‘All-risks’ buyouts

Ian Aley discusses the growth in pension scheme ‘all-risks’ buyouts that extend beyond mortality and investment risk to cover incorrect data and benefits errors

There has recently been an increase in the popularity of pension scheme buyout transactions where an ‘all-risks’ approach is adopted. Here, in addition to the usual risks taken on under a buyout, namely mortality and investment risk, the insurer also covers further risks, such as incorrect data and errors in the benefit specification.

The all-risks structure enables ‘unknown’ as well as ‘known’ liabilities to be transferred to an insurer thus minimising the risk of future costs in connection with the scheme. As expected, with greater cover, there is greater cost, the amount varying considerably depending on the quality of the scheme’s data and governance processes yet for many schemes this premium is worth paying.

The two main drivers for transacting on an all-risks basis are a desire for certainty over future costs, or to complete the buyout and wind-up in a short timeframe.

The all-risks approach achieves these objectives by avoiding the lengthy post transaction data verification and premium adjustment process that is typical of the traditional buyout.
Examples of the risks that might be included in an all risks transaction are data errors, missing beneficiaries, legislative changes, reconciliation of guaranteed minimum pensions, GMP equalisation, and wind up costs.

The level of due diligence that the insurer will undertake will be similar to that undertaken in an M&A transaction. Reviews of the scheme data, administration and scheme governance processes will occur prior to completing the transaction and the trustees will be expected to provide the insurer with access to all the scheme records and documentation.

The premium charged will reflect the quality and accuracy of the data and processes. In a few, albeit rare instances, scheme records have been deemed of an unacceptable standard and insurers have declined to provide a quotation.

There are two models for transferring these risks to the insurer, which provide slightly different outcomes. The first transaction of this type was completed some years ago by the EMAP pension schemes. This was achieved by the insurance company securing the liabilities of the schemes via a bulk transfer process whilst simultaneously becoming the schemes’ sponsoring employer. Prior to the transfer, EMAP topped up the schemes’ funding levels to the buyout cost, including a premium to reflect the all-risks nature of the transfer. On completion, EMAP had fulfilled their obligations to the scheme and the insurer took on responsibility for wind-up and meeting all risks including data changes, wind-up expenses and communications costs. In this case, achieving a ‘clean-break’ in the quickest possible time was the key priority to enable M&A activity to take place.

Whilst this approach provides for a comprehensive and rapid removal of all of the financial risks, the structure of the transaction was particularly complex and there are a number of barriers which need to be overcome.

Recently transactions have completed all-risks transfers by specifically covering certain risks within the buyout policy.

An example of this is the recent transaction completed by the Merchant Navy Officers Pension Fund (MNOPF).

In this instance the buyout policy was structured so that the insurer is liable to cover risks such as data changes and missing members, but the responsibility for winding-up (including expenses) lies with the trustees and employer.

As with many schemes in this situation the need for the all-risks cover was driven by a desire to minimise the possibility of future funding contributions being required once the original buyin had transacted. This all-risk buyout solution is a more straightforward approach than the bulk transfer example above.

So is the additional premium associated with an all-risks buyout worth paying? The trustees will need to consider the particular circumstances of their scheme and the risks they may face over the period before winding-up before entering into a contract.

However, it is certainly an issue that is worthy of consideration when approaching a scheme buyout and is likely to be appropriate for a number of schemes.

Ian Aley is head of pension risk solutions at Towers Watson

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