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Perfect Preparation-Engaged Investor

Sep 01 2008

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Careful advance planning is an essential element of guiding your scheme through a buyout, as Christine Senior discovers

Arranging a buyout is a major undertaking for trustees, and as with any complex task, well-ordered preparation can make all the difference between a smooth or a bumpy path through the process.

A first step is to take a detailed look at what the long-term plan is for the scheme. Any scheme which is closed to future accrual is effectively already on the road to buyout, even if it happens at some stage further down the line. Colin Beattie, managing director of Aegon Trustee Solutions, says trustees should take a long view. "It might be 10 or 15 years away," he says. "But if you have an agreed horizon, that is one important aspect, then you can work back from it. The goal here is to ensure liabilities are extinguished properly, minimizing risk."

One way to minimise risk is to buyout parts of the scheme gradually, rather than wait till the whole scheme has wound down. "We encourage clients to think about building a plan, how many stages there should be, agreeing funding towards that plan, and looking at the investment strategy," says Beattie. Then you think about when you are going to do the first stage of buyout and invest appropriately

A SELLERS MARKET

What a difference a year makes. This time last year the buyout market was awash with new providers falling over themselves to pick up business. Trustees were spoiled for choice. Now market conditions have toughened, and insurers are less inclined to quote for buyouts that don't fit their business model.

"It's a sellers' market," says Clive Wellsteed, a partner at Lane Clark & Peacock. "Trustees need to demonstrate to insurance companies why the insurer should quote for their scheme. Therefore it's in the interest of trustees for schemes to be in good shape when they go to the insurer at the outset to ask for a quotation.

That's all the more reason to appoint a specialist adviser to guide you through the process. Most of the big actuarial consultancy firms have specialist buyout arms. How can you get your scheme in the best shape to attract an insurance company? Which insurance companies should you approach? It makes sense to get quotes from a handful whose businesses most closely match the profile of your scheme. Some target larger schemes, some schemes with blue collar workers, some white collar workers and so on.

We find insurers turning down quotation requests now when they used to quote on everything." says David Ellis, a principal at Mercer. "The reason is it's not in their target market any more."

HOW CLEAN IS YOUR DATA?

A big step to make your scheme an attractive proposition is to ensure the member data you hand over to the insurer is in order, to get the quote as accurate as possible. Data is often out of date, or vital information is missing. Spouses' pensions are a particularly tricky area - in many schemes these are only calculated when the member actually dies. This data cleansing process is likely to take a few months to complete, so this in itself puts trustees in a dilemma: do it early before getting quotes and perhaps risk missing a good price or go to the insurer with less price changes because the data has changed.

Also bear in mind that the more information you provide, the more accurate the quote is likely to be. Mortality data is of particular interest. Your members may live longer or shorter lives than the population as a whole, so individual mortality information for your scheme is particularly useful.

Just as some types of liabilities appeal more to insurers, the same is true of investments. Insurers prefer certain types of investments to be handed over as part of the deal. If the buyout covers pensioners, the insurer would prefer you to hand over corporate bonds or gilts. "Insurers will be much keener to quote if the investments are held as they would want to hold them already," says Wellsteed. "The key thing insurers like is inflation and interest rate swaps. That is exactly what insurance companies invest in themselves."

BUY-INS AND BUYOUTS

If you are planning a partial buyout, to cover say pensioners only, this is termed a buy-in rather than a buyout. In this case the bulk annuity from the insurer remains as an asset of the scheme rather than being attributed to individual pensioners, though the income from the annuity remains contingent on pensioners' lives.

This arrangement preserves the relationship between pensioners and the scheme. "If you buy an insurance policy and it's an asset of the scheme, in a sense you're not buying out anything," says David Clinton, a managing director at Lucida. "What the trustees have done is insure the benefits due to be paid to pensioners. The pensioners are still members of that scheme, but the trustees have a partnering arrangement with the insurance policy provider."

A buy-in also provides greater flexibility. If circumstances change in future, say the sponsor goes bankrupt, as an asset of the scheme the annuities could potentially be reassigned to other beneficiaries.

"Unless you have an agreement with the insurer that allows you to reallocate that value to another group of people you may run into problems," says Ellis. "You would want that in writing as part of the legal agreement."

You might also want to assess the strength of the individual insurers. L&G and Prudential have been in the buyout business for years, but others are more recent arrivals with shorter track record. Is that an important consideration to you as a trustee? Once you have narrowed down the possible insurers, consider a more detailed examination of the financial strength of providers, just as you do with your employer's covenant.

Finally, the Pensions Regulator has just brought out an addition to its Trustee Toolkit which guides you through the whole process of preparation for a buyout, from checking whether your trust deeds need updating to considering your funding position, investment strategy and membership data, and setting out a detailed project plan alongside your sponsoring employer.