Q&A: Transferring scheme risk to insurers

The Panel

Jo Carter
Principal, bulk pensions insurance advisory
Mercer

Jo Carter is a Principal in Mercer's UK pension risk transfer and is responsible for advising trustees and corporates on bulk annuity transactions.

She joined Mercer in 1997 and has been a specialist bulk annuity broker 100% of her time for 13 years, having advised on 20 transactions.

Carter is a member of the Institute and Faculty of Actuaries and is authorised by the Financial Conduct Authority to provide investment advice in relation to pension buyouts and buy-ins.

David Ellis
Partner and UK leader, bulk pensions insurance advisory
Mercer

David Ellis is Mercer's UK leader for bulk pensions insurance advisory. David has 22 years' industry experience overall, including 13 years' 100% dedicated experience of defined benefit pension buy-ins, buyouts and wind-ups.

He has been the lead adviser on 27 pension risk transfer projects involving insurance premiums totalling £13 billion, including five of the six pension buy-outs in the UK to date over £1 billion in size.

He is a partner at Mercer, a fellow of the Institute and Faculty of Actuaries and is authorised by the Financial Conduct Authority to provide investment advice in relation to pension buyouts and buy-ins.

Increasing numbers of schemes are transferring pension risk to insurers. What are the main barriers?

Carter: Affordability (or even perceived affordability - sometimes the solvency liabilities can be materially different to reality - making a deal either eminently affordable or even more out of reach) is the main barrier to full buyout and most schemes would need a significant sponsor contribution in order to achieve full buyout. Pensioner buy-in may be easier to achieve and pensioner liabilities can often be insured at the same level as (or better than) the scheme's technical provisions liability for those members. However, it's important to consider the merits of a pensioner buy-in in the context of the scheme as a whole - does it help or hinder the long term journey plan?

Another key barrier to transferring pensions risk is lack of preparation by trustees and sponsors, and not being able to move quickly as market opportunities present themselves. Opportunities can be short-lived and we see clients miss them if, for example, the sponsor's internal governance procedures haven't been fully considered or if there is ambiguity around the plan benefits.

A particular issue for smaller schemes at the moment is not being able to obtain insurer pricing because insurers are busy and focussing their attention on larger deals.

If a company or trustee is considering transferring pension risk to an insurer, what do they need to consider?

Carter: Beyond the obvious factors, such as being able to afford a transaction and having sufficiently clean data with a clear understanding of the scheme benefits, it is important for trustees and sponsors to really understand the market pricing for their scheme.

Adviser estimates can give a good indication but each scheme is unique and there is no substitute for obtaining scheme-specific insurer pricing (in fact solvency liabilities calculated by the scheme actuary can be up to 10% different to actual insurer pricing) which can then be used to set strategy, understand costs and finesse timing.

Key to achieving optimal pricing is presenting an attractive business opportunity to the insurers to maximise insurer engagement and competition. Part of that is being clear with the insurers on the target price, so the insurers know what they're aiming for and can try to source suitable investments so that they can really put their best foot forward.

If initial pricing shows that a deal is currently out of reach, it's important to maintain insurer engagement and obtain regular pricing updates so that opportunities can be exploited when they arise. Engaging with the insurers will also enable the trustees and sponsor to shape the deal to achieve the best value for money. It's entirely feasible to build a partnership with insurers and share up-to-date information both ways - scheme-specific information in return for pricing and terms - on a regular basis. This gives the decision makers managing the scheme and at the insurers the right management information, empowering them all to act decisively at the right time.

Finally, trustees and sponsors should use experienced advisers who can not only run the broking process well but are able to focus on the key value-add areas and drive the optimal overall outcome.

Is the pension risk transfer market consistent, from insurer to insurer and from scheme to scheme?

Ellis: No, not necessarily. Different insurers will prefer different liability profiles or deal-size and therefore particular schemes may appeal to some insurers and not others (and in fact, an insurer's preference can change over time as they look to ensure a diverse range of risks are being taken on). Further, an insurer may at any one time have a particular asset opportunity, for example, that enables the insurer to offer very attractive pricing for a certain type of liability. The offer may be short-lived and trustees/sponsors will need to be well-placed to take advantage.

Insurer pricing is influenced by many different factors and insurers will potentially react to market events differently. For example, we saw some insurers reacting more cautiously to the introduction of Solvency II than others and this was reflected in pricing and willingness to write business. This was seen in the increased spread between insurer prices that was seen in the first half of 2016, with the spread reducing as those insurers with a more cautious initial stance to Solvency II became more confident.

How can sponsors and trustees ensure they're well placed not to miss opportunities as they arise?

Ellis: Identifying optimal terms is challenging, but ensuring advantageous pricing opportunities are captured is within the grasp of all schemes. The key is to be in the right place at the right time, which simply means being in the market, receiving multiple monitoring quotations from multiple insurers as from scheme to scheme and, over time, any one insurer could end up meeting a scheme's target price, even though they may have started the monitoring process in last place. That is why we built the Mercer Pension Risk Exchange (in the US, UK and Canada) to enable schemes to be in exactly the right place at the right time. This was evidenced during the so-called "Trump bump" in the US in October/November 2016 when a number of our clients took advantage of this short lived phenomenon through MPRE.

So what can be done to make things better overall?

Ellis: The real pinch point in the market is insurers' ability to engage with sufficient numbers of schemes, not just when they are pursuing an imminent transaction, but also when schemes wish to monitor market pricing over the medium term. Standardising industry processes would go a long way to creating efficiencies and allowing a greater number of schemes to get pricing from insurers, both from a monitoring and transacting perspective. Through standardising can come industrialisation, which will bring additional opportunities for pension schemes and insurers, better accessing the true capacity of the markets. We are starting to see evidence of this, such as an innovative deal in Canada where two schemes (with complementary pension increase policies) were brought together and packaged under one annuity deal.