The risk business

The panel
CHAIRPERSON: Jill Bourne FIA, partner, Lane Clark & Peacock
Bourne co-heads LCP’s buyout steering group which acts as LCP’s central source of knowledge on the buyout market. Bourne has over 11 years’ industry experience and qualified as a Fellow of the Institute of Actuaries in 2000

Mark Wood, chief executive officer, Paternoster
Wood held a number of senior positions in the financial services industry (including chief executive, Axa UK and chief executive, Prudential – UK and Europe), before setting up Paternoster, the insurance company that takes on the risks associated with defined benefit pension schemes, in December 2005.

David Evans, business development director, bulk annuities, Legal & General
Evans is a qualified actuary based at Legal & General’s office in Surrey. His focus is on product development, pricing and the marketing of the company’s bulk annuity products. Evans joined Legal & General in 1996 initially as a member of its financial reporting team and has now been working in the bulk annuities business for over eight years.

Tony Read, product development manager, AEGON Trustee Solutions
Read is responsible for the design and implementation of new products and services. AEGON Trustee Solutions is a leading provider of bundled defined benefit scheme solutions including and bulk buyout annuities.

Andy Reed, director, wholesale pensions solutions, Prudential
Reed is a qualified actuary with over 20 years’ experience in the UK insurance industry. Having implemented various significant bulk transactions, Reed is currently responsible for Prudential’s innovation within the DB market.

Margaret Snowdon, operations director, Lucida
Snowdon is a fellow of the Pensions Management Institute and a past vice-president. She is a fellow of The Pensions Advisory Service as well as chairman. Snowdon speaks at industry conferences and is a frequent contributor to pension journals.


BOURNE: What are your reflections on the transactions placed in the market – including P&O, Weir and ENI Lasmo – over the last quarter of 2007? What will the market look like in 2008 and beyond in the light of this recent experience?

WOOD: In the last quarter of 2007 we saw the largest ever bulk transaction, the largest e-auction to date (ENI Lasmo) and the first full immediate de-risking of a company’s obligations in respect its pension scheme on the day of the transaction (Emap). The market in the final quarter of 2007 looks as if it will have been about the same size as the entire market in 2006. As far as we can see from our pipeline, and the transactions which will close prospectively in this first quarter, the market is set to at least double again in 2008.
In our view, the benefits of transferring pension scheme risks to a regulated insurance company will be greatest for mid-cap companies. Nonetheless, we could see several pension schemes – including those of FTSE100 companies – with liabilities approaching £1bn evaluating the buyout option.

EVANS: For sometime now there has been reference to the potential growth in the pensions buyout market and it would appear that the forecasted opening up of the bulk buyout market to pension schemes is now happening. There are a variety of risk transfer solutions now being employed and the recent transactions involving P&O, Lasmo and Weir, reflect this step change in demand to include open schemes as companies recognise the benefits of paying a fair price to take highly volatile liabilities off their balance sheet. To see the market developing to include large, open schemes in addition to the traditional distressed buyouts during Q4 2007 means the market outlook for 2008 is positive.

READ: On paper 2007 was a good year for schemes to buyout benefits as higher interest rates pushed up bond yields, which in turn reduced the cost of securing benefits. We also had generally favourable equity returns for most of the year. Coupled with this we saw various innovative solutions come to the market including some non-insured buyout and some insured non-buyout solutions.
In any market, price will depend on supply and demand and in 2007 trustees could take advantage of some very competitive annuities pricing. Time will tell whether or not such levels of pricing will prevail in 2008. My view is that this market may not escape the impact of the world uncertainties surrounding “credit crunch impacts”. It is therefore possible that 2008 could become a “triple whammy” for trustees:
i) Scheme assets fall as result of stock market falls;
ii) Liabilities rise due to bond yields falling;
iii) Insurance terms harden due to the uncertain outlooks.
On the plus side there continues to be a lot of market development going on at the moment along the lines of buying out benefits over a number of years, incorporating both pricing basis guarantees and investment consultancy.

