Spoilt for choice?

When it was announced that Citigroup had purchased the closed pension scheme of Thomson Regional Newspapers, taking the investment and longevity risk on to its own balance sheet, it looked as though the world of traditional scheme buyouts had been changed irrevocably.

The bulk annuity market has evolved greatly over the last two years, as numerous new players have entered the fray, previously the preserve of Prudential and Legal & General. The increased competition has acted as a catalyst for the development of new solutions and products all aimed to chip away at the estimated £1trn worth of UK defined benefit assets.

But the advent of the Citigroup deal, along with developments such as the agreed £400m takeover of communications support services firm Telent by Edmund Truell’s Pension Corporation, has placed a large question mark over whether the insured buyout route is necessarily the only – or best – option.

Citigroup, for instance, has structured its deal as an acquisition whereby it will continue to run the pension scheme and transfer the liabilities onto its own balance sheet.

This means it can be governed by pensions regulations rather than the more stringent insurance rules, while at the same time potentially offering a better covenant than the one already in place.

If a party is in the position to remove pension liabilities from a employer’s balance for a lower cost than an authorised insurance company buyout, while also demonstrating a sufficient covenant to gain trustees’ consent, why can’t Citigroup’s move set a precedent that is replicated across the industry? Does Citigroup’s move mark the start of a trend for UK schemes?

Xafinity Paymaster annuities and payroll director Keith Boughton says: “This is a clear example of how new players are starting to make a difference and to come up with innovative ideas to address the issue.

“The traditional insurance companies operating in this market have not had the ability to take these steps.

“Pension Insurance Corporation seems to have broken new ground with its relatively low key acquisition of Threshers and subsequently Thorn, in order to gain access to the pension funds.

“Citi have now followed suit with their acquisition of Thompsons Regional newspapers and most recently there has been the announcement of the proposed deal for Pensions Corporation to buy Telent.

“So long as the necessary funds can be raised to fund these acquisitions, this model could prove most successful going forward – for the simple reason that the cost of removing the pension liabilities and exposure to market movements would be less than the conventional insurance buyout route.”

However, Paternoster chief executive Mark Wood is not sure buyouts following the Citigroup formula will be able to offer lower prices – at least not without offering the same sort of security as a company adhering to insurance regulations.
Wood says: “The Citi transaction is, to say the least, opaque. We do not consider that there is any real pricing advantage to this structure.

“If the trustees have secured an insured solution providing security for their member then Citi will be required to put capital equivalent to an insurance company in place and the price will be consistent with our own pricing. If not then we must assume benefits are less secure.”

He continues: “In a nutshell the difference between the Citi transaction and the several transactions we have completed is that Citi has acquired a company that has a DB pension scheme, they will run the company – a shell – to minimise and ultimately remove the pension scheme deficit, after which they will consider a buyout to crystallise the assets and liabilities, potentially releasing benefit to themselves.

“En route they may take an aggressive approach to asset management to reduce the deficit, pledging Citi security, in some form or other, to the protection of the pensioners.

“Paternoster buys out pension scheme assets and liabilities, protecting promises to pensioners with solvency capital through a regulated insurance company; any surplus at the time of the buyout is split between the pensioners and the company; the investment strategy followed is extremely cautious to ensure that matched assets and liabilities deliver promised pensions.

“Trustees will tend to favour buyout over other liability transfer structures, as liabilities must be realistically assessed by the insurer, company covenant is replaced with insurance capital and trustees receive a statutory discharge from their responsibilities and personal liabilities.”

Improving on the covenant
BDO Stoy Hayward Investment Management John Broome Saunders believes the buyout model, whereby a scheme remains as a trust and continues to operate within the regulatory framework of occupational schemes, has “a degree of potential”.

He says: “Funding is clearly more flexible and the incoming buyout sponsor does not have to apply the relatively stringent life company reserving requirements, which allows considerably more investment flexibility.”

In spite of this, there are two major drawbacks, he says: “Firstly, there is no straightforward mechanism to efficiently access scheme surplus should it arise in the future. Secondly – and perhaps more critically – there are still a bunch of trustees running the scheme, who are obliged to look after the interests of members. The biggest challenge of this buyout route is probably ensuring the trustees’ wings are sufficiently clipped at the outset to ensure they do not cause problems down the line.”

Aon Consulting principal and actuary Paul Belok believes that a proposition along the lines of Citigroup’s arrangement is “clearly attractive”, but expects companies to be wary about the ability of such buyouts to remove all future liability in the way that insured buyouts are able to.

He says: “Companies will be less interested in exploring this route if they still potentially remain on the hook if things go wrong in future.”

