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The Actuary The magazine of the Institute & Faculty of Actuaries
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Pension buy-ins pain-free

Successfully executing a large pension scheme buy-in can be challenging, with a number of moving parts and overlapping workstreams. Selecting a provider with relevant experience and expertise can make a transaction that meets stakeholders’ needs significantly more likely. This article sets out some of the execution headaches that can arise and suggests some steps that could avoid them. Here, ‘large’ is defined as a transaction in excess of £500 million.

Execution headache 1: delays lead to a budget shortfall
Typically, a number of providers are asked to provide initial pricing on a ‘vanilla’ basis using market conditions at a date in the past. Security structure discussions then commence, which can present a range of options with different value propositions for the pension scheme trustees or sponsor. During this phase, the providers’ relative premium levels will not remain fixed, and if the client has a target level for the transaction premium — either in absolute budget terms or relative to a valuation basis — the premiums may be volatile relative to this target.

The next step is usually the selection of one or two providers to progress the transaction, followed by an intensive period of work to agree documentation capturing the client’s specific requirements. Pricing will continue to fluctuate relative to the target premium during this period and, indeed, market movements may be such that the transaction becomes unaffordable and the effort of preparing the trade goes to waste.

Overall, this typical process does not guarantee execution of the transaction within the client’s target price.

Remedy
A solution is to use a target-based approach, whereby the transaction documentation is agreed with the insurer but is only executed when the provider and target premiums are aligned. This allows the scheme to use market conditions to transact at an affordable level, and ensure the opportunity to transact is not missed. For this to be successful, the target must be well defined and readily calculated, and the chosen provider must be able to execute immediately when market conditions permit.

Execution headache 2: large transactions could lead to additional investment complexity
Large buy-ins require a significantly different execution skillset to smaller, vanilla cases due to the investment issues involved. For example, the insurer may need to source a very large number of bonds in which to invest the premium shortly after transacting; over £1bn in a recent case. This is a potentially significant issue. Additionally, the transition of the scheme’s assets to the insurer is a non-trivial task, and could jeopardise execution if transition costs are more significant than expected.

Remedy
The trustees should select a counterparty experienced in underwriting the execution of a large transaction, with the ability to transition large volumes of assets efficiently and access bond markets in the required size (eg. via a private placement).

Execution headache 3: post-transaction arrangements
Large buy-ins require effective structural security such as collateral, which will add to the ongoing administration costs of the scheme, and must become operational shortly after transaction execution to provide the necessary security. In addition, the collateral arrangements should facilitate swift action by the scheme in the event of insurer default.

Remedy
Verify the capability of the scheme’s custodian or consider the combined use of a collateral manager with relevant experience along with a step-in asset manager, ready to take control of the collateral assets in the event of insurer default. Using an efficient third party will reduce the cost of managing the collateral. Due to the number of considerations around the operation of collateral and the documentation needed to appoint a collateral manager, it is worth planning this stage early in the quotation process.

In summary, the execution of a large pension scheme buy-in need not cause trustees, sponsors or their advisers any headaches provided there is effective planning of the quotation process, clear requirements and a thoughtful choice of counterparty.

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Kathryn Jones is an actuary at Rothesay Life