Róisín O’Shea, Rothesay
Premium certainty is less common than you may think in a bulk annuity transaction and a traditional bulk annuity comes with a few moving parts.
- The headline premium
- The balancing premium
- The residual risks
Let’s look at these in turn alongside ways to mitigate them in order to secure ultimate price certainty at the point you select your insurer.
The headline premium
When insurers provide a best and final quotation it will be based on a market conditions date in the past. This is the date used by all insurers for inflation assumptions, interest rates and investment spreads. Using a set date does make sure that all insurers are quoting on a consistent basis but it also means that by the time you are considering the proposals the premiums will have changed, and so will the value of your assets. It is then a more difficult task to understand how insurers’ pricing may have moved since – each insurer’s price will move in a different way and this will depend on the underlying assets they are assuming they will use to fund the transaction. This is not something the trustee usually has sight of.
To gain premium certainty during the period between exclusivity and inception a price -lock can be put in place. At the point exclusivity is granted it’s possible to convert the premium into a portfolio of assets (the ‘price-lock portfolio’). From that point forward the scheme is able to monitor how the premium is changing during the exclusivity period by tracking the specified assets. Ultimate premium certainty is achieved when the insurer is able to create a price-lock portfolio that is made up of assets already held by the scheme and offer this price-lock from the market conditions date of the best and final quotation (if it’s not too far in the past). The premium can then be paid simply by transferring the scheme assets to the insurer at inception of the policy.
To gain premium certainty during the period between exclusivity and inception a price-lock can be put in place.
The balancing premium
In most bulk annuity transactions an initial premium is paid at the policy inception, and then after the data cleanse period (usually around 12 months after the initial premium is paid) a balancing premium is paid to reflect the cleansed member data. This balancing premium could either be additional money owing to the insurer or a refund to the scheme. The balancing premium will very much depend on the accuracy of the scheme data and any specific cleansing actions were identified during the insurer’s due diligence process. The cost of the balancing premium will be unknown at the point of inception and therefore it is very difficult for the trustee to know the full cost of the transaction when selecting an insurer. Whether the balancing premium is positive or negative, it can create issues – such as regarding affordability or “trapped surplus”.
A single premium structure allows the trustees to pay an up-front premium that covers everything. There will be no balancing premium to be paid at a later date. This structure will allow trustees and the sponsoring employer to have sight of the total cost (net of expenses) of the transaction before entering into the contract, with no surprises to come later. An up-front premium that covers everything is only possible if the insurer is willing to underwrite the risk and any additional costs associated with the data cleanse period. In a transaction with a finite budget (which is most!) this structure allows trustees to react quickly to favourable pricing knowing that there will be no further premium required.
A single premium structure allows the trustees to pay an up-front premium that covers everything. There will be no balancing premium to be paid at a later date.
The residual risks
No scheme is completely free of outstanding risks once it has entered into a buy-in or buy-out, and from time to time issues may come out of the woodwork that are not covered by the insurance policy. Missing beneficiaries may also come to light or data errors that the trustee wasn’t aware of. These types of liabilities will need to be met by the trustees at the point they become aware of them. But how does a trustee ensure that they have enough funds to meet these potential liabilities? And how can any trustee take this into account when selecting their insurer?
The trustee could consider purchasing residual risk cover. Many insurers offer the ability to purchase this cover up front as part of the initial transaction or at a later date when winding up the scheme. Residual risk cover will provide premium certainty around any ‘unknown unknowns’ from the point that the cover incepts. Understanding what each insurer is willing to offer and the scope of the cover is important during the initial insurer selection.
Residual risk cover can also be offered from the point of inception on buy-out transactions, for a fixed, upfront premium. This, together with a single premium structure, it’s possible to achieve ultimate security for trustees and their members.
In a survey we completed with Mallowstreet the results showed that nearly 60% of schemes aiming for buy-out are considering residual risk cover
When do I need to start thinking about this?
Considering each of the structures I have mentioned above is probably something you should do before approaching the market. Each insurer’s solution is likely to be a little different, so remember, don’t be blinded by the headline premium, carefully consider what each insurer is offering and think about how much premium certainty you will require.
About the author
Róisín is part of Rothesay’s Business Development team. She has spent most of her career focused on pension de-risking and has worked on a wide range of transactions both at Rothesay and also during her time in Aviva and Legal & General’s bulk annuity teams. Róisín is a Fellow of the Institute and Faculty of Actuaries and has received the Chartered Enterprise Risk Actuary accreditation.