2014 ANNUAL. From JLT Employee Benefits for the year ended 31 December JLT Employee Benefits

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1 2014 ANNUAL From JLT Employee Benefits for the year ended 31 December 2013 JLT Employee Benefits

2 FOREWORD Mark Wood CEO JLT Employee Benefits Welcome to JLT Employee Benefits first Annual Buyout Market Watch Report, which brings together market commentary, statistics and affordability indices from our quarterly reports with topical articles, case studies and independent industry insights to give you a varied and colourful picture of the UK pension insurance market, both over 2013 and into the future. Our clients face a complex and constantly changing pension landscape. However, we believe that the de-risking momentum we saw build over 2013, together with the early stages of an economic recovery and new market dynamics following the March 2014 budget announcements, will create opportunities this year for wellprepared schemes to take significant risk off their balance sheets. The JLT Buyout Team successfully helped 28 schemes of varying shapes and sizes achieve 30 well-designed de-risking 2 outcomes over 2013, with highlights including an innovative, trigger-based buy-in deal for JLT Group s own defined benefit pension scheme and the first whole of market medically underwritten buy-in for the British Arab Commercial Bank Pension Scheme. We are delighted that both schemes have been shortlisted in the best de-risking strategy category of the 2014 Financial News awards for excellence in pensions. Finally, I d like to express my personal thanks to all our external contributors: independent trustees, pensions lawyers and insurers. Your insights are appreciated and we look forward to working with you and others across the industry to achieve meaningful results for our clients in Mark Wood CEO JLT Employee Benefits Already this year, the innovative work carried out by the JLT Buyout Team has been recognised within the industry and we are delighted to have been shortlisted in the De-risking Provider of the Year category at the 2014 Pension Awards and also at the European Pension Awards for the European Pension Consultancy of the Year award. In addition, we are delighted that two of the deals we recently brokered have been shortlisted in the Best De-risking Strategy category at this year s Financial News Awards. The British Arab Commercial Bank (BACB) 12m first ever whole of market medically underwritten buy-in on a whole of market basis with Partnership The two trades ( 120m and 85m) for the JLT Pension Scheme on a trigger basis with Prudential The other three shortlisted deals all involved over 1bn of liabilities and therefore this recognition is particularly pleasing as it is based entirely on the innovative approach the JLT Buyout employed for our clients.

3 CONTENTS Foreword... 2 Editor s welcome Headlines and highlights... 5 Medically underwritten bulk annuities The future of pension insurance?...6 Case study Medically underwritten bulk annuity... 7 Trigger-based strategies How can they be best applied?...8 Smaller schemes Any hope of a competitive deal? Case study 8m Pensioner buy-in using Buy-inSure...11 Trustee lessons learned Market statistics...14 Current issues and regulations affecting the buyout market...16 JLT Buyout Affordability Index...17 A view from the bench What not to miss Building on the momentum and looking to the future What recent insurer developments mean for the UK bulk annuity market?...21 Market view Insurer round table...22 Is your scheme buyout ready?...24 JLT Buyout Team

4 EDITOR S WELCOME Ruth Ward Senior Consultant JLT Buyout Team The JLT Buyout Team is pleased to present its inaugural Annual Buyout Market Watch Report for the year ended 31 December We hope it equips you with a good understanding of market developments over 2013, as well as providing insights into forward trends over 2014 and beyond. Martyn Phillips, Head of Buyouts, shares his 2013 headlines and highlights opposite. We also feature: 2013 MARKET STATISTICS AND ANALYSIS 2013 saw the second largest annual volume of bulk annuity business written to date, falling just 600m short of 2008 levels, together with the highest annual volume of longevity swap transactions on record. Momentum was carried forward to Q1 2014, with a combined 3.6bn of buyin trades for the ICI Pension Fund and a 5bn longevity swap for the Aviva Staff Pension Scheme announced in March We share details of transaction and quotation volumes, insurer market shares, large bulk annuity and longevity swap transactions and buyout affordability trends, together with commentary by the team (see pp ). EXPERIENCED VIEWS Members of the JLT Buyout Team have advised on a wide range of transaction types, varying in size from below 1m to in excess of 1bn, covering deal structures from conventional bulk purchase annuities to fully bespoke de-risking solutions. Over 2013 we gave particular focus to developing solutions that allow small to medium sized pension schemes to benefit from some of the deal features and advantages that larger schemes typically enjoy: Robert Edge and David Barratt discuss our BuyinSure and whole of market medically underwritten bulk annuity propositions and illustrate how these have worked in practice for two of our clients (see pp. 6-7, 10-11). Conventional wisdom often dictates that a competitive price can only be achieved through a multi-insurer broking process: Tiziana Perrella discusses an alternative trigger-based structure that achieved excellent results for JLT Group s own pension scheme (see pp. 8-9). EXTERNAL PERSPECTIVES JOINING THE DOTS Three independent trustees share their experiences and lessons learned from bulk annuity transactions (see pp ) - ignore at your peril! Meanwhile, pensions lawyers discuss what not to miss on the legal aspects of larger trades (see pp ). Finally, a panel of insurers come together to share their views on developments and innovations for 2014 and beyond, including trustee challenges and future capacity constraints (see pp ). EMERGING TRENDS The latest addition to our team, James Staveley-Wadham, shares his views on where the market is headed over 2014 and beyond (see p. 20). We also comment on recent insurer developments and the impact of the March 2014 budget (see p. 21). Finally, I describe practical steps for getting your scheme buyout ready and well-placed to take advantage of any market opportunities to de-risk (see pp ). We would be happy to answer any questions that this Report provokes - full contact details can be found on pp In the meantime enjoy! 4

