Member option exercises – a help or hindrance for insurance?
The focus for many schemes as their funding levels improve is to research all avenues which may help bridge the gap between scheme assets and an insurance premium to fully settle the scheme liabilities. Liability management exercises are often one of the first options considered. But what are the implications of such bulk exercises when it comes to insuring your scheme?
- What is a liability management exercise?
- Transfer value exercises
- Reshaping benefits
1. What is a liability management exercise?
There are many types of liability management exercises that are considered by schemes on their de-risking journeys, in order to reduce or remove risks, and improve funding levels relative to a buy-in or buy-out premium.
Examples of such exercises are transfer value or winding up lump sum exercises where the relevant liability is discharged at a value less than the premium otherwise payable. Alternatively, benefits may be reshaped through a pension increase exercise or simplifications may be applied to certain benefit entitlements which make them more cost effective to insure.
Liability management exercises are often one of first options considered when trying to bridge the gap between a scheme’s assets and an insurance premium.
2. Transfer value exercises
Since the introduction of Freedom and Choice in 2015, we have seen an increasing number of schemes looking to run transfer value exercises either before or after coming to the insurance market.
A trustee will likely consider each of the following points when deciding whether to run a transfer value exercise:
- Could this exercise bridge the gap to buy-out? Scheme transfer values are generally lower than the premium payable to fully secure that liability. As a result, even modest take-up levels could improve scheme funding levels.
- Are transfer values offered by the scheme at a higher level than those provided by an insurer? If so, trustees may take the view that members should have one last chance to transfer on better terms.
- Is there a lost opportunity cost to the scheme? If a member transfers out shortly after buy-out, has the scheme lost some value by paying across a premium amount greater than the transfer amount settled in respect of that person?
While these are all important considerations and may seem to release value to the member or the scheme, it is worth considering the possible offsetting implications on any insurance premium payable. For example:
- Many insurers already allow for savings in respect of future transfer take-up in the premium quoted. The premium will therefore increase if the assumption for future take-up is reduced, which is likely to be the case after a proactive transfer exercise has been run. Many insurers derive their take-up assumptions based on past experience on their book (in a similar way to assumptions for pension commencement lump sums).
- Insurers and reinsurers will be concerned about the selection risk associated with liability management exercises which again may increase the premium payable. The key selection risks are ill-health and marital status. For example, most transfer value bases do not take into account a member’s actual marital status and will instead use a standard assumption of say 80% married. This means that any member who is single is able to realise value for a benefit they were never actually going to receive. In fact, we have seen instances where communications to members have almost encouraged this adverse selection.
Many insurers already allow for future transfer take-up in the premium quoted. The premium will increase if the assumption for future take-up is reduced.
3. Reshaping benefits
Under a PIE offer, a member may be offered a higher, non-increasing pension in exchange for their current increasing pension. This may be run as a one-off exercise or schemes may offer this option as a matter of course to members at retirement.
Trustees may consider reshaping the benefit obligations payable to a form that is more cost effective to insure. For example, this may be helpful where a number of pension increase underpins exist which are expensive in the insurance market.
While as an insurer we are still exposed to adverse selection as a result of these exercises, this is generally much less pronounced than in a transfer value exercise. This is because the value of the uplift is paid over time whereas, for a transfer value, the member receives the full value of their benefit upfront. In order for an individual to choose whether or not to convert their pension increases on health grounds, they need to have a longer-term view on their life expectancy which is much more difficult.
As such we are happy to work with schemes who want to implement a PIE either before entering a bulk annuity which may create a saving, or after, potentially resulting in a refund. However, not all market participants will take the same approach and discussing this intention early will help trustees identify the right insurer early in the process.
We are happy to work with schemes who want to implement a PIE either before entering a bulk annuity, or after.
About the author
Pamela Bentley is Co-Head of Pricing and Reinsurance at Rothesay. She joined Rothesay in 2009 and is responsible for underwriting of new liability transactions. Pamela has been directly involved in most of Rothesay’s liability transactions to date. Prior to joining Rothesay, Pamela was at Willis Towers Watson in London and San Francisco. Pamela is a pensions actuary and a Fellow of the Institute of Actuaries.