For example, Belok points out that Citigroup’s deal and some of the early non-insured buyout proposals, rejected by The Pensions Regulator and negatively termed “scheme abandonment”, are “not radically different”.

The most important difference is that structures now being proposed have a much greater focus on the strength of the sponsor covenant.

He adds: “It is key to demonstrate that this will be improved as a result of the deal.”

However, while Pension Corporation’s proposal in relation to Telent has similarities with Citigroup’s deal, it is worth noting that neither the trustees nor the regulator were party to the negotiations (the trustees of Telent’s pensions scheme have since protested to not being privy to the talks and threatened to call in TPR over the matter).

Belok says: “It is interesting to note that some of the other – arguably similar – deals involve a relatively small operational business being acquired with a large attaching pension scheme, and these are not classified as abandonment nor do they require the regulator’s blessing.

“This potentially creates a challenge for the regulator in terms of achieving consistency of approach. The question is where the regulator will draw the line.”

Mercer principal Richard Giles describes the Citigroup acquisition as a “landmark transaction”, but makes it clear the move is not the first of its kind.

He says: “Ed Truell was involved in the acquisition of the Thorn and Thresher pension schemes earlier in the year, which had many similarities to the Citigroup deal. However, the Threshers and Thorn deals both also involved the purchase of the operating businesses, followed by the sale of parts of these businesses.

“More recently we have seen Pension Corporation’s bid for Telent and the setting up of Occupational Pensions Trusts. The signs are this is the beginning of an important new phase in the management of DB schemes.

“There is the potential for regulatory arbitrage between the pension industry and the insurance industry. All of the above solutions seek to exploit this arbitrage. Whether industry regulators remove the arbitrage opportunity in the future is open to debate.”

The critical ingredient, Giles believes, is the relative covenant.

He adds: “If the security of pension members is better after the deal than before, then such a transaction is a runner. This extra security can be provided in different ways, including using an investment bank’s balance sheet, providing more funding into the scheme and using contingent assets.”

Broome Saunders agrees that, from a regulatory point of view, there is “probably a degree of comfort if a scheme is replacing a relatively weak trade sponsor with a well-capitalised sponsor such as Citibank.”

However, it may not be as simple as that.

He adds: “Of course, as the recent Northern Rock saga illustrates, simply being a bank does not necessarily guarantee financial strength.

“There must be a lingering regulatory fear that smart lawyers have found a potential loophole and if things go wrong these new sponsors might attempt to junk the schemes on the pension protection fund.

“One concern for new occupational buyout sponsors is the likelihood of regulatory change. If such buyouts grow in practice, the anomaly between occupational and life company reserving is likely to become harder to maintain.

“After all, life company reserving rules are designed to ensure companies that aim to make a profit from annuity business do so without compromising the security of annuitants. Since the new occupational buyout companies are also aiming to make a profit from annuity business, they should arguably be subject to the same set of rules.”

Special case
Lane Clark & Peacock partner Jerome Melcer certainly believes the Citigroup deal marks the start of a trend.

He says: “Given the interest this has generated and other subsequent activity – particularly the mooted takeover of Telent by Pensions Corporation – it could be argued the trend is already gathering momentum.

Melcer explains why, in theory, such a formula should appeal to other pension schemes.

He says: “Based on reports that describe the sponsor as a ‘shell’ company, one would expect this particular aspect might have made the deal more straightforward than otherwise – bearing in mind the process the trustees will have gone through in weighing up the proposition.

“For a solution to be durable, it will usually need to satisfy the interests of a number of stakeholders, including the trustees, the old and new sponsors, and TPR.

“This will inevitably constrain the number of situations where a non-insured buyout is preferred to other solutions, or indeed to the status quo. Nonetheless, I expect we will see a variety of scenarios in which a deal can be structured using similar techniques.”

Allen & Overy advised Thomson Regional Newspapers’ pension scheme on its acquisition by Citigroup, and senior associate at the law firm Jane Dale believes it was a special situation unlikely to be replicated elsewhere.

She says: “The Citigroup deal is not necessarily a typical structure. It was quite a special case and I do not think it necessarily sets a precedent. The scheme was closed and essentially had no recourse to an employer. This is not a one-size-fits-all solution.”

Dale does, however, believe the buyout market as a whole could be on the brink of significant increase in activity.

She says: “There is no immediately apparent reason why bulk buyout in general, and other creative deficit-management solutions, will not take off – in particular, in those structures which have accommodated the expectations of trustees into their design. We are working on a number at the moment. It may have been a slow start, but there are a number of large buyout projects in the pipeline, and we are anticipating an increase in activity in the run-up to the year-end.

“There are a lot of new providers hoping to get into this market, as well as the more established names and the increased competition has meant prices are getting very keen. More and more companies and trustees are seriously considering the options.”