5 2013 HEADLINES AND HIGHLIGHTS Martyn Phillips Director and Head of Buyouts JLT Buyout Team 2013 proved to be a strong year for the pension insurance market, with momentum building over the period and continuing into Q Highlights included: Bulk annuities Longevity swaps Total business volume over bn 8.9bn Total number of deals over 2013 c Largest vanilla trade in bn buyout for EMI (written by PIC) 3.2bn longevity swap for BAE Systems (written by L&G) Largest medically underwritten trade in 2013 Insurer developments Other significant events 33m buy-in for an unnamed construction company* (written by Partnership Assurance) L&G acquired Lucida (following its closure to new business in November 2012) Three funds (Blackstone, GIC and MassMutual) acquired a combined 64% stake in Rothesay Life, leaving Goldman Sachs as the largest shareholder First whole of market medically underwritten buy-in (for British Arab Commercial Bank)* - Deutsche Bank / Abbey Life continued to participate in the longevity market - * Advised by the JLT Buyout Team See pp for a full analysis. AND ONTO 2014 Q saw the two largest deals to date (to end March 2014): A 3.0bn buy-in for the ICI Pension Fund with L&G (forming part of their total 3.6bn buy-in). A 5.0bn longevity swap between Aviva Life & Pensions UK Ltd (to cover longevity liabilities relating to the Aviva Staff Pension Scheme) and three reinsurers: Munich Re, Scor and Swiss Re. Bulk annuity deals announced over Q already account for over 3.9bn of liabilities (prior to release of official figures). This represents over 50% of the annual total for 2013 and over 75% of annual volumes for each of the preceding three years. The Chancellor s budget announcements of March 2014 are anticipated to increase insurers appetite and capacity for writing bulk annuity business, as well as potentially encouraging new entrants. It all points to a very big 2014! 5

6 MEDICALLY UNDERWRITTEN BULK ANNUITIES THE FUTURE OF PENSION INSURANCE? David Barratt Senior Consultant JLT Buyout Team Since the first medically underwritten buy-in was completed by Partnership Assurance in late 2012, the appetite for this type of transaction has grown rapidly. Three other insurers are now actively quoting for this type of deal: Just Retirement, Legal & General and Aviva. A medically underwritten buy-in differs from a conventional buy-in in the information insurers use to price the lives covered by the policy. Insurers gather data on members (and spouses ) health and lifestyles in order to make better informed assessments of how long they will live. This allows for more accurate pricing (and potentially lower margins for prudence) than simply relying on each individual s age, sex, postcode, pension size and occupation (if available). During 2013 more than a dozen underwritten buy-ins were written, with insurers reporting a strong pipeline of new deals for 2014 (at the time of writing we believe in excess of 20 underwritten buy-ins have been completed since the first such trade in late 2012). Highlights included the first whole of market underwritten buy-in for British Arab Commercial Bank and the largest underwritten buy-in reported to end March 2014: a 33m transaction for an unnamed construction firm, both advised by JLT. We believe the whole of market broking process that we have developed for completing underwritten buy-in transactions will revolutionise the market and is an important step for schemes looking to de-risk in the most cost effective way. Given that the price adjustments offered by the above insurers will vary for given impairments, trustees will only get the most competitive price by reviewing multiple quotations (similar to other common insurance purchases, e.g. motor or home insurance, where our individual risk profiles mean we can only get the best deal by shopping around ). As all parties become comfortable with the concept of medical underwriting, we expect this type of buy-in to become the norm for small to medium sized schemes, especially in light of MetLife s exit from the market (announced in February 2014), which has limited the options for obtaining non-underwritten quotations for smaller transactions. We expect this type of buy-in to become the norm for small to medium sized schemes Although the majority of transactions to date have been for smaller schemes, and we would expect this trend to continue, larger schemes are also able to benefit from underwriting. Executive schemes with high average liabilities or large schemes insuring solely the highest pensions in payment are prime targets as they represent significant risks and would otherwise be priced ultraconservatively. This is evidenced by the medically underwritten buy-in announced in February 2014 for the Institute of Chartered Accountants Staff Pensions Fund. This deal covered 24m of the highest individual pension liabilities out of total scheme liabilities of 200m. Due to the growth of this market, and with a number of new whole of market deals in progress, an industry working group has been established to develop a good practice guide for stakeholders in this area. The group, which is chaired by JLT Employee Benefits Director, Margaret Snowdon OBE, and includes representatives from four insurers, several employee benefit consultancies, an independent trustee firm and a pension law firm, expects to report in Q Read more about this market development and how it could benefit your scheme in our explanatory leaflet on Medically Underwritten Bulk Annuities and in our latest Let s Talk article, both available from our website (www.jltpcs.com). 6

7 CASE STUDY MEDICALLY UNDERWRITTEN BULK ANNUITY THE CLIENT British Arab Commercial Bank (BACB) is a wholesale bank and a leading provider of trade and project finance for Arab markets. Working closely with the Bank, the trustees of the BACB Pension Scheme have been actively de-risking for several years, insuring risk relating to pensioner members through a series of bulk annuity transactions. THE ISSUES In September 2013, the trustees appointed JLT Employee Benefits (JLT) to advise on a pensioner buy-in for the scheme. Since the previous bulk annuity transaction, new retirements had led to a further circa 13m of uninsured pensioner liabilities building up. The client was aware that there were a number of new retirees with high pensions and high individual liabilities. They were conscious that insurers might price these lives particularly cautiously to reflect the risk of these members (and their spouses) living for longer than expected. However, they were also fairly confident that these high liability individuals would engage in a medical underwriting process and that this would give rise to more accurate prices. They were optimistic that the additional health information obtained would allow insurers to remove some of their margins for prudence, ultimately leading to lower prices. JLT s newly developed whole of market medically underwritten broking process also gave them the opportunity to run a competitive process, with several insurers contesting the business. THE DEAL Three out of four insurers active in the underwritten bulk annuity market agreed to quote for this deal from a single set of underwriting information, with the trade ultimately going ahead with Partnership Assurance in late December This was the first transaction following a broking process in which multiple insurer quotes had been produced based on common underwriting data. The process took less than four months from start to execution of the transaction, including time taken to write to members and collate medical data (including general practitioner reports): considerably quicker than many traditional transactions. The trustees belief that members would engage in the underwriting process was justified, with an impressive 95% liabilityweighted response rate from the members involved. The trustees achieved a very competitive price, which was ultimately below the corresponding scheme funding liabilities and close to the accounting liabilities. They benefited both from more accurate pricing afforded by the additional health information, and from strong competition between the participating insurers. WHAT THE CLIENT SAID With a response rate representing 95% of the pension liabilities, we were able to give the insurers detailed information to accurately price this whole of market buy-in exercise. With JLT Employee Benefits advising us, we were able to achieve a competitive price by selecting Partnership Assurance and we are pleased with how streamlined the process was. The continual de-risking of our pension scheme is an important goal and ensures long-term security for our members. Graham Wardle Chairman of the Trustees, BESTrustees At the time of writing, this transaction has been shortlisted for the Best De-Risking Strategy category of the Financial News Awards 2014 for excellence in pensions. 7

