Aviva looks at the three things it believes are crucial to the success of the de-risking process and how to arrive at these 'happy endings'.
By: Aviva
What makes a bulk annuity transaction successful? From the perspective of the trustees, three accomplishments stand out as being crucial to the success of the de-risking process:
• Ensuring a competitive process by obtaining quotations from a range of trusted insurers.
• Agreeing a price all parties are happy with.
• Executing the transaction efficiently with no surprises.
But how do we arrive at these ‘happy endings'? It could be argued that one factor, perhaps more than any other, lies at the heart of all three successful conclusions: the quality of the scheme data provided.
Switching to the insurer's point of view, it's crucial to fully understand the risks being taken on. We live and die by the quality of the data we have.
Why do insurers need such high-quality information?
The process is all about making an investment decision based on sound assumptions, with the expectation of making a profit. The more complete the data, the more certain we can be about our assumptions; so the more confident we can be when pricing. Trustees also benefit – from promptly delivered quotations and more assurance that they're comparing like-for-like quotes.
Agreeing a price all parties are happy with
To do this, the data needs to include all items which may affect price – something most schemes are unlikely to have. One reason for variance between the requirements of the insurer and the scheme is the difference in how trust-based pension schemes and insurance contracts are funded.
Ultimately, once a bulk annuity policy is finalised the price is set and, in general, the insurer cannot go back to the trustees asking for more money.
For a pension scheme, it's justifiable to have less than ‘complete' data, as any differences between the assumptions made and actual experience will feed through as surplus or deficit in future valuations. Ongoing contributions can be adjusted to correct any imbalance. This is acceptable as it doesn't change the ultimate cost, just the pace of funding. If an overly cautious assumption leads to an employer paying too much in one year, they will pay less later.
For an insurance contract, the trustees need to be certain they're securing the correct benefits for their members – which means providing complete data. This could be done upfront or after the transaction, where any errors and omissions can be rectified via premium rebalancing.
Finalising the transaction efficiently with no surprises
Many trustees will assume their scheme data is in pretty good shape as they collected members' information at the outset. However, over time this data may change, become corrupted or lose detail through digitisation or on transfer of administrator. Gaps will usually exist where certain data isn't required for the general administration of the scheme.
This means that some cleansing work will be needed to fill in the gaps. The more that can be done before the transaction, the lower the likelihood of any late surprises.
One way to limit the potential for surprises is to ask insurers to include Data Guarantees in their quotations - the "guarantee" meaning that the insurer will not expect a data item to be obtained after the transaction, so the price can be adjusted retrospectively. For example, a simple add-on to a Bulk Annuity is for insurers to guarantee demographic assumptions such as marital statuses, dependants' dates of birth and the mortality rating factors they use.
But the pricing of such guarantees is still dependent on the quality of the data provided. The more complete the data, the fewer assumptions we need to make and so the more precise the premium quoted.
So what will insurers ask for?
Trustees may be surprised to find that the scheme data they hold doesn't provide the complete picture for insurers. Some examples are:
i) Up-to-date marital status and spouse date of birth.
ii) Current postcode – key to assessing longevity.
iii) Accurate split of the member's pension – so insurers can value and administer benefits correctly.
iv) The spouse's pension that would be paid if the member died tomorrow, split into tranches.
v) GMP amounts verified by HMRC - to ensure the insurer is taking on the correct liability.
This is by no means a criticism of pension scheme administrators or actuaries – just an honest assessment of the higher data standards required by insurers to crystallise liabilities, due to the one-off nature of the Bulk Annuity transaction. Getting the data in good shape early gives the best possible chance of a successful transaction.
