I apologise to all who have been waiting to see Hymans Robertson’s presentation on how to de-risk your DB pension. I am afraid my partner is abroad with the keys to the technical cupboard so you may have to wait till next week -but it will come!
But what is much better is that Linda Jardine, the Hymans consultant who gave the presentation has answered the questions put to her in a most satisfactory fashion. Here are the responses.
The big one!
Q Why should schemes still be aiming for buy-out – the justification for buy-out (the effect of reporting a pension scheme liability on the sponsor’s balance sheet on its future) has disappeared if there are sufficient assets in the scheme to complete a buy-out.
A We may not have captured the essence of this question correctly so if it is helpful for us to follow up further, do let us know. On the working assumption this question was about Buy Out versus Run On we have provided some high-level pros / cons of each approach below as we see them. It is however important to note that the decision between a Buy Out and Run On is very scheme specific and will depend on the schemes funding position, the strength of the sponsor covenant, and the trustees’ risk appetite. Regular review of the scheme’s strategy and market conditions is key to ensure that whatever approach is taken continues to remain appropriate.
| Pros | |
| Buy Out | Run On |
| Risk Transfer – effective you remove the schemes exposure to longevity, investment and other risks. | Surplus – potential for schemes to generate a surplus over time which is then used to enhance member benefits. |
| Clean break – assets and liabilities are transferred to the insurer. | Flexibility – ability to retain control over investment strategy and respond to changing market conditions accordingly. |
| Member security – benefits secured with insurer providing greater security of pension benefits. | Cost – potential more cost effective short term. |
| Cons | |
| Buy Out | Run On |
| Cost – can be expensive as insurers charge a premium to take on the liabilities. | Ongoing risk – schemes continue to bear longevity, investment and other risks which over the long term can be significant. |
| Timing – cost is influenced by market conditions (interest rates / inflation etc). Poor timing = higher cost. | Sponsor Covenant – scheme remains reliant on sponsors financial health. |
| Preparatory work – preparing for a Buy Out can take several years e.g. data cleanse, benefit review etc. | Regulatory burden – continued requirement to meet regulatory requirements which can be complex and time consuming. |
More Technical Questions and answers
Q A related issue – how should schemes provide for residual risks associated with a whole scheme buy-in? Put another way why buy-in rather than buy-out?
A We have responded to this question based on it being about the key considerations for Trustee’s when it comes to residual risk.
Residual risk cover is a key area for the scheme and sponsor to decide on as it insures against the risk that data or benefit specifications provided to the insurer contain errors. There will be steps taken during the Buy In / Out journey to mitigate against these risks e.g., conducting a full benefit review to ensure the benefit specification shared with the insurer is consistent with scheme rules and administration practice.
In addition, residual risk cover adds a further layer of protection and typically comes three different forms:
1) Sponsor indemnity – obtaining sponsor indemnity can be a valuable protection so an important area for consideration early in the project is strength of the company indemnity. Engaging the support of the Covenant Advisor by them conducting a robust review and assessment is key.
2) Trustee indemnity insurance – useful in protecting trustees against personal liability arising from their duties. Typically, the scheme’s legal advisor will support with the activity needed to assess and put in place the most appropriate level of insurance.
3) Residual risk insurance – consideration of an insurer specific product designed to cover residual risk. Typically, the scheme’s risk transfer advisor will be well abreast of insurer products and provide advice on how best to pursue.
Q Given it takes min 1, up to 3 years to complete buy out or whole scheme buy in, what’s the relevance of today’s pricing?
A Today’s insurer pricing is a critical reference point for DB schemes planning for Buy Out. In short, regular monitoring and strategic planning is essential to ensure a scheme takes full advantage of favourable pricing when it is ready to move to full Buy Out.
Insurer pricing today provides a snapshot of the cost to secure the scheme’s liabilities at the current time. This pricing is influenced by various factors, including interest rates, inflation expectations, and the insurer’s view on longevity risk. It is important that schemes regularly review insurer pricing as part of the schemes de-risking strategy as this ensures they remain aware of current market conditions and can make more informed decisions about the timing of a Buy Out.
Furthermore, the pricing of a Buy Out can change significantly over time due to fluctuations in market conditions. Additionally, the scheme’s funding position may improve or deteriorate over time, affecting the affordability of a Buy Out. For these reasons regular monitoring and updating of the scheme’s funding position are essential so that the scheme is best placed to act when pricing is favourable.
Here are the slides , Linda used
Thanks Linda