8 TRIGGER-BASED STRATEGIES HOW CAN THEY BE BEST APPLIED? Tiziana Perrella Principal JLT Buyout Team There is no doubt that securing a bulk annuity policy is not all about the price; the quality of the counterparty and the robustness of the contract are very important considerations, particularly where the trustees are concerned. GET ME THE BEST PRICE! Having said that, it would be naive to ignore the fact that price is a fundamental selection criteria, with only a minority of transactions not being completed with the insurer able to provide the cheapest price. As a broker, the (sometimes unspoken) subtext to my conversations with clients is that they expect the best price. Traditional broking processes have therefore tended to focus on the delivery of the cheapest price (and less traditional ones too: online auctions, for example, were quite openly all about the price). Whole of market exercises aim to involve as many insurers as possible, relying on competitive pressure to lead to the cheapest price. I HAVE A QUOTATION. WHAT DO I DO WITH IT? I would argue two things: First of all, a quotation, obtained via whatever process, is relatively useless unless a full assessment has been carried out in advance to ascertain what price would result in a transaction proceeding from the trustees and/or the sponsor s perspective; Secondly, a whole of market exercise may not be the most efficient broking process for all schemes (although we believe it will remain so for schemes towards the smaller end of the market and, in particular, for medically underwritten deals). The first point seems obvious; however it is surprising that many trustees and sponsors are unwilling (or unable) to consider, and sign off in advance if possible, an acceptable price for a transaction to proceed. This leads to uncertainty once the figures have been obtained and delays in the next steps in the exercise, so that favourable windows of opportunity are often missed. Even if a deal does proceed on this basis, the extended process and the lack of clarity mean that the various parties are unsure as to whether the exercise was a success or not. The second point is slightly more subtle. A whole of market exercise is, by necessity, a longer process than where one or two potential counterparties are selected at outset. Finalising the terms and price normally involves conversations at a very high level within the insurance companies. These conversations will only take place once an insurer has either been selected on an exclusive basis, or is on a shortlist. Pre-selecting a partner in advance will ensure that this level of engagement is obtained much more quickly. If the insurer in question is also given a firm price as a trigger, a serious assessment of whether a transaction is feasible can be made very quickly indeed. For larger schemes, an insurer may also be willing to source the right combination of assets to deliver the trigger price, although this may be over a slightly longer period. This will result in an optimal solution which can be easily assessed as such, so that a transaction can then proceed in a straightforward manner, especially if the legal and investment aspects have been dealt with in advance. IS THIS THE END OF WHOLE OF MARKET EXERCISES? As the bulk annuity market becomes more fragmented (underwritten vs. non-underwritten policies; different underwriting approaches within the underwritten model) I expect more and more deals will be written on the basis of not just a trigger price (which can also work for whole of market exercises) but also a targeted counterparty. Whole of market exercises are likely to remain the most suitable option for smaller schemes as, for these, there is merit in obtaining as many quotations as possible. However, following MetLife s exit from the market and given that a number of insurers have minimum size requirements, which may be increased when the market is busy, it is likely that smaller schemes will have to obtain an underwritten quotation if they wish to maximise the interest in their scheme. David Barratt provided further details on this option in his earlier article on medically underwritten bulk annuities (see pp. 6-7). 8

