Michael Walker, Associate Partner at Aon
As the philosophy lesson goes, if you fill a jar to the brim with golf balls, it is full, right?
But what about if we add a handful of pebbles to fill the voids between the golf balls? Is it now full? What if we then pour in sand to fill the smaller gaps between the pebbles - is it full now? In fact, there is still some room to top the jar off with water, before it is sealed with a watertight lid.
Golf ball funding level
In the case of reaching buyout, the first scenario of filling the jar with golf balls is much like estimating your typical solvency funding level. It is based on the available building blocks of your current scheme data, a good understanding of the scheme's key benefits and will get the job done to provide an indication of your proximity to full buyout funding, or in other words, how full your buyout jar is. However, inevitably there will be gaps in the data and benefits which need to be filled before an insurer is willing to price the risk. So how do we fill these gaps and what needs to be considered to achieve buyout?
Data and benefit pebbles
The first step is to consider the quality of data and accuracy of benefits in payment through a data cleanse and benefit review. In terms of benefits payable, a summary document known as a benefit specification is provided to the insurers in place of the full scheme rules to administer the scheme.
Preparing this document at an early stage for the full scheme and comparing against scheme rules and administration practice will mean that insurers and trustees can be confident the benefits are clear and understood. In conjunction with this, a data cleanse can highlight the missing or incorrect data to be rectified and provide peace of mind for trustees at the ultimate wind-up, that their members are receiving the benefits they are due.
It has been well documented in recent months that solvency funding levels for the majority of defined benefit (DB) pension schemes have improved significantly and more schemes than ever before are approaching full funding on a buyout basis - good news! In fact, recent analysis across Aon clients indicates median improvements of around 10% in funding levels since January 2021, resulting in a surge of schemes approaching insurers for quotations.
Change in solvency funding level for Aon clients since January 2021
Source: Aon 2022
However, limited insurer resource and more schemes coming to market means insurers are likely to be more selective than previously. This means that only schemes with the right level of preparation (the data and benefit pebbles) can capture current favourable pricing after the unexpected upswing in their funding levels.
Granular detail of GMP equalisation
GMP equalisation is then the sand between the pebbles. At the buy-in phase, this can be a work in progress, but as the scheme transitions to buyout, equalisation needs to be agreed and implemented before an insurer will issue individual policies to members. If a the GMP method is still to be agreed, consideration should be given to each prospective insurer's appetite and administration capabilities for each method to ensure a smooth transition to buyout.
Watering down the residual risks
At buyout and eventual wind-up, schemes aim to be as watertight as possible, with clean data and benefits to ensure all members receive exactly their entitled benefits. Despite best efforts, it may be almost impossible for schemes to achieve perfection. This is where residual risks cover, trustee indemnity insurance and employer indemnity strategies will trickle through to fill the remaining tiny gaps and create an avenue for unknown benefits to be paid in the future. Early discussion of which option is right for your scheme will reduce the likelihood of leaks. Smaller schemes will tend to focus on trustee indemnity insurance and employer indemnity strategies while larger schemes often add residual risks cover. This requires more preparation with detailed due diligence being carried out on the scheme's data and benefits.
Filling your buyout jar
If you get the sequence of filling your buyout jar wrong, the task to fill it with all the contents may seem like a doomed game of Tetris. You may need a reset to achieve the desired result. However, if done correctly and with a clear strategy in place, it creates the best outcome. At a time when buyout may be in touching distance, it has never been more important to set this strategy for success.
This post is funded by Aon
