Frankie Borrell, head of client solutions from Legal & General’s pension risk transfer team, explores how innovation in the pension insurance market is supporting greater choice for trustees.
There are over 5,000 defined benefit (DB) pension schemes in the UK and no two are the same. Despite their unique circumstances, all now need to decide on a safe harbour and to chart a course for getting there. Indeed, The Pension Regulator's 2021 annual funding statement reminds us that, rather than being a nice-to-have, "the Pension Schemes Act 2021, once implemented, will make it a legal requirement for schemes to have a specific long-term strategy designed to deliver an agreed long-term objective".
During that voyage, all trustees have the same primary objective: how do we maximise security and certainty for our members? The great news is that innovation in the de-risking market is opening new routes which better meet pension schemes' individual needs.
For those pension schemes that are targeting a full bulk annuity transaction but aren't yet able to afford it, a deferred premium transaction may be attractive. Similar to buying a house with a mortgage, where the alternative could be saving for years only to realise that affordability has moved away from you, it allows a pension scheme to lock down risk at prices today. The part of the premium that isn't immediately affordable can then be paid in known, manageable instalments.
This approach could work particularly well for a pension scheme that is invested in illiquid assets that will take a number of years to mature, or those with a recovery plan in place with their sponsor that can't be accelerated. A deferred premium buy-in delivers security for members earlier, with greater certainty over the ultimate cost for trustees and their corporate sponsors.
Assured payment policies
Deferred premium solutions won't be right for every pension scheme, with partial insurance solutions providing a possible alternative. One example is an assured payment policy (APP) which offers inflation and investment risk protection, while the pension scheme retains its longevity and other demographic risks. An APP can be thought of as delivering the opposite risk reduction to a longevity insurance transaction.
APPs are accessible - being around 15-20% more affordable than a buy-in for deferred members - and create more certainty regarding the timing and cost through to buyout.
As a pension scheme matures, an APP can be converted into a buy-in. This was seen in practice with the AIB Group UK Pension Scheme, which recently converted to buy-in around 20% of the £250 million APP that they entered in 2019.
Some pension schemes may be aiming for a safer long-term self-sufficiency position than their current funding level can provide, perhaps because of concerns over their sponsor's covenant.
For these pension schemes, insured self-sufficiency (ISS) can offer a substantial buffer of risk capital to protect against adverse experience such as longevity, investment and inflation risk. This is coupled with a holistic cashflow-matched investment strategy.
These support pillars bring an insurer's toolkit to the trustees and allow the pension scheme to in effect run itself like a mini insurance company. ISS will typically be 10-15% more affordable than a bulk annuity but provides a different level of risk protection. The solution covers both pensioners and deferred members and it creates a clear path to buyout where that's the ultimate objective."
Making the right choice
With a growing number of options available, trustees are able to customise their de-risking path to choose the right solution to meet their pension scheme's individual needs.
It's important to understand a pension scheme's current position on the high seas, the safe harbour it wishes to navigate to and what's crucial for it along the way. Engaging both advisers and insurers early is important: often we find people are closer to dry land than they think.