9 WHAT IF THE TRIGGER IS WRONG? Trustees and sponsors may be unwilling to commit to a firm trigger for a transaction if they believe this could result in insurers quoting a higher price than they would quote otherwise. In practice this is extremely unlikely to be the case if the trigger has been agreed with the support of an experienced broker. An experienced broker will have a good understanding of the market pricing available to schemes of various sizes, so that schemes will be able to identify a suitable trigger price and also pre-assess whether this may be achievable given current market conditions. HOW DO YOU MAXIMISE THE CHANCE OF A DEAL? My main recommendations would be as follows: 1. Select a trigger price, and focus on one which is good enough. The price could be chosen relative to the value of the Technical Provisions for the relevant population, the yield on the assets to be used to fund a transaction or any other assessment of the value of the risk being covered. Aiming for the best price, which is an unknown and uncertain target, is unlikely to get the trustees anywhere. 2. If possible, pre-select one or two insurers who have been identified as being the most likely to be able to deliver the trigger price and signed off as suitable counterparties. Nobody can absolutely guarantee that one of the excluded insurers may not have been able to provide equivalent or better terms; however this should not matter if the trigger for a transaction has been hit anyway. 3. Do as much work as you can in preparation - this includes selecting the assets to be used to pay the premium (and even starting the disinvestment process, if this is likely to be complicated), signing off the benefit specification and even agreeing contractual terms in advance. 4. As required (and dictated by market events and insurer developments), re-assess the trigger price if and when shifts in markets dictate a change is necessary to maintain a trigger aligned to market dynamics. HOW CAN IT WORK IN PRACTICE? Over 2013, the JLT Buyout Team pioneered an exciting new buy-in structure to insure over 200m of pensioner liabilities for JLT Group s own pension scheme (as two separate transactions of 120m and 85m) at a very competitive price. The transactions proceeded with a carefully pre-selected counterparty, Prudential. The structure adopted was as follows: 1. Pensioner member data was cleansed and supplemented using tracing services, and divided into multiple tranches by duration. 2. Challenging trigger prices were set up front for each tranche of liabilities. 3. Legal terms were agreed that would apply to all tranches, whether transacted separately or together. 4. An insurance counterparty was preselected to work with. This structure had multiple advantages over a traditional competitive broking process. Up front governance in agreeing triggers and selecting an insurer ensured full engagement from all parties. Sub-divided data allowed more precise duration targeting, and the combination of smaller data tranches and agreed legal terms allowed all parties to move quickly to take advantage of market conditions on two separate occasions. This structure had multiple advantages over a traditional competitive broking process Also, working exclusively with one insurer and committing to transact on a pre-agreed trigger gave that insurer the ability to access higher-yielding assets within its wider portfolio with which to hit the demanding price targets. Mike Reynolds, Group Finance Director, Jardine Lloyd Thompson Group plc, said: We are very pleased with this innovative solution to facilitate buy-in transactions as part of JLT s long term plan to proactively manage its balance sheet. At the time of writing, this transaction has been shortlisted for the Best De-Risking Strategy category of the Financial News Awards 2014 for excellence in pensions. 9

10 SMALLER SCHEMES ANY HOPE OF A COMPETITIVE DEAL? Robert Edge Associate Consultant JLT Buyout Team For smaller schemes, on-going running costs can appear disproportionately high relative to scheme size and the only cost effective longterm solution is a full scheme buyout. However, many have been reluctant to come to market, believing a bulk annuity solution is not possible for them. Robert Edge breaks down the myths. THE MYTHS There is no market for smaller pension schemes looking to de-risk through a bulk annuity purchase. Even if an insurer is willing to provide a quotation, their price will not be competitive. There is little chance of securing enhanced contractual terms for a smaller scheme/transaction. THE REALITY Large transactions tend to grab the headlines, but our market analysis indicates that transactions of below 100m have typically, over the last few years, accounted for over 90% of the total number of deals completed. We are aware of several insurers actively seeking smaller schemes to transact with and, by working with them, we have been able to secure competitive pricing for our clients. The medically underwritten bulk annuity market has developed rapidly since the first deal in late New entrants from the individual annuity market have increased competition at the smaller end of the bulk annuity market, albeit they will usually require some degree of medical underwriting. Enhanced contractual terms can be negotiated even for small (e.g. sub 10m) transactions by those with sufficient purchasing power, e.g. employee benefit consultancies developing propositions of interest to a wide client base or trustees of multiemployer, non-associated pension schemes who may be able to combine bulk annuity trades. Enhanced contractual terms can be negotiated even for small transactions OUR APPROACH JLT has developed Buy-inSure, a robust pensioner buy-in solution for schemes wishing to secure between 5m- 60m of pensioner liabilities on a fixed-fee basis. Buy-inSure is specifically targeted at improving outcomes for small to medium sized pension schemes and has been designed to provide:»» A robust and clearly defined process.»» Enhanced insurer engagement (from a carefully selected panel of insurers, who have committed to our process and timescales).»» Condensed transaction timelines.»» Enhanced contractual terms (via pre-negotiated contracts).»» Optional services including: a pre-packaged, cost effective legal review and opinion, a data cleanse service and on-going monitoring against triggers.»» Medically underwritten terms, where applicable. Although 5m is the minimum pensioner liability that we broke through BuyinSure, JLT successfully secures bulk purchase annuities (including deferred pensioner members, where desired) for pension schemes of less than 5m (including deals involving premiums well below 1m). Over 2013, the JLT Buyout Team secured 12 buy-ins/buyouts of below 5m. For smaller schemes, it is important to note that running costs (per member) can be considerable: almost four times those of large schemes and almost six times more than the very largest schemes according to research published by the Pensions Regulator in April Small schemes considering a full buyout should consider buyout prices in this context. Read more about Buy-inSure in our brochure available from our website (www.jltpcs.com). 10