REED: 2007 saw some large pension funds looking to de-risk via buyouts and new risk management approaches. A large amount of liabilities were placed in the last quarter, as players sought to secure business by the year end. However, most of these enquiries had been ongoing for some time. There are no guarantees 2008 will mirror the last quarter, as various factors impact affordability and the circumstances of scheme sponsors, such as the FTSE and interest rates. We believe interest in de-risking will continue to grow and as further innovations become established, more schemes will proceed with risk management strategies.

SNOWDON: The recent transactions mirror what Lucida has said from the outset that a traditional buyout will suit some organisations but not all. Some companies and trustees are looking for more sophisticated and tailored solutions. The trend is moving towards more holistic and immediate approaches and it is becoming clear that many scheme sponsors would like to be rid of their closed defined benefit scheme risks.
What appears to be happening over the last few weeks is that the publicity surrounding transactions drives “me too” behaviour, with the result that all subsequent requests for quotations are based on the shape of the last deal publicised.
2008 will see a number of Emap-style deals, although it only takes one difficult execution, as we have already seen, to create anxiety among trustees and employers as well as additional cost for the insurer. Even better solutions will emerge in 2008, but care must be taken so as not to try to fit a square peg into a round hole. All pension schemes are not the same.


BOURNE: Do you think the stock market and the press currently give sponsors of pension schemes de-risking through buyout appropriate recognition?

WOOD: Emap’s share price rose by a couple of percentage points on the announcement of their corporate restructuring plans which were facilitated by the transaction with Paternoster. There is no doubt that such transactions are being viewed favourably. However, as work produced by Casanove (the elephant in the data room) has shown, there is no direct correlation between share prices and pension de-risking.
By transferring pension scheme liabilities to a regulated insurer, the sponsoring organisation should be seen as acting responsibly: it has protected the ability to pay pensions with solvency capital. The promise made to employees is therefore protected and retained. The potentially volatile financial effects of the pension scheme are removed from the balance sheet and the costs of fulfilling the promises of the defined benefit scheme are fixed.

EVANS: The P&O transaction made front page news, so it is clear the media is recognising the importance to corporate UK of pension buyouts. The emphasis of the press coverage is on pension schemes looking to manage risks such as increasing life expectancy, inflation and stock market volatility. These are key considerations for companies. So coverage on the various transactions can help to provide useful reference for other companies who are potentially looking to do the same.
Whether the stock market responds to pension scheme de-risking depends on several factors. Generally a company will need to be in the FTSE350 to get the required depth of analyst coverage. In addition, the pension deficit needs to be material as compared to the market capitalisation of the listed entity.
When reviewing some of the larger deals that have occurred in 2007 there has been little stock market reaction. However, looking at the specific deals shows why what are considered significant transactions in the buyout market are not necessarily of the same importance to the analysts. For example, Lasmo is a part of ENI Spa. ENI Spa has a market capitalisation of approx e100bn (£74bn). So although the pension deficit may have been material to Lasmo, as just one part of ENI Spa it is far less material.
However, with future uncertainty about increasing longevity and increasingly onerous regulation, the stock market focus may change and so the reaction to buyout transactions may not always be so muted in the future.

READ: For insured buyouts, I believe it is important trustees and employers fully understand why costs are higher than FRS17 and what scheme members get in return. The reasons for higher costs are more realistic longevity assumptions, the capital requirements adopted by insurance companies for solvency, plus the capitalisation of all future administrative expense. In return members receive guaranteed benefits within a regulatory framework supported by the FSA and under which members are protected by the Financial Services Compensation Scheme.
Where corporate transactions take place along the lines of non insured buyouts the degree of protection offered will depend on the new level of employer covenant with the new sponsor for an ongoing scheme.
It is important to understand that these two propositions are very different, each is operating in its own space, and each may be appropriate in different circumstances. There is an education piece to be done and articles such as this undoubtedly help.

