What makes a buy-out a challenging task?
Guy Freeman, Rothesay
Reaching the endgame of a buy-out and completing the transfer to an insurer is a challenging task. Having insured many of the largest buy-outs, there are number of aspects that make buy-outs different from the far simpler pensioner-only buy-ins. Pension schemes need to think carefully about these areas in their planning.
All of the pension scheme assets are needed
Unless the scheme is in the rare situation of having a surplus, a key aspect is that all of the pension fund assets will be needed, primarily to pay the bulk annuity premium. This has two important consequences. The trustees will need to pay close attention to:
- any assets that can’t be transferred to insurers as illiquid assets can delay insurance; and
- how the fund will cover its cashflow commitments once the bulk annuity is in place to ensure all payments are made to the members on time as usual when the trustees no longer has a large liquidity buffer.
Unless the scheme is in the rare situation of having a surplus, a key aspect is that all of the pension fund assets will be needed
Capturing the moment is not simple
Buy-out transactions involve significant risk transfers to insurers and careful planning is required to capture the desired outcome. Pension fund liabilities typically have durations over 20 years and there will be movements in value between the insurer’s premium and the value of the pension fund assets. The contribution from the sponsor required to bridge the shortfall in the fund’s assets can therefore be highly sensitive to movements in interest rates, inflation expectations and asset values as well as to movements in the insurer’s buy-out premium. Company boards will often have a fixed budget for their contribution to fund a buy-out and a planned transaction can quickly move in or out of affordability. So how do you capture the moment and ensure a transaction can be completed within agreed targets for costs?
Careful planning is required to capture the desired outcome
Need to cover all of the liabilities
Part of ensuring that a transaction works for the trustees and the sponsor is to be confident that all of the pension fund’s liabilities are covered for the price quoted and nothing is missed out, or at least there are funds set aside to cover any additional cost and a solution for anything not covered by the insurer. A sponsor will often be making a large contribution to facilitate a buy-out and won’t want any unexpected, additional costs arising in the future. Proper due diligence on the liabilities is required and typically some unexpected gaps emerge. So work needs to be done to ensure that no members are omitted and that the benefits paid in the past and secured by the insurer in the future match the member’s entitlements.
Proper due diligence on the liabilities is required and typically some unexpected gaps emerge
Understand the run-up to issuance
As buy-out is the aim, it will be necessary to think about what happens in the period between signing a bulk annuity with the insurer and converting this bulk annuity into individual ones held by the members and completing wind-up. The steps to buy-out need to be fully understood and factored into the design of how the bulk annuity contract will operate. Again this sounds simple but there are many tasks to complete not least a transfer of administration and GMP equalisation.
Once the individual policies have been issued, the trustees have no further obligations to pay any pension benefits. The pension scheme can then complete its wind-up and the employer can return its full attention to running their business.
There are many tasks to complete not least a transfer of administration and GMP equalisation
The members are affected
Trustees will focus on the how the members are affected and the most obvious change is that a different party will be paying their pensions each month and they will be dealing with a new administrator. Trustees will want to know that their members will be treated well, and that the new administration processes are robust and reliable and that the handover doesn’t create step changes for example in tax codes.
It is not only about administration for the members though. The terms for any member options are also very likely to change as the insurer terms cannot or will not match trustee’s approach to setting factors in the past. Typically this results in an improvement in tax-free cash at retirement but not always, and transfer values can sometime be reduced. Trustees will want to think about this area and how to communicate it to members.
The terms for any member options are very likely to change
Protection for the trustees
Once all the details for benefits and processes are nailed down and everything has been costed, trustees will start to think about their own position. Trustees will want to ensure that they achieve an appropriate level of discharge of the fund’s liabilities and have an indemnity from the sponsor or insurance in some form to protect against any additional costs unexpectedly emerging after the wind-up has been completed.
Protect against any additional costs unexpectedly emerging after the wind-up
Getting it right in the bulk annuity
Schemes may insure their liabilities in one or many steps. Either way it will be important to ensure that their bulk annuity transactions take account of what needs to happen not just in the period up to the transaction but also in the period up to issuance. Bulk annuity buy-ins have been covered widely in pension industry publications before. To complete a buy-out successfully though, there is a lot of additional thinking, planning and work to do.
To complete a buy-out successfully though, there is a lot of additional thinking, planning and work to do
About the author
Guy was previously co-head of Business Development, having been at Rothesay since it started up in 2007. He has played a leading role in many of our transactions with pension schemes, including those with Uniq, GM, Vestey, Lehman, CAA, the Post Office and Toshiba amongst many others. He now uses his experience to support the business development team whilst working part-time.