The challenges for small pension funds to buy out their liabilities are well-known. A solution has emerged and is set to become popular across the DB universe, writes Stephanie Baxter
A major innovation is underway in the bulk annuity sector to help small defined benefit (DB) schemes go to market.
Many small schemes find it more challenging to achieve the competitive insurance pricing enjoyed by larger schemes, many of which are taking up a lot of market capacity.
Around three years ago, KPMG started thinking about how to help those schemes save on the costs of buying out liabilities and get competitive quotes from insurers. The answer was ‘group insure' - which groups smaller schemes together and takes them to the market at the same time. To date, it has helped seven small pension funds totalling £90m of liabilities split between pensioners and deferred members to purchase insurance more efficiently, at a lower cost and with more choice than going to the market individually.
The first transaction was finalised in June 2017 through Scottish Widows - a buy-in for two schemes totalling around £35m of liabilities. The second one at the end of 2017 was a £13m buyout for three schemes via Legal & General, and a third emerged at the end of 2018 to buy in the liabilities of two funds with Scottish Widows.
According to KPMG, these schemes have made savings of up to 5% compared to what they would have had going to market individually.
The schemes' liabilities are not consolidated, and each scheme's benefit structure is maintained and gets its own insurance policy. They get more provider interest and greater economies of scale at a time when insurers are unable to give quotes for all of these small schemes. Part of the structure is getting them to go into the market at the same time. KPMG presents the schemes as an overall scheme but it is sectionalised so the insurer just looks at one screen with just three sections. The schemes choose an insurer and then they all transact on the same day.
One of the tranches was for the James McNaughton and Modo Merchants pension schemes, which are sponsored by the Wiggins Teape Group.
Head of pensions Keith Taylor says the group was looking to manage its pension liabilities and take risk off the table. It had already done a £400m pensioner buy-in with Scottish Widows for the Wiggins Teape Pension Scheme, but the other schemes were a lot smaller.
"KPMG said, ‘For a lot of small schemes it's very difficult to go to market and get reasonable terms, because insurers are happy to have a £200m, £300m, £500m buy-in, but when it's around £20m to £30m, they're not very interested," says Taylor. "KPMG then said they were setting up an arrangement to link a lot of smaller schemes together to get economies of scale, and actually get decent prices on the market, because instead of going to market with maybe £20m of potential buying liabilities, it might be £50m or more. So we thought that was a good idea, and the trustees thought it was a good idea. There was a bit of pushback, because the Wiggins Teape Pension Scheme didn't really want to get involved at that stage so we were left with the two other schemes. Group insure can have schemes from different employers, and there is no requirement to be connected or associated. But we're fortunate that we are two schemes still both within the same group, both with the same trustee. So actually, they found it to be a really viable proposition."
Capital Cranfield client director Jacqueline Woods is a professional trustee on one of the schemes involved in the second tranche at the end of 2017.
She adds: "I have a number of small schemes that are getting buyout ready and the employer is keen to buy out - it's just a matter of price. We had done a lot of data cleansing so we were ready to buy out if we could, but we were very aware that as a small scheme with just £4.5m of assets and 29 members, it would be very difficult to have a competitive tender process and we were unlikely to get many insurers interested.
"So we decided to go with KPMG's group insure solution as a joint decision between the trustees and employer. We wanted to be able to see how the first tranche turned out, and then go into the second tranche if it was successful. We had some feedback on the first tranche, which was very successful and so we decided to go ahead with it.
But the journey has not been entirely plain sailing; there have been challenges along the way. One of the issues is these arrangements require a very thorough approach in the screening process, and schemes have to be committed.
As KPMG senior manager for pensions James Staveley-Wadham says: "We can't just take any schemes willy nilly to market; they have to be pretty much ready to go. We can't take speculative schemes to the market. So we have to be really thorough in the screening process. That's why it does take a bit of time, because we have to be really sure that these schemes are committed, because the worst thing I could do is take 16 to the market, and five aren't really interested.
"Every scheme has to have a feasibility process - it's really at that point, that we say, 'you can't go because there are data issues', or 'we've got data issues, and we need to factor that in'. Because insurers now really won't quote if there are any concerns the transactions are not going to happen."
Insurers have become much better at screening over the past couple of years, and which is why it took KPMG a while to get the first couple of deals away.
"We've had to be very clear with a client if they're not ready to go. The mantra insurers share with us is 'win fast, lose fast' - they just want to know if the scheme is ready to go, and if so they'll give it a quote. If the quote's good, the scheme will transact, if it's no good, we'll move on to something else."
For example, in the second transaction, KPMG ended up taking four schemes to the market out of a universe of 10; it couldn't take the six for numerous reasons, data being one.
Fees and value for money were top considerations, says Woods: "While buying in and buying out isn't new, by being part of a larger group, as trustees we were concerned there were no cross subsidies for fees. Although you all get grouped together, all your fees are your own fees.
"Also, as a small scheme bringing in a large consultancy firm, we wanted to ensure we got value for money. Fees were something that we had to consider very carefully, but there was always clarity on the fees that we got from KPMG - there were no surprises."
What range of scheme size does this solution work well for?
"Smaller schemes probably mean different things to different people but it could be up to £100m. Typically, our schemes have been smaller but as we're seeing bigger pension schemes, they are really taking up all the capacity in the market. So I think over time we will see standard group insure schemes increase to bigger sizes. So we've got a structure now, and proof of concept that it's working," says Staveley-Wadham.
In the latest development, KPMG is collaborating with Mobius Life's institutional DB platform to make the process more efficient by providing asset transfer services to ensure the scheme assets are buyout-ready. It will reduce the risk of insurer pricing and the scheme's assets moving in different ways, along with reducing insurer hedging costs, due to shorter timescales in passing the scheme's assets to the insurer.
Staveley-Wadham says: "This is all about aggregation and using economies of scale, because for more and more schemes, the idea of a bespoke process just isn't sufficient anymore. We're taking the standard process that works really well, grouping schemes together, and now taking the asset piece just to make it more efficient. And getting the clients ultimately right around getting the sort of bigger scheme process, but at a much lower cost, and giving them more access to the market."
Mobius Life and KPMG's group insure business will collaborate when it is in the best interests of schemes to achieve buyout. The arrangement is not exclusive, and both firms will work with other providers and advisers to support their clients.
Mobius Life institutional distribution director Craig Brown explains: "Because we have £15bn assets on the platform and we're an aggregator, we get better fees but also better choice. So if smaller clients are in there for six weeks waiting to do the trades sitting in the platform, we can very easily put them into matching assets, whatever that might be; it could be putting them into an annuity-ready fund etc. To do that on their own, they wouldn't get a quote from an insurer and even if they did get one it wouldn't be good value, and it'd be very difficult to implement."
This solution is probably one of the biggest innovations in the bulk annuity market and is likely to become more widespread as an increasing number of schemes seek buy-in or buyout.
Aviva Life & Pensions has concluded an £875m buy-in with its own staff pension scheme, following on from a similar transaction last year.
Nearly every trustee is confident of the next stage in their scheme’s strategy, despite almost an equal number being forced to consider replacing plans within the prior 12 months, according to research by Barnett Waddingham.
Companies could be overstating their pension liabilities by up to £60bn due to their life expectancy assumptions, according to XPS Pensions Group.
Just Group has completed a £74m pensioner buy-in with the UK pension scheme of a US-listed engineering business.
Defined benefit (DB) schemes that provide GMPs must revisit and, where necessary, top-up historic cash equivalent transfer values (CETVs) that have been calculated on an unequal basis, a landmark court judgment said last week.