11 CASE STUDY 8M PENSIONER BUY-IN USING Buy-inSure ABOUT Buy-inSure Buy-inSure has been deigned by JLT Employee Benefits to provide a robust pensioner buy-in solution for schemes wishing to secure between 5m- 60 of pensioner liabilities on a fixed-fee basis. Whilst schemes wishing to make these smaller transactions have historically struggled to obtain the competitive pricing and flexibility offered to the larger end of the market, with Buy-inSure schemes wishing to insure 5m- 60m are assured that they will get full value for money and could be able to transact in as little as two months from going to market. THE CLIENT J. & J. Denholm Limited, part of the Denholm Group, started out as a shipping company, but their business has developed and they now operate in the shipping, logistics, seafoods and oilfield services. Working closely with JLT, the trustees of the Denholm Pension Scheme have been actively de-risking for several years, insuring risk relating to pensioner members through a series of bulk annuity transactions. THE ISSUES In May 2013, the trustees appointed JLT to advise on a pensioner buy-in for the scheme. Since the previous bulk annuity transaction new retirements had led to a further 200k p.a. of uninsured pensions in payment building up. The key objectives were to reduce the scheme s exposure to investment and mortality risks through the purchase of a buy-in policy (with a view to converting this to a full buyout and securing the remaining scheme liabilities as soon as this became affordable). The pensioner population was generally believed to be in good health. THE DEAL JLT undertook a feasibility study, using sample rates provided by a panel of insurers to estimate buy-in costs for the latest tranche of pensioner liabilities. This analysis, delivered in under two weeks, gave the trustees a timely assessment of current market conditions. The feasibility study indicated that the cost of a pensioner buy-in could be within the tolerance of both the trustees and the sponsor. It was therefore determined that JLT should be engaged to complete a full pensioner broking exercise via their BuyinSure proposition. Under Buy-inSure, the trustees were able to obtain buy-in quotations from three insurers. A fourth insurer declined to quote on grounds of transaction size, but this still allowed a competitive exercise with three parties contesting the circa 8m deal. The prices obtained through the broking process were consistent with the initial feasibility results and the trustees were therefore keen to transact in a timely manner. The trustees benefited from our reduced transaction timescales and were able to transact within just six weeks of requesting quotations, compared to a conventional broking process which might take up to six months or, in some cases, even longer. WHAT THE CLIENT SAID JLT Employee Benefits organised a competitive tender using Buy-inSure, resulting in a transaction completing in under six weeks at a good price. With the support of the employer, the trustees have a history of insuring benefits for our pensioners. As such, we believe this transaction to be a very positive step for the scheme and its members. Alistair Wesley Group Pensions Manager, J. & J. Denholm Limited 11

12 TRUSTEE LESSONS LEARNED For most trustees, a bulk annuity transaction represents a significant and possibly unfamiliar event in their scheme lifecycle, often representing the most material long-term decision they will make. Deals can be complex and are usually time sensitive. We caught up with three independent trustees, who have each been involved in several such transactions, and asked them to share their experiences and lessons learned. Rachel Tranter BESTrustees Steve Delo PAN Trustees Michael Chatterton LawDeb Pension Trustees APPROACH WITH CARE Steve reminds us of the gravity and timeliness of a bulk annuity transaction, unlike typical trustee activities, a transaction could take place very quickly, involving many different elements, along with the introduction of new parties (including the selected insurer), with the outcome that some (or all) of the scheme s liabilities are secured. Due to the nature of an annuity contract, it is very difficult to unwind the benefits once they have been secured. Unlike typical trustee activities, a transaction could take place very quickly, involving many different elements, along with the introduction of new parties It is therefore imperative to work with an adviser with significant experience in this area. Michael recommends the appointment of a specialist annuity purchase adviser, with a defined mandate to arrange, provide advice and manage the execution of the transaction. This adviser does not have to be the incumbent adviser. RIGOROUS PREPARATION IS ESSENTIAL Thorough preparation is vital to achieving a successful outcome. Steve cautions if the various elements of the team are not aligned with a common aim and objective, there is a real risk that the process could result in no liabilities being secured, having incurred considerable adviser fees. Rachel undertook two transactions recently, and observes that the process can be quite different depending on who is driving the deal, i.e. the trustees or the sponsor. Typically these deals are driven by the trustees but occasionally the impetus comes from the sponsor. She describes how each party can have their own advisers and require certain levels of advice. Consideration needs to be given to the roles and responsibilities of each adviser, to avoid unnecessary duplication with the resulting increase in costs and delays in the execution process. It is also important to ensure that nothing falls between the two stools! Michael lists some of his key considerations at the planning stage: Agree and document the approach with the sponsor. Appoint a sub-committee with delegated authority to run the process. Develop a project plan, with scheduled meeting dates and an agreed execution path. Confirm the benefits to be secured, including obtaining appropriate legal sign-off of the specification and provision of the inception data. Ideally the quality of the data should mean the post-transaction data cleansing process should be a formality, with only minor changes to the data and price. Agree which liabilities should be secured under the transaction. Sometimes these will be secured in full, sometimes not, e.g. secure all benefits on a non-increasing basis, or certain tranches of the membership only depending on age or liabilities. If benefits are not secured in full, define and document a process with the insurer to agree on what terms and when additional liabilities would be secured. 12

