Legal & General’s deferred premium solution enables pension schemes to lock into a buy-in policy then spread the premium payment over a number of years, removing the potential obstacle of significant upfront costs

When pension schemes look at the options available to de-risk, buy-in and buyout policies are usually top of the agenda as they allow complete removal of longevity and investment related risks. However, while securing liabilities with an insurer may be the ideal solution for a pension scheme, the cost involved in funding this option can often make it difficult to achieve.

With over £3 billion of bulk annuity business arranged so far in 2013, the level of demand for de-risking by pension schemes is clearly high. However, the reality of paying the upfront premium has made transactions impractical for many. Legal & General has found a solution to this: pay the premium over a multi-year period. This facility was recently used by the trustees of the Kenwood Pension Scheme and Legal & General expect more pension funds to find this alternative solution attractive and follow suit.

Legal & General entered into a buy-in agreement with the trustees of the Kenwood Pension Scheme in June this year to insure its remaining liabilities, mainly for those members that had yet to retire from the scheme. Under the terms of the agreement, members’ benefits were fully insured straight away yet only part of the premium was paid upfront. The rest of the premium is being paid over a number of years to suit the sponsoring employer, Kenwood Appliances Ltd. This meant that the de-risking could be completed without the barrier of having to fund all of the liability upfront.

Legal & General’s head of bulk annuities Tom Ground says: “We expect that this approach to financing transactions will become increasingly popular as it allows volatility and risk to be removed immediately, while also providing greater certainty over future contribution requirements for companies.”

Ground further explained that: “In order to create such a bespoke solution for a fund, we would work closely with the sponsoring employer, trustees and their advisers to put in place a financing arrangement that all parties are comfortable with. Interest is charged on any deferred premium payments but we would expect the terms to be attractive and to be below the cost of alternative financing such as bank borrowing.”

Despite the Kenwood policy being bespoke, the implementation process took no longer than for a standard buy-in arrangement. So the tailored structure of this solution can be put in place relatively quickly.

“It gives pension schemes the option to act now when market conditions are favourable. Employers are not always in a position to make a significant one-off premium payment. This type of solution is also suitable for schemes that have illiquid asset holdings where they may have sufficient funds but are unable to sell the assets straight away,” Ground explains.

The biggest advantage of allowing flexible payment schedules is that this approach should open the bulk annuities market up further to other schemes that are under-funded but looking to de-risk.

Pushing boundaries in order to meet pension scheme needs is nothing new to Legal & General. The structure put in place for Kenwood follows on from the innovative solution Legal & General introduced last year, where a ‘forward starting’ buy-in policy is put in place covering all benefit payments from a specified future date, which may be over 10 years in some cases. This requires the trustees to continue paying existing pensioners over a fixed period, using contributions from the sponsoring employer or other plan assets to make these pension payments.

The benefit of this approach is that it allows a pension scheme to lock in buy-in terms and market conditions immediately while also removing the ‘tail risk’ associated with increasing longevity. The scheme is required to pay pension benefits for a limited and specified time before the insurer takes over.

As Legal & General creates ground-breaking solutions that help to meet the needs and concerns of pension scheme trustees and employers, it is expected that pension schemes will increasingly look at insurance as part of their risk management strategy with many adopting these alternative funding structures.

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