"…The pessimist complains about the wind;
The optimist expects it to change;
And the realist adjusts the sails."
This poem by William Arthur Ward really struck me because I love the mindset of the author: if there's a roadblock, what are you going to do about it - complain, hope or take action and adapt? This mindset can be applied to practically any challenge and, clichéd as it sounds, even pension scheme investments.
One of the most common concerns I hear from my clients today is that they want to buyout but they are stuck with a sizeable, often unintended, illiquid allocation. This is seen as a ‘roadblock' on their buyout journey - so what can they do about it? Well, the good news is - there are solutions available, you just need to be realistic and adapt to the new circumstances.
Why are we seeing this ‘roadblock' more often in today's markets?
For many schemes buyout is the ultimate step to take to improve the security of members' benefit in the long term, but to do this transaction, schemes will need to have a "transaction ready" investment strategy. This is a portfolio of assets that are aligned with insurer pricing, highly liquid and low risk.
Clearly "illiquid" assets are not by name highly liquid, nor typically low risk.
Following the liquidity crisis in 2022, we've seen the size of pension schemes shrink while their illiquid assets, which are less sensitive to short term yield changes, become a bigger proportion of their overall asset allocation.
This means that many pension schemes are now financially close to affording a buyout transaction, but they are not deemed ‘transaction ready' due to the lack of liquidity in their investment strategy.
So, what are the options?
Insurers are only too aware of this illiquidity issue and as an industry, there is a lot of innovation to find solutions. In recent deals we have already seen a combination of different approaches from pension schemes and insurers demonstrating that a transaction remains possible, even with illiquids.
- Deferred premia - Insurers have become more comfortable offering a deferred premium where there is visibility over the run-off profile of the scheme's illiquid allocation. This is where you can agree to pay the insurer a small portion of the premium at a later date, with interest applied during that deferral period. This then allows the run-off, or orderly sale, of your illiquid assets.
- Financing solutions - As a twist on the deferred premium, some insurers are now offering financing solutions from within their wider group - to help schemes overcome this liquidity issue in the interim period.
- Insurers taking on illiquid assets in specie - For larger schemes in particular, insurers are increasingly taking on or locking pricing to illiquid assets. If the illiquid assets can be passed to insurers with reasonable/low discounts, then this approach could avoid the risk of a scheme being forced to sell these assets at a lower value to enable a transaction. Any approach involving a discount to the value of the asset carries potential regret risk if a transaction does not then proceed.
- Role of the sponsor - Loans from sponsors can allow a pension scheme to afford the insurance premium, while allowing the run-off or orderly sale of the assets. The assets could also be sold to a sponsor, or even to other schemes within the same group.
- Secondary market sales - Specialist brokers can be appointed to find the best market price and buyer for illiquid assets. This takes place on the secondary market where other solutions are not suitable or possible and often comes with a significant discount.
- Waiting (hoping) - You can always wait for your illiquids to run-off naturally before you approach insurers, ensuring that the value of the assets is maintained - but be aware this could take several years to happen, and you may miss out on a good pricing opportunity to secure a transaction.
What's my conclusion?
I'll admit, I'm an optimist at heart. However, as I face challenges, as well as my clients' challenges, it's my head that forces me to be a realist.
So, to be a realist, I will leave you with three key takeaways:
- Take action early. Do not be a pessimist or an optimist - prepare early and adapt. If you're thinking about buyout, I've given you some ideas of the solutions available to deal with your illiquid assets. Make sure you are aware of the options available to you as soon as possible.
- Elevate the importance of investment strategy. If you need to find a solution for your illiquid assets, this should form part of your insurer negotiations. There is a lot at stake for pension schemes where illiquid assets represent 10-20 percent of their total assets, investment solutions need to be at the forefront of negotiations.
- Make sure you have the right advisers. Not only are Aon a leading adviser in the pension risk transfer market, we also have a specialist investment team with a proven track record in finding solutions for illiquid assets. For further information on how we can help, please reach out to your usual Aon representative or contact us on: [email protected].