-out pricing overtime. And I think that's great, it gives a very safe route to buy-out. But for someone who can't or doesn't want to do buy-out, it also provides a self-sufficiency solution, that is what it is intended to do. It's a helpful benefit that ISS asset value will converge to buyout pricing over time.
[Jonathan Stapleton]: It sounds a great solution, presumably there are some schemes it is more suitable for and others less so. Do you have criteria in this area?
[Russell Lee]: Of course, so ISS provides I think attractive pricing for schemes that have maybe £250/300 million more in terms of assets. If you have more than £500 million, then we’re able to access long lease property; things like that on a segregated basis and the pricing will improve further. If people want to/if people are interested we’re always happy to do pricing indications for them – that tends to be something that we can turn around quite quickly.
[Jonathan Stapleton]: Russell, thank you very much for joining me and thank you very much indeed for watching.
If you are interested in hearing more about ISS, please do get in touch with Legal & General.