Colin Parnell, Senior Actuarial Consultant at Capita, sets out a roadmap to success for trustees looking for an insurer to buy out their pension scheme.
As a trustee, passing the responsibility for your defined benefit (DB) pension scheme on to an insurer is an ideal way to eliminate risk for your sponsoring employer while securing benefits and peace of mind for your members.
However, bulk annuity purchases are a very popular option for DB pension schemes and the market is currently busy. This means that schemes with assets of less than £150m must work particularly hard to attract insurers’ attention.
The key to this is thorough preparation and realistic expectations - insurers are choosing to quote on the best prepared cases and are rejecting the rest.
Here are 10 important things to consider now to make sure your pension scheme, no matter its size, is an attractive prospect to the right insurance company.
1. Legally reviewed benefit specification
Do you have a clearly-written document that sets out in detail all benefits in the scheme? It’s often best to create this document using an insurer’s template as some will insist on this before they will give you a quote. Has your legal advisor reviewed it and have the scheme’s actuary and administrator confirmed that it matches current practice? Have you and the sponsoring employer considered discretions in the rules and decided how you want them to be reflected in the insured benefits, which can’t allow for trustee and employer discretions?
2. Transaction-ready data
Is the member data that you hold consistent with the benefit specification and is it in a format that insurers can use?
As a trustee, you should check that members are alive and live at the addresses that are on your administration system, and that you have information about their marital status that meets the eligibility criteria for dependants’ benefits.
You may ask why your member isn’t data transaction-ready. Administrators often manipulate data during a typical benefit calculation to make it fit for purpose. For example, they may perform calculations to split a pension into different slices that may have different normal retirement dates, increases or a spouse’s pension attached. Insurers require a higher standard of data than the typical ongoing pension scheme – they don’t manually intervene to improve the data during calculations.
3. Wind-up-ready data
Typically, if the insurance policy reflects an incorrect benefit due to errors in the member data that’s been provided to the insurer, the cost of correcting it won’t fall upon the insurer but on the scheme. Therefore, it’s up to you to be satisfied with the data before the scheme winds up.
Initially, you may choose to insure benefits based on transaction-ready data only. This might be the right choice when you’ve identified an acceptable insurance price and you want to transact quickly to secure it. It may also be acceptable when you hold the annuity policy as a scheme asset (without scheme wind-up) for some years. However, until you carry out detailed due diligence on the data, there is a possibility that it may contain errors that could change the eventual cost of insuring the correct benefits.
Insurers prefer to engage with schemes that have wind-up-ready data because they are usually easier to implement once insurance has been purchased. Typical due diligence tasks include testing data for missing, inconsistent or unreasonable values; independent sample testing of member records and calculation routines; asking members to self-certify their benefits.
4. Project plan for purchasing insurance
Insurers will want to engage with schemes that have a credible plan in place to purchase the insurance. For example, have you lined up advisors and key decision makers to review the insurance quotes and execute the transaction?
Many trustees need employer support so it’s vital that you engage with your key decision makers as early as possible. Typically, a transaction process takes 12 to 14 weeks. Once an insurer has provided a quotation (usually within eight weeks), you have up to four weeks to transact or you may lose the offer or be asked to pay more.
You should try to avoid protracted transaction processes as insurers’ can change their pricing and scheme funding positions quickly. Short transaction processes reduce this risk.
5. Agreement to transact based on indicative pricing
Insurers want to know that trustees have done their homework before asking them to provide a price, as providing a quote is expensive. Have you and the sponsoring employer received estimated insurance pricing recently, for example, and did this reveal a realistic prospect of a transaction taking place? Has the employer considered the implications for its financial reporting and is it satisfied with them?
6. Simple transaction process
Insurers will usually want simplified processes for smaller transactions that are below around £30m premium. Before agreeing to quote, they may seek confirmation that the intended pricing process is simple, for example:
- quote on an exclusive basis (increasing their chances of gaining a return on their time invested in the process)
- one round of pricing or assurance that there won’t be several rounds of pricing at different financial conditions dates
- little or no negotiation on the legal terms in the insurance contract.
They’re also keen to avoid calculating premia on different member sub-groups, due to the additional time and expense involved. If you’re considering insuring sub-groups of members, it may be better for your actuary to perform the calculations to identify the members to be insured and liaise with the insurer as required.
7. Strong governance
Insurers often prefer to work with experienced and knowledgeable market practitioners. This is because they have realistic expectations for the transaction process that increase the chances of a transaction being successful. You can improve your position by receiving training on how to run the transaction process efficiently and by following your advisors’ recommendations for preparatory work.
8. Manage related projects
Insurers are keen to avoid significant changes in the data and benefit definitions while they’re putting together a quotation, as this can lead to a lot of recalculation work for them. So, once you’ve provided data to insurers, try not to change it except to notify them of significant member movements such as deaths and transfers out. There are usually opportunities to alter the data after the initial purchase.
And try to complete any liability management exercises (for example, transfer value offers or Pension Increase Exchanges) or data improvement activity before you send data to insurers. You can manage alternative approaches with their agreement.
9. Scheme assets ready for transaction
Insurers want to be confident that a transaction won’t be derailed by last-minute changes in financial markets. Therefore, it is often preferable to earmark a portfolio of assets to be disinvested to fund the annuity premium and, where required, move the assets into a portfolio that broadly matches movements in the annuity price.
10. Equal treatment of men and women for Guaranteed Minimum Pensions (GMP)
Historically, men and women haven’t been treated equally in respect of any GMPs - this needs to be addressed before a scheme can wind up. There are many ways to deal with this issue and industry thinking is developing all the time. Insurers would prefer methods that are easier for them to administer – currently, conversion of GMPs is preferable to methods that require an annual check (although this may be possible with some insurers).
Therefore, if you’re planning an annuity purchase and have GMPs in your scheme, you should consider insurers’ preferences. Many trustees choose to defer this task until after the annuity purchase – typically, insurance contracts provide the opportunity to fine-tune the data and benefit definitions after the initial purchase but before the contract is finalised.