Aon have worked out that buy-out has limited attraction. It has limited attraction for a pension consultancy that makes its money from actuarial and investment advice, often extended to fiduciary management and it makes little sense to sponsors who pay up to a 20% premium to an insurance company to get them to buy-out a scheme. It leaves trustees redundant and offers members no prospect of discretionary benefits. While a buy-out removes a problem, it looks like a wasted opportunity to members, trustees, sponsors and advisers.
Having marched clients to the top of the hill and given them the prospect of buy-out, is the Grand old Duke of York about to march them down again?
Aon’s answer to that is “ASTRO”, an investment strategy which is an acronym for “active strategy to run on”.
It claims to enable schemes to “target material levels of surplus over time whilst maintaining exceptionally high levels of security for members“.
As we all know, there is no such thing as a free lunch, so “active” readers will be asking what gives. What gives is that 20% premium that schemes don’t need to pay to an insurance company. Assuming all else is equal in terms of asset returns and the unwinding of the actuarial prudence in mortality assumptions, schemes get to keep the 20% of scheme assets which can be paid to members , sponsors and advisers.
For those who follow these things , this is the DIY capital-backed journey plan where “strong/trending strong” sponsors, keep the scheme on their balance sheet and pocket the premium.
Aon say that such an idea is written into the Mansion House reforms but I think this is a stretch. My reading of the deal is that Jeremy Hunt & Co were happy to see a relaxation on the rules surrounding scheme funding (the DB funding code) in exchange for a scheme committing to a long-term growth strategy which benefited the economy. There is a quid per quo here which isn’t quite reflected in Aon’s proposal
Putting it into numbers, our modelling shows that a mature £1 billion scheme that has sufficient money to buyout, could instead invest in the same way as an insurer for the next 20 years and generate around £300 million of surplus
The security offered is that there is only a one in two hundred chance of things going wrong and a 99.5% chance of things going right – which isn’t far off the risk of an insurance company going wrong.
Put this way, why would a pension scheme want to buy-out in any circumstances?
As Aon accept in a question asked at the end of a webcast on ASTRO, ASTRO is unlikely to pass the “fast-track” test laid down by TPR as part of its funding code. It requires too feisty a discount rate.
The answer is of course that this kind of arrangement needs a sponsor with the deep pockets to stand behind the arrangement (“a strong to trending strong covenant”). You also need a scheme of a size where the fixed costs of running the scheme don’t make the scheme unviable (even with a 20% kicker).
Not being an insurance company, Aon can , through Astro, offer the heads the insurer wins , tails the sponsor and member win ( and whatever happens Aon wins) solution ! What is not to like?
What I don’t like is the paucity of ambition. Do occupational scheme trustees aspire to invest like an insurance company in corporate debt and in funding infrastructure. Why not aspire to own real assets and put them to good use? Why not aspire to own companies and ensure that they are managed in a way that is beneficial to society and the planet and that offer the good governance that pension schemes can demand?
Why in short, should there be constraints placed on trustees to invest like an insurer?
As I have recently written, the advantages of being a long-term investor are not about “harvesting an illiquidity premium” , a theoretical construct, but in entering into long term ownership of assets where your capital cam make a difference to the asset itself”. In short, the advantage is in equity ownership over debt.
So I’d like ASTRO a whole lot more if it offered a way to invest that wan’t like an insurance company!
Is there merit in running on?
Undoubtedly there is. There is merit for a scheme in running on, either to guarantee future benefits or to offer future accrual on a non-guaranteed CDC basis. The cost of running on is greatly increased when schemes close (the red box below). The best way of running on is as a scheme open to new accrual (DB or DC)
The second best way of running on, is to lengthen the duration of the scheme to invest in assets with as long a time horizon as possible. This requires a purposeful investment strategy which needs a committed sponsor and trustees who take a long term view on asset ownership.
Most sponsors are not prepared to take this long term view on their own, they want to know there light at the end of that tunnel, whether that light is a buy-out, a superfund or a handover to a second sponsor offering contingent assets in lieu (the capital backed journey plan). The sponsor might even want to hand on to a superfund, if the market for that structure develops.
There is one further stakeholder in the mix, the tax-payer. Through various corporate and personal reliefs, the UK tax-payer has subsidised a funded DB plan over the years to a point whether much of the scheme’s value (surplus) is down to tax-breaks.
It seems reasonable that Government, as agent for the tax-payer, has some influence over the disposition of assets within the scheme. Investing like an insurer means ripping out the gilts base of a scheme and replacing them with corporate debt- that usually means the debt of overseas companies. It also means reducing exposure to growth seeking “real” assets so that a gilts + investment strategy is driven by the increased yield from corporate bonds over gilts without the volatility of investing in equity.
This is a recipe for stability, but not for growth. Britain is stable at the moment to the point of stagnation. Were the Mansion House reforms no more than the chance of pension schemes to behave like insurance companies. As a tax-payer, I want more value for my money than that!
Aon are demonstrating the loss in value to pension stakeholders when schemes transfer to insurers through buy-out. So ASTRO has done some a priori good.
But by asking occupational schemes to behave like insurers, it is asking a sponsor to be an insurer (albeit with the long-stop of the PPF and without the matching adjustment and solvency rules.
To those who want to see pension schemes solve societal problems, this arrangement does no more than an insurance company can do, and probably rather less.
I think ASTRO is a step in the right direction , but a missed opportunity – unless it adopts a more positive approach to the management of a scheme’s asset base.
For more information on Astro, watch the seminar and the corporate blurb here.
An article on Astro has been published in Professional Pensions here