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A buy-in is a bulk annuity policy that is held by the Trustee. This can either be held for the long term or simply just for the period of time before moving to buy-out.
A buy-in will always precede a buy-out. This is because the first step in buying-out will always be a bulk annuity policy with the Trustee (the buy-in policy) before the insurer issues individual policies for beneficiaries which achieves the buy-out.
The initial amount which the Trustee will pay to the insurer to go on-risk. Subject to adjustment as part of the data cleanse.
A buy-out refers to the process where the insurer steps into the shoes of the Trustee and issues individual policies to scheme members. The members’ benefits are then provided directly by the insurer. The Trustee is discharged from liability in respect of those benefits it has bought out. If all benefits are bought out, the scheme usually winds up.
A buy-in precedes a buy-out. A buy-in that is intended to move to buy-out is often called a buy-out.
Collateral refers to a pool of assets held as security in return for an insurer’s obligations under the insurance policy. If the insurer goes insolvent, or if certain triggers occur, the Trustee can have recourse to those assets. If a transaction is collateralised, this means that there is collateral being held. The collateral is usually held by a separate custodian. There is no obligation to have collateral.
The insurer will only insure the benefits and risks the Trustee asks them to, and what they insure is the coverage. Therefore, anything outside the scope of the coverage described in the contract or the benefit specification will not be insured and the Trustee will have to pay out of its own pocket for this. Whether or not a certain risk (for example GMP equalisation) is covered will be a matter of negotiation and may be subject to the payment of an additional premium.
This is a process where the administrator will cross-check and verify certain data they hold for the members of the scheme (usually referred to as the Initial Data) for the purposes of the buy-in. For example, this may involve checking members are still alive; whether their date of birth is correct; and whether their sex is correct.
This is often referred to as verification. The data cleanse will likely be followed by a Balancing Premium also known as a Premium Adjustment. This can be a complex and lengthy process and can be carried out in advance of a de-risking project, or after the transaction has been entered into and before buy-out. The aim is to make sure the data is as accurate and complete as possible.
Some longevity swaps are structured this way.
The insurer acts as a pass-through or go-between as far as possible and the Trustee contracts with the reinsurer as much as possible.
Also referred to as a pass-through structure.
The Financial Conduct Authority.
This is the member data post-data cleanse/verification (i.e the data has been checked, errors corrected) and the insurer and the Trustee have agreed that this is the final data. There is often a balancing premium to pay once the final data has been agreed.
This is the Financial Services Compensation Scheme, which is a body which compensates holders of insurance policies subject to certain conditions and limits if the insurer goes insolvent.
Some longevity swaps are structured this way. The Trustee enters into an insurance policy just with the insurer and has no visibility over the insurer’s own hedging arrangements.
This relates to the insurer’s matching adjustment requirements. If an insurer wants to place the assets held under the Trustee’s bulk annuity policy into its matching adjustment portfolio, the policy has to comply with certain terms.
If a term or payment (for example, payment on termination of the policy) does not comply with the matching adjustment requirements, the insurer may request this be covered by a separate policy so as to avoid invalidating the whole contract from qualifying for matching adjustment. This excess or additional insurance will be put into a gap policy, that is just a separate insurance policy, that is not eligible for matching adjustment.
This is the spreadsheet, or other file, containing the key data for payment of members’ benefits (i.e. names, NI numbers, dates of birth, pension in payment). This is normally provided right at the start of the transaction, and then once the documents are signed the verification/data cleanse period begins. The initial premium (i.e. the price the Trustee pays at the start of the transaction) is based on the Initial Data.
The period under the contract before the Finalised Data File is confirmed.
Invitation to quote or request for proposal: This is essentially a tender which goes out at the start of the process to insurers who will return their price on the basis of that document. It is usually accompanied by the benefit specification.
How long members live.
An insurance policy similar to a buy-in but the only risk the insurance policy covers is longevity. It covers members living longer than expected. The survival of dependants is usually covered as well.
How much capital an insurer has to hold is determined in part by the value of its liabilities. Insurers value the present value of their liabilities using a discount rate.
A matching adjustment (MA) is an upward adjustment to the discount rate, which has the effect of reducing the amount of liabilities and has the effect of reducing the insurer’s Solvency II capital requirements.
An insurer can only use matching adjustment where it meets certain conditions and has a matching adjustment portfolio. When an insurer has a matching adjustment portfolio, this means that it sets aside a portfolio of assets to support a known/predictable portion of its liabilities. The return on the assets in the matching adjustment portfolio match the liabilities attributable to that portfolio – i.e. the assets match that proportion of its liabilities, and so the overall risk is reduced and the insurer is able to use matching adjustment to reduce its Solvency II capital requirements.
An insurer may put a bulk annuity contract into a matching adjustment portfolio, which means that the contract needs to comply with the matching adjustment requirements. If a term is non-compliant, it may be put into a gap policy.
This is the absolute minimum level of capital insurers can hold without losing their licence. As described below, Solvency II requires a level of capital high above that minimum.
This is put in place when the Trustee wants to pass scheme (including member) data to the insurer so the insurer can provide a price. This governs the insurer’s use of that data and includes protections for the Trustee.
This is a court-approved regulatory process for an insurer to transfer some or all of its business to another insurer. The process is overseen by the court and the PRA and FCA, and an independent expert is appointed who considers the impact of the transfer on policyholders, including any trustees who hold an insurance policy.
The Prudential Regulation Authority.
At the outset of the transaction, the insurer’s pricing terms may be agreed relative to market conditions. Therefore, over time, the exact amount of the premium moves in line with market conditions or the insurer’s investment strategy. This leads to a risk that the premium moves so much that the Trustee can no longer afford it.
In order to pay the premium, the Trustee will usually set aside cash and assets (i.e. shares, bonds, gilts) to fund the premium.
Under a “Price-Lock Portfolio” the insurer agrees that their premium will be tracked in line with a portfolio of identifiable assets usually gilts but often also including corporate bonds and swaps. If it is entirely made up of gilts then it is called a gilt lock.
This means that the Trustee can make sure the movement in their assets matches the movement in the premium.
Where the Price-Lock Portfolio matches assets held by the Trustee then it is often called an Asset Lock.
The “price lock” is usually agreed at the outset of exclusivity.
The insurer with whom the Trustee transacts may itself insure its liabilities with another insurer, called a reinsurer. The reinsurer will not be involved with the Trustee in the buy-in or buy-out transaction as they do not have the right regulatory permissions to deal with the Trustee directly, but the insurer may have restrictions on its ability to insure certain benefits if it cannot obtain reinsurance in the market.
The Trustee may have more interaction with the reinsurer under a longevity swap depending on the structure.
Risk margin is an amount in addition to the best estimate of liabilities that is designed to represent the additional cost of getting a willing insurer to take over the liabilities. It is calculated in accordance with Solvency II.
Solvency II is an EU directive which regulates how insurers can carry out their business. It imposes Solvency II capital requirements on insurers, so that they can withstand economic and other shocks. The requirements of Solvency II are linked to the amount of an insurer’s liabilities.
Under Solvency II, insurers have to hold sufficient capital to withstand a "1 in 200" shock event – i.e. enough capital so that there is at least a 99.5% chance that they will be able to meet their liabilities over the next 12 months.
Also referred to as the cancellation payment, this is the amount which the Trustee will be paid if the policy terminates (if there are termination rights). The amount often depends on whether the termination was the fault of the Trustee or the insurer, and often has a relationship to BEL.
This forms part of the balancing premium/premium adjustment and represents the difference in the benefits which were paid during the data cleanse from what should have been paid in light of the Finalised Data File.