13 Define the provider selection process, which may differ depending on the circumstances, e.g. a scheme approaching the market for the first time would typically expect to approach the whole of the market. A scheme that has already transacted and has a relationship with one insurer may choose to work with them on an exclusive basis for future transactions. In both cases, it s important to be clear on the price a transaction would take place at and the impact on the scheme. Define the provider selection process, which may differ depending on the circumstances DATA, DATA, DATA Rachel reminds us that data quality can have a large bearing on the ease (and price) of a transaction and comments there can be many issues to resolve, particularly for schemes established many years ago and/or those looking to insure the oldest pensioners first. She recommends that trustees: Start GMP reconciliations as early as possible - they won t stop a transaction from taking place, but can take a long time to resolve, e.g. for one case that she has been involved with, the GMP reconciliation alone will have taken over 12 months by the time it s completed. Attempt to locate missing data. Spouses data is most commonly missing - try to find and record spouses dates of birth and details of tax-free cash taken by members at retirement (so that spouses pensions can be accurately recalculated if necessary and insured at the correct level). Insurers will typically make prudent assumptions regarding missing items, so it could pay to spend the time tracing missing data. Draft a comprehensive benefit specification (with legal signoff), even if you re not planning a transaction immediately. It s inevitable that there will be some inconsistencies thrown up between administration practices or the scheme booklet(s) and the definitive rules and it s better that these are addressed/clarified sooner rather than later. Insurers will typically make prudent assumptions regarding missing items, so it could pay to spend the time tracing missing data MAKE GOOD USE OF AVAILABLE EXPERIENCE It always helps to have access to someone who s been through a bulk annuity transaction before to provide guidance and insight into the process and the many potential stumbling blocks. Steve believes that an independent trustee, either in their role as chairman or as part of the wider board, should be able to deploy their experience of other transactions, to make the process as swift and efficient as possible. Steve explains that an experienced (independent) trustee or consultant can help by: Arranging additional training for the trustees and, if required, the sponsor. Being realistic on the time and commitment that is typically required for these transactions. Identifying business-as-usual activities that need to be addressed during the transaction and how these can be managed to ensure they don t derail the process. Ensuring alignment of all the parties, including advisers, working on the transaction. He adds, this robust governance structure is central to the success of the transaction. There is also a balancing act between making sure that decisions are made quickly, at the right time, with the right information, but also pausing to resolve issues if needs be. So plenty of food for thought. As our panel has highlighted, there are many aspects to be addressed during a transaction and any preparations that can be completed (even months or years) in advance can simplify the process and increase the likelihood of a successful (and more certain) outcome. Ruth Ward discusses preparatory actions that trustees can take later in this Report in her article on getting your scheme buyout ready (see pp ). Our thanks to our contributors. 13

14 2013 MARKET STATISTICS Ken Womack Associate Consultant JLT Buyout Team A comparison of longevity swaps and buyout deals transacted over the last 10 years is illustrated in the graph to the right. 18,000 16,000 Buyout and Longevity Swap Market Since ,000 12,000 m 10,000 8,000 longevity buyout 6,000 4,000 2, Year The chart to the right illustrates insurers relative bulk annuity market share based on deals completed since January Aviva 10% Bulk Buyout Business Written Jan Dec 2013 ( 34.1bn) MetLife 6% Others 2% Legal & General (including Lucida) 24% Others MetLife Aviva