say 50 years, or for the
remaining lifetime of the
lives covered.”
To date all completed cases involve significant sums, and it is realistic to expect that this will continue for the foreseeable future. A realistic minimum for such a transaction would typically be £300 million. This is primarily driven by the requirement to complete a scheme mortality investigation and have statistical confidence in the conclusions drawn from such an investigation, and the significant impact of fixed expenses in such an arrangement.
Issues for scheme trustees to consider in longevity insurance would be: • The scheme’s counterparty exposure to the third party. This is mitigated to a
significant extent by the collateral arrangements.
• Whether to go for a swap related to the actual scheme mortality, or a population index.
• Whether the swap covers the expected future lifetime of the lives, or for a limited duration.
• Whether to contract with an insurer or an investment bank. Note that a contract with an insurer is covered by the Financial Services Compensation Scheme. • If longevity insurance is initially taken out, whether on subsequent Buyout or
Buy-in this can be transferred to the eventual insurer. It is not typical for such a contract to have a novation to a third party clause inserted as both parties would need to be comfortable with the new party and the counterparty risk to that new party. Clearly if the subsequent Buy-in or Buyout was arranged with the same counterparty as the longevity insurance this would seem to provide the best chance for such a novation to succeed.
• The operational aspects of agreeing and reconciling the regular instalments need to be considered as well as the requirement to calculate and meet any collateral payments/receipts.
13. Liability Management
• Managing a scheme’s liabilities ahead of a Buy-in or Buyout can reduce the overall settlement costs through reducing or simplifying the liabilities to be insured.
• There are different ways in which liabilities can be managed for active, deferred and pensioner members of a scheme.
• The Pensions Regulator has recently issued guidance on inducement exercises and schemes considering liability management solutions should refer to this guidance.
There are steps that can be taken to manage the scheme liabilities ahead of an eventual Buy-in or Buyout, which help reduce the overall settlement cost. Liability management in a defined benefit pension scheme is any action which helps control or reduce future benefit payments, and hence scheme liabilities. In the same way that a scheme has active, deferred and pensioner members, there are liability management solutions relating to each category of member. The Pensions Regulator has recently issued guidance on inducement exercises and schemes considering liability management solutions should refer to this guidance. The guidance starts from the premise that trustees should start from the presumption that such exercises and transfers are not in most members’ interests, and they should therefore approach any exercise cautiously and actively. The regulator’s principles for doing so are summarised below for ease of reference:
Principle 1 – Clear, fair and not misleading. An offer should be made a way that is clear, fair and not misleading, tailored to the needs of its audience, to enable members to understand the risks and make decisions that are right for them.
Principle 2 – Open and transparent. The offer should be open and transparent so that all parties involved in the process are made aware of the reasons for the exercise and the interests of the other parties. There should be no undue pressure on individuals to accept an offer and reasonable time should be given to make an informed decision.
Principle 3 – Manage conflicts of interest. Conflicts of interest should be identified and appropriately managed in a transparent manner, and where necessary removed.
Principle 4 – Trustee consultation. Trustees should be consulted and engaged from the start of the process, with any concerns addressed before progressing. Trustees should ensure the offer is consistent with tPR guidelines.
Principle 5 – Independent financial advice. Fully independent and impartial financial advice should be made accessible to all members and promoted in the strongest possible terms; in almost all circumstances, the structure of the offer should require that members take financial advice. The employer should pay for advice and require members to take advice before making a decision.
http://www.thepensionsregulator.gov.uk/guidance/incentive-exercises.aspx Some of the main types of liability management are set out below.
13.1. Liability management for active members
Closing the scheme to future accrual is the typical liability management for active members. Whilst it is not legally possible to reduce accrued pension benefits, it is possible to turn off future accrual of pension benefits by closing the scheme to future accrual. Active members will need to be offered some other form of pension benefit outside of the scheme, with eligibility to a defined contribution scheme often being the replacement scheme of choice nowadays. Closing to future accrual caps the build up of further defined benefit liabilities, and also ensures the scheme is then in a position to either Buyout or Buy-in those liabilities. Even if a scheme has not closed to future accrual, insurers can quote annuity prices for these liabilities, with a truing up adjustment required at the end of the process to reflect any items such as salary increases which were not included in the quotation data or a longer period of accrual than initially envisaged.
The other main form of liability management for active members is capping the growth of future pensionable pay rises. Many defined benefit schemes offer a pension based on a final salary at retirement or date of leaving, and liability valuations for active members typically anticipate a level of future salary growth on these accrued liabilities. If pensionable salary growth is capped, then this reduces accrued liabilities to the extent that the cap is lower than the level of future salary increases anticipated in the liabilities. If the cap is lower than price inflation, which is possible, then this can lead to larger savings on the accrued liabilities than closing to future accrual.