Innovation and creativity has introduced a more positive tone to the world of scheme buy-ins, buyouts and longevity swaps, reports Graham Buck

Recent months have been marked by significant innovation in the buyout market, such as last month’s deal between Prudential and Centro (formerly West Midlands Integrated Transport Authority), which featured a comparatively rare occurrence – a buyout involving a local authority, which followed a handful of buyout deals already struck in the public sector. Prudential is acquiring £272 million of assets from the £7.7 billion West Midlands Pension Fund, and will protect the fund and its sponsor against volatility in the investment market and unanticipated increases in the life expectancy of the pensioners.

The deal follows other ‘firsts’, such as the pension insurance buyout agreement announced in March between Pension Insurance Corporation (PIC) and the motor components manufacturer DENSO Corporation.

The agreement devised between PIC and the trustees and sponsors of two of the Japanese multinational’s UK pension schemes covers around £200 million of liabilities and covers accrued pensions, allowing scheme members to continue accruing future final salary benefits through insurance provided by PIC.

As the provider notes, the deal marks the first time that pension funds have entered into a buyout accommodating future accruals in a similar way to an open defined benefit scheme, but with added security of the insurance regulatory regime protecting benefits.

“This meant dismantling the current scheme and moving it from a pensions framework to an insurance framework within an insurance contract, after the company secured the necessary tax and regulatory clearance,” says PIC’s co-head of business origination Jay Shah.

“The net result is that DENSO has no further liabilities relating to benefits accrued by members in the past, and thus no further charges or other costs to be incurred.”

Captive solution
Also attracting attention is the debut of Long Acre Life, a new insurer that launched in December with the remit of devising more affordable buy-in and buyout solutions to companies with defined benefit liabilities in excess of £500 million.

The new company, with a manage­ment team headed by former chairman of The Pensions Regulator, David Norgrove, expects to begin transacting business later this year, once approved by the Financial Services Authority. It has announced its aim as delivering the economic benefits of captive insurance traditionally applied to property/casualty insurance to buy-ins and buyouts.

Although the cost of buyout varies from one scheme to another, typically the pricing has been calculated at around 140 per cent of the IAS19 liabilities. Long Acre’s initiative – designed by PensionsFirst, which is also a shareholder in the insurer – is to create a mutual insurance solution owned by schemes, their sponsors and outside investors that will share in the insurance profit that would otherwise be paid to a third party insurer. By adopting the captive model, the aim is to reduce the buyout cost to around 120 per cent.

“The company aims to sign up its first scheme later this year, but we have no set timetable or targets as we recognise it will take time for people to become familiar with the concept,” says Norgrove. “It has, nonetheless, already attracted considerable interest from companies which like the idea of shareholders’ money not going to third parties.”

At the other end of the scale, insurer Partnership has been developing the concept of enhanced de-risking for smaller schemes, typically with up to 200 members and liabilities of less than £30 million and with a sizeable proportion of enhanced annuity candidates. The basis is on underwriting individual lives and its director of corporate partnerships, Will Hale, says that the company is working with leading employee benefit consultants with the aim of concluding its first deals over the next few months.

An active market
All of this innovation takes place against a resurgent market for pension and longevity risk transfer, with £12.4 billion of deals concluded in 2011 after a highly active fourth quarter.

The total, comprised of £5.3 billion in buy-ins/buyouts and £7.1 billion in longevity hedging deals, was the second-best since the risk settlement market hit its stride six years ago and surpassed only in 2008. As Spence & Partners head of employers advisory services Alan Collins notes: “Longevity swaps have been promoted as the new ‘big thing’ for several years, but never appeared to gain that much traction.”

This could reflect the lengthy period often needed to structure deals, with activity from previous years now finally coming to fruition.

Market volume in 2011 was helped by the mega deals that secured approval from The Pensions Regulator, says MetLife Assurance chief executive Wayne Daniel. The first was the £830 million ‘deficit for equity’ swap concluded for food group Uniq in December with Goldman Sach’s insurance arm Rothesay Life. “The deal was a ‘last resort’ measure involving a company in considerable financial difficulty with a sizeable deficit,” says Daniel. It involves 90.2 per cent of the company’s equity being transferred to the scheme, with Rothesay covering liabilities and guaranteeing payments to members “at least equal in value” to compensation levels provided under the Pension Protection Fund.

Even bigger was the £1.1 billion bulk annuity buyout engineered by Legal & General for Turner & Newall’s pension scheme, a decade after asbestos claims forced the building materials manufacturer into administration. “We can expect to see more of these structured transactions being placed within the re/insurance sector instead of with the banks,” adds Daniel.

Two other longevity deals for companies in rather better financial health were a £1 billion agreement for glassmaker Pilkington, also involving L&G plus German reinsurer Hannover Re and a £3 billion swap with Deutsche Bank for trustees of the Rolls-Royce Pension Fund.

“L&G learned a great deal from structuring the Pilkington transaction and it’s likely that they will be able to replicate the model elsewhere and more cheaply,” says JLT Pension Capital Strategies head of buy-out services Tiziana Perrella. “Longevity can now be offered on schemes with liabilities of no more than £50 million, whereas until recently the minimum figure was £200 million.”

She adds that L&G has also demonstrated flexibility in accepting less conventional assets, such as intellectual property rights, as collateral in deals. Among those gaining media attention was that agreed with drinks group Diageo two years ago, under which its pension scheme will own a range of maturing whisky under a 15-year partnership.

“Asset-backed contributions to schemes are becoming more popular, although they can be both complicated and costly to set up – particularly when the asset used as collateral is property.”

Price worth paying
After the more subdued activity in the period after the financial downturn, it seems likely that more employers will look to insurance providers to take over the risk of active schemes.

“I’m loath to suggest that the markets have settled down, but it’s true that insurers are becoming more comfortable with pricing as they come to grips with Solvency II’s requirements and as credit spreads remain stable,” says Aon Hewitt managing principal and head of risk settlement Martin Bird. “The insurance market has learned much since 2007 and relatively ‘plain vanilla’ annuities can usually be executed quite quickly.”

“Buyouts admittedly still appear expensive, but that’s really only the case if the company genuinely can’t afford it,” says Collins. “My advice to those that can is to go ahead so that you can remove the liabilities off the balance sheet.”

Another positive development, for companies seeking to de-risk their defined benefits schemes but deterred by the cost, is the ability to spread the cost over several years. Aviva’s recent introduction of deferred payments has really opened up the buyout market says Xafinity principal consultant Ian Johns.

“Although yields are low, there is nonetheless considerable competition among providers and most are bullish on prospects for writing new business,” he adds. “So they are looking for flexible and innovative solutions to attract new business in.”

These are likely to include more staged buy-ins as the prelude to an eventual buyout, and what Bird dubs the “pick and mix approach” – with the market more amenable to schemes deciding which risks they are willing to retain and those that they prefer to hedge.

Although uncertainty over Solvency II’s impact on pricing, the repercussions of the ECJ’s gender discrimination ruling (which is likely to start affecting annuity rates late this year) and continued volatility in the equity markets all cast a cloud, Bird believes that competition and innovation are set to continue.

“Sponsors and trustees are also talking to the capital markets as well as to insurers and reinsurers,” he reports. “So the overall picture is quite an upbeat one compared to that of 2009 and 2010.”

Written by Graham Buck, a freelance journalist

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