Early insurer engagement and the de-risking endgame

The arrival of freedom and choice in 2015 served as something of a 'big bang' moment for pension flexibility. While new rules revolutionised the landscape, it could be argued other areas of the pensions process remain in need of significant reform. 

This is particularly the case when it comes to de-risking and the underwriting of liability management exercises (LMEs). LMEs continue to be popular tools for trustees and sponsors as they help to reduce the size and level of risk in their pension schemes, while simultaneously offering members benefit flexibility.

Yet often the process of conducting LMEs is lengthy and complex, and done in conjunction with buyout timeframes and pressures. 

The norm is for these exercises to be undertaken in the run up to a bulk annuity transaction, to provide insurers with a clean and more insurer-friendly data set that can help attract better pricing and competition from bidding insurers.

However, the inherent problem with this process is the time taken to run it, and a large possibility that trustees could find themselves missing out on potentially favourable market conditions. Indeed, the time taken to conduct an LME could, while making the scheme more attractive to insurers, be self-defeating if it means missing the real target of an affordable buyout - e.g. if liabilities fall by 5% but market conditions increase premiums by 10%, a pricing opportunity has passed the scheme by.

It doesn't have to be this way; disruption to the pensions landscape is on the rise and many schemes are looking to move to buyout earlier by working more closely with insurers to underwrite take-up rates for LMEs as part of a wider transaction. As an insurer, why not underwrite LME take up rates and allow them to be run concurrently with transacting a bulk annuity?

Why do it this way... 

When you can do it this way:

It is an approach we believe has begun to gain traction in recent months for a number of reasons, namely that it has the added benefit of giving certainty to trustees and sponsors at the point of transaction, whilst take-up risk is passed on to insurers at no extra cost. There will of course be potential winners and losers in this and, while not for all schemes, this could be the difference between a bulk annuity deal and no deal. 

By partnering with an insurer, there are benefits for:

However, there are several considerations that trustees and sponsors must think about before undertaking LMEs with insurers as well. 

What take up rates can be expected?

Aviva research suggests that typical rates for Enhanced Transfer Value/Flexible Retirement Options are around 15%, while Pension Increase Exchanges are roughly double that amount (see chart 1). 

Chart 1: Typical Take Up Rates 

Of course, actual take up rates will depend on scheme-specific factors such as the level of the LME offering, quality of communications and the experience of the adviser.

How are sponsors incentivised?

Given the fact the exercise is underwritten by the insurer, sponsors need to remain incentivised via contractual obligations to ensure member communications are effective and successful. 

Manage reputational risk?

Reputation can be managed via the insurer if it has adequate input into the offer being tabled as well as input into the communication with members. At Aviva for example, we require a commitment from parties that the exercise complies with the 2012 Code of Good Practice on Incentive Exercises.  

Buyout costing?

The insurer needs to think about the assumptions underlying the buyout cost for members who decline the offer, whilst also considering the difference between the scheme transfer value basis and its own buyout pricing basis. This is particularly important as transfer values may look more attractive to single members rather than married members and could skew take-up rates.

Having seen the real benefits that underwriting LMEs can have, we at Aviva now regard them as a fundamental part of our de-risking solutions for defined benefit pension schemes. And with pension freedoms having kick-started the process of insurers working more closely with trustees at various stages of the buy-out process, there is no reason why the next stage of pensions evolution shouldn't focus on trustees approaching de-risking in a more holistic and transparent way with an insurer partner. 

Such a partnership could not only provide specific assurances to trustees, but we believe would lead to a better organised de-risking process that is, crucially, able to provide much needed cost-certainty. 

By Amrit McLean, sales and proposition director, Defined Benefit Solutions, Aviva

Glossary: