Choosing what to insure
Oliver Cohen, Rothesay
It's no secret that the world of DB pensions is full of the weird and wonderful. GMP equalisation is just the recent icing on a cake made up of layers of trust rules, legislation and case law.
When a scheme approaches the market and considers what to insure, the easy answer is simply “scheme benefits” – and for many schemes this will be achievable, operationally efficient and cost-effective. However, for others, their more complex ingredients mean that more careful consideration is merited. Everything is possible, at a cost, but it’s not always sensible. Wind-up is a one-time opportunity to consider the entire scheme and the form of benefits to secure for the long-term. Trustees, with the help of their advisers, will of course still need to be careful of the usual legal pitfalls if mirror benefits are not insured, but if these can be navigated then the benefits to all parties (including employers and members) can be significant. In this article I consider four common areas where a bit of pragmatism can go a long way.
Fixed factors
Fixed factor underpins exist in many schemes – sometimes through custom rather than legal entitlement.
For example, a scheme might use 4% pa early retirement factors, and seek to insure this as an underpin. To do so adds cost to a transaction, as insurers must consider the additional liability likely to result from the scheme’s factors compared to using their standard cost-neutral factors. The cost implication is of course greater when the scheme’s factors are “in-the-money” (i.e. more generous than insurer factors), but the option cost remains even when the scheme’s factors are “out-of-themoney”. In both cases you have additional operational costs which may be hidden in the premium, and legal costs (perhaps drafting a second, non-MA eligible, policy to accommodate the factors). The benefit of an early retirement factor underpin naturally accrues disproportionately to members who retire the earliest, which might not feel a very rational way to spend scheme assets. An alternative (to this, and many other similar complex, relatively expensive benefits that are poorly understood or little valued by a membership) could be to simply uplift benefits for all members. This is likely to deliver more “pounds-in-the-pocket” to members for each pound of premium, as there is less “bleed” to capital or on the expenses of administering the underpin, and doesn’t randomise outcomes based on retirement age. It is worth checking whether fixed factors are a legal entitlement in the scheme’s rules, or whether they are a discretionary practice which can be modified.
Revaluation and pension increase underpins
We often see surprising complexity in revaluation and pension increase underpins.
Again, these are rarely appreciated by members, and underpins may arise due to interactions with statutory minimums. Where these underpins exist, they can be harder to remove than those in relation to option factors, but it is still worthwhile asking your lawyer for some creativity. They are rarely administered properly, which could mean an expensive rectification, and insurers will charge for the option value of the underpin – so even an underpin that a scheme actuary might consider to be low value or out-of-the money (such as CPI vs RPI pension increases) adds to cost, sometimes materially. This can derail a process on which resources will already have been committed. If you are making a change to benefits or approach, remember to ensure you don’t make any problems worse or introduce a new underpin that wasn’t there before!
Definitions
Across the industry, schemes operate a wide range of definitions for assessing spouse, dependant, child and ill-health eligibility.
Insurers will be looking for ease of administration, consistency across their book, definitions that are unlikely to lead to foreseeable complaints and that can be assessed with the minimum of discretion or ambiguity. The advantage to flexible trustees who can read across their definition more readily to an insurer is partly economic, but mainly contributes to greater clarity/certainty on likely eligibility. While uncomfortable, forcing consideration of unusual claim circumstances is important when entering a transaction as the trustee will not be around to make decisions after buy-out. While an open definition allows flexibility and discretion for an ongoing scheme, it can lead to undesirable consequences in the longer term. We have case studies on our own backbook of outcomes that were not foreseen or likely to have come up before, especially on smaller schemes, and all insurers will take into account their own experience and risk appetite when agreeing definitions. It should be seen as a positive opportunity for trustees to learn from the real-life experience of insurers and to critically consider the true purpose of their scheme, rather than retaining loose or out-of-date language for the sake of it.
Member options
Commutation, early/late retirement, transfers are of course a given.
Surrender to purchase additional spouse pension, choice of level of pension increase, or optionality over some other benefit feature in the name of giving members extra choice are very much not. Lots of schemes have unusual, half-forgotten options like this. In reality very few members are aware of them and even fewer access them. Trustees should assess if including these options in a transaction is actually adding value. They may be free for schemes to retain in the rules, but insurers will need to consider administration and reinsurance implications, as well as any obligations under Consumer Duty, and this could have an impact on premium. Very low take-up options could be removed for future retirements, which will simplify future retirement processes to little or no member impact.
Scheme size
A final consideration is scheme size.
- Larger transactions are likely to continue to seek insurance closer to scheme benefits – they have market power that means insurer appetite is unlikely to be significantly dampened by complex structures. Where the scheme is also seeking residual risk cover, it will be important to ensure any analysis supporting simplifications is shared with and agreed by the insurer.
- Smaller trades, in contrast, can access a broader range of pricing if they are willing to critically assess non-standard features and consider alternatives – so a double advantage of a more competitive process and more efficient premium spend.
In summary
Don’t just accept the status quo – there are big advantages to be had from challeng ing the current process. We are always happy to discuss with schemes the pricing implications of decisions that are being considered to help assess if a change is worthwhile.
About the author
Oliver Cohen
Oliver is Co-head of New Business Pricing and Head of In-force Management at Rothesay. He is an actuary who has been at Rothesay since 2016, having qualified at LCP. His responsibilities include leading the team’s residual risk underwriting, and (following execution) is accountable for servicing of member option calculations across Rothesay’s book. He has been involved in a wide range of transactions including Asda, Thales and the Part VII transfers of Scottish Widows and Prudential. He is a member of Rothesay’s Underwriting and Liabilities Committee.