Pension de-risking: why it pays to de-risk your DB scheme
Phil Goss and Sarah Parkin from our Pensions team featured in Raconteur’s Understanding Pensions Report in the Sunday Times recently. They discussed why it pays to de-risk pension schemes.
The report highlighted that pension liabilities are one of the greatest financial challenges facing companies today. As the majority of DB schemes mature and have a shortfall between their funding and the level of benefits promised, there is growing interest from sponsors seeking to effectively remove or minimise their exposure to risk while improving the security of members’ benefits.
The de-risking market has seen an exponential growth with many solutions to suit schemes of all shape and sizes. One option is to transfer risk to an insurance company through a bulk annuity policy (known as a buy-in or buy-out).
With help from Sarah and Phil, the report highlighted the following areas for any company or scheme considering a buy-in or buy-out.
Considering all of the options
A buy-in or a series of buy-ins will typically precede a buy-out and this can be an important step in the scheme’s journey to fully securing members’ pensions. But as with any transaction, it is vital that schemes consider all options before they conclude on and execute their strategy.
Preparation is paramount
For trustees to be in a position to capitalise on opportunities they must have a clear objective and thorough preparation in place. Insurers are increasingly looking for evidence of well-prepared schemes. Those that have an understanding of the insurers’ investment processes and appear serious about reaching their endgame will attract the best pricing available.
Sponsors and trustees, who have a strategy and plan ahead, will maximise their ability to negotiate favourable terms. And better terms mean better risk reduction.
Data is key. Carrying out a thorough data cleanse to ensure member data and the benefit summary used in the policy are accurate will remove ambiguity for insurers, which could affect the price and place the scheme in a better position to move quickly.
Members may feel apprehensive about change, particularly at the buy-out stage. It is important that schemes communicate the changes to members as soon as feasibly possible and it is often helpful to keep them informed of the overall strategy and objectives for the scheme. Members may incorrectly assume that any change to the pension arrangements is bad news, so companies must clearly explain what the changes entail. This gives members the opportunity to understand more about the process and the benefits for them.
Act now or hold tight?
A question is inevitably raised about whether not now is a good time to de-risk your pension scheme is. Our experience is that the appetite for de-risking has remained buoyant and the ongoing market volatility has created attractive pricing opportunities, particularly for those schemes that are well prepared. As always, counterparty risk and how the sponsoring covenant compares to what will be provided by the insurer requires consideration but the current environment does introduce additional complexities.
What we have seen is schemes that had already made the decision to transact and were well progressed in preparing for a transaction have continued and have been able to capitalise on more competitive pricing. For those schemes that are still at the earlier stages of planning or preparation, our recommendation is to keep going. Being well prepared will pay dividends, even if it is some time down the road.
With the economy continuing though a period of deep uncertainty, there is the potential for further attractive pricing opportunity and well-prepared schemes would be best placed to take advantage of opportunities in such an environment.
How will this change in the future?
Going forward, with the backdrop of the expected increased regulatory framework and the Pension Regulator’s new funding code, de-risking solutions will increasingly form part of pension scheme management and in many cases offering a win-win solution for both scheme sponsors and members.
Keep an eye out for our upcoming de-risking blog series which will look at areas not often discussed when schemes are looking at de-risking.