REED: Press coverage has typically been dominated by messages regarding occasional big wins acquired by providers, with little detail given to the financial benefits to sponsoring employers from removing liabilities. Recognition is often limited to what the transaction has achieved, such as a company restructure or sale, not why this has been possible.
Share prices do not necessarily take a sudden upturn when liabilities are removed – principally because the liabilities, although potentially large, are difficult for the City to evaluate and are, in any event, spread over time. However, credit rating agencies are now increasingly looking at pension scheme deficits and mortality liabilities.

SNOWDON: It takes time for analysts and the press to understand the impact of pension scheme de-risking on the fortunes of sponsoring companies. Until fairly recently buyout transactions were viewed by many as a withdrawal of support for company pension schemes and therefore somewhat negative. This is no longer the case, with many seeing buyout, as a positive response to changing circumstances.
In a very small number of cases, we have seen a positive movement in share price in response to a buyout or similar corporate transaction. For others, the recognition may take longer to materialise, assuming the solution adopted is the right one, of course. Once buyout deals are linked to positive market movements, interest in de-risking pension schemes will increase.


BOURNE: Insurers are now increasingly being asked to insure non-traditional risks, such as providing insurance against beneficiaries missing from the data held, GMP equalisation risks and other data and benefit contingencies. Is insuring such additional risks likely to become a standard feature of buyouts in the future?

WOOD: Almost certainly. We have seen a strong demand for these additional protections and although some of our competitors are currently declining to underwrite these risks, the approach taken by Paternoster on Emap and other transactions is likely to drive the market to move quickly in this direction.

EVANS: There has recently been a notable shift towards requests for products such as the non-insured buyout or variations of this type of product. The aim of developing and marketing such products is to offer schemes increased optionality when considering a pension buyout. Therefore, while it would seem very likely that insuring additional risks will increase in the future, it should not become a standard feature and take away the choice from the scheme.
Generally, it will be beneficial for the scheme to cleanse its data prior to the transfer because for any unquantifiable risks passed to the insurer additional reserves will need to be held meaning the company will pay a risk premium to insure their liabilities. However, there will be some circumstances, e.g. mergers and acquisitions where it is necessary for the company to have a clean price for the removal of all liabilities without having time to fully cleanse the data.
It should be noted that bulk annuity quotations have included unknown and unquantifiable risks for as long as the market has existed. The new market for non-traditional risks is therefore simply an extension of the traditional market.
At Legal & General we understand different companies/trustees have different objectives and different reasons for considering a buyout and as such we aim to be able to tailor our products to meet their specific requirements.

READ: This is a new market development and we await with interest the reactions of the various regulators, i.e. FSA (for insurers) and TPR (for trustees). For trustees, perhaps the main issue is to address the reasons behind these requests and continue to work with advisers to eliminate as many of these risks as possible before buyout.
Insurers for their part are only considering the “known unknowns”, and defining them appropriately within their contracts. There is also the issues of “unknown unknowns”. By this I mean insurers will be concerned about what may surface in the future that are not known at the time of buy out. In summary, I believe the best solution is for all parties to continue to work together.

REED: Buyouts are designed to secure benefits and add certainty to the cost of running the scheme. Prudential is keen to ensure such agreements are in the best interests of all parties and defining the scope of the benefits covered is fundamental in achieving this.
With any insurance based agreement, the more unknown factors there are, the greater the potential risk to the acquirer and consequently the higher the associated costs for taking on those risks. Trustees may achieve a more attractive price with good quality data and quantifiable risks.
While pension schemes may wish to cover additional risks, we believe the viability and economic rationale of any provider willing to cover these at very low cost should be questioned. Insurers, like all businesses, need to be confident in the quality of the data and may insist a specialist third party completes a data audit/cleanse exercise.

SNOWDON: As I mentioned above, brokered buyout deals follow patterns of behaviour, so when a deal is struck in which data risk is transferred, then others will do so too. There is a cost attached to data and missing beneficiary risks, and at the moment this is being covered on a loss-leading basis to win business with little thought given to the risks transferring, but it is an attractive and relatively simple extension to buyout.
I have been warning trustees of this for years and advising that actions ought to be taken to understand this risk inherent in schemes. The emergence of hungry insurers with a fresh view of risks has offered an opportunity to trustees to transfer the problem to someone else. And why not? Will this trend continue? It certainly will for the foreseeable future.
GMP equalisation risk is the bete noire of the pensions industry and being able to insure against this possibility in future can certainly help with the winding up process. Trustees should also look at other ways they can be (and possibly already are) protected against most of these risks – either through the trust itself or via trustee indemnity insurance, although care must be taken to understand what is covered and what is not.


