Corporates must engage early with trustees on risk transfer options
14 Jun 2022
As DB schemes move closer to buy-out, it is important to understand the dynamics between sponsors and trustees, and how these play out in various situations.
Until recently, most DB corporate sponsors could only dream of using insurance buy-in solutions, let alone achieving full buy-out.
That has changed as improved funding levels and significant improvements in insurer and reinsurer pricing in recent years has put more pension schemes on the fast track to buy-ins and ultimate buy-out. Funding levels of many schemes are ahead of plan following favourable investment conditions over the last three years, with higher gilt yields further improving funding positions for many schemes.
At our Optimising your DB endgame strategy webinar on 12 May, we heard from James Mullins, head of our risk transfer solutions team, who told us buy-ins are increasingly being used as a tool for de-risking pension schemes and as a steppingstone towards their endgame, it also reflects the pricing available in the insurer market at the moment.
This means schemes can move from holding broadly matching assets to a buy-in, providing interest, inflation and longevity matching at an attractive price.
Schemes are closer to buy-in and buy-out
Our analysis shows that 45% of the FTSE 100 companies that sponsor DB pension schemes have now completed a risk transfer transaction. Last year, over £10bn of buy-ins were repeat transactions for pension schemes that came back for a second or third transaction.
And we expect to see a lot more activity over the next five years – not just pensioner buy-ins, but schemes being able to afford to fully insure and then move to buy-out.
This combined with more choice from newer risk transfer options such as emerging superfunds and capital-backed solutions means it is important to really understand the dynamics between company sponsors and trustees, and how those play out in various situations.
The good news is there is a lot of common interest between trustees and sponsoring employers, both in terms of wanting to use risk transfer solutions and how to go about it.
In many situations, there is a joint working party between the trustee and the sponsor. This enables the sponsor to have a seat at the table, influence discussions and work together with the trustee collaboratively and positively for the benefit of the members and sponsor.
Buy-in transactions are a great way to start getting governance in place, for example by using the joint working party approach. This will then stand the sponsor and trustees in good stead as they get nearer to their endgame, when a whole range of decisions need to be made.
Buy-outs come with other issues, for example, because it has seemed like a distant prospect, often very little time has been spent on the role of trustees and the company, in terms of respective powers and responsibilities in a buy-out situation.
At our webinar, James highlighted the importance of understanding these powers and recommended that corporates look at them. For example, corporates should check who has the power to enforce the termination of the scheme and the move from buy-in to buy-out. If the trustees have the power, this could cause challenges for corporates especially if there is a different end-game vision.
For many companies, once their scheme gets to full buy-out funding, they will want to buy-out so that the pension scheme is fully off the corporate balance sheet. However, it is worth remembering that trustees may take a different view in some cases. They could argue that if they can fully insure the scheme via a series or a single buy-in transaction, then they might as well sit tight and run the scheme on with insurance in place, but also the financial backing of the sponsor.
Reaching an optimal end-game strategy
From our experience, the benefits of sponsors engaging early with trustees are enormous.
There is strong economic evidence that companies engaging with their trustees at an early stage on the end-game strategy is critically important to achieving an optimal strategy.
Taking this action is not about corporates trying to take control of that process or thinking the trustees will not approach it in the right way. Instead, if the company and trustees come together at an early stage, both bring their ideas to the table, using all their resources and with their advisors working closely together, this will result in the best possible end-game strategy for all parties.