BOURNE: Buyouts are often thought of as being long processes. Is this fair in the current market? How have you responded to the desire from pension schemes and their sponsors for the process to be quicker and more streamlined?

WOOD: Typically, trustees and sponsoring companies investigate the cost of buyout in order to decide whether to embark on a six to nine month project (from initial interest to transfer of assets). Clearly, as we have seen, markets can move significantly during this timeframe and schemes can move into surplus and deficit.
Regardless, trustees/sponsoring companies should not wait for ideal market conditions to start work on the issues associated with a buyout, but should prepare fully and then be ready to buyout when the market conditions are favourable. Typically, a time consuming element which can cause significant delay is ensuring the cleanliness of scheme data.
The time it will take to wind-up a scheme depends on its size and complexity and the circumstances of the wind-up. In some cases a wind-up can be concluded within nine months, although it is not uncommon for the process to take up to two years and sometimes longer.
Don’t accept delays: the buyout of a pension scheme does not need to take years – it can be achieved within months.

EVANS: Traditionally the pension buyout process is lengthy. A key reason for this is that delays may occur at the initial quotation stage, where insurers might make different assumptions if the data and benefits are uncertain or unclear. This can make comparisons very difficult and further quotations necessary.
There are key elements of the buyout process that may be improved by the trustees and their advisers, for example, ensuring that the quotation request is clear and unambiguous, data is fully cleansed and by ensuring that GMPs are in the process of being reconciled with NISPI etc.
The buyout process may be accelerated by deciding the insurer for a buyout by use of internet auctions. However, as yet, auctions do not seem to fully factor in considerations such as financial strength, brand, administrative capabilities or experience.
Transferring members’ liabilities is a complex and intricate process which needs to be completed diligently and rigorously to ensure the members are not disadvantaged now or in the future, and so realistic timescales should be applied accordingly. Because of this, on occasions, the process is necessarily lengthy.

READ: The diversity of pension schemes is huge and it will never be a case of “one-size fits all”. A scheme with liabilities of £500m looking to buyout requires a vastly different approach from a scheme of £50m.
For smaller schemes, developments such as online auctions assist where price tends to be the key driver. The process is more transparent and there is less ambiguity in the data leading to a more efficient process overall. Investment in technology is also key and AEGON Trustee Solutions continues to do this to a very significant level as well as supporting the auction process for the right type of scheme
For schemes at the larger end, trustees and employers are more concerned about setting out a roadmap to achieve full buyout over a number of years into the future and thereby bringing in a degree of structure.
This is the case with the joint venture between UBS and Aegon Trustee Solutions which brings together for the first time asset management expertise and insurance company annuity expertise including guaranteeing a pricing basis for years ahead.

REED: It is fair to say buyouts require a very detailed approach, due to the size and nature of transferring such liabilities. Discussions involve various parties with different viewpoints and trustees/sponsors rightly seek independent advice. Typically, buyout discussions have taken a long time. This is unlikely to change, as ensuring the successful transfer of liabilities and long-tetm security of members’ benefits cannot be rushed.
Developments such as the introduction of online auctions have not removed the need for a detailed end-to-end process. Instead, auctions have placed greater emphasis on price, in a market where other factors (such as financial strength, track record, servicing capability and a trusted brand) are equally important.
Due diligence is essential to the decision making process, but can take time.

SNOWDON: Buyouts need not take a long time, but for many companies and employers, it is totally new ground and they have to take professional advice, get to grips with the process, the issues and the options available.
Lucida has invested in building holistic solutions and is able to take on the entirety of scheme risks within a matter of weeks of striking a deal and, because of our deep pensions operational experience, to complete a scheme wind-up in less than a year.
Without this expertise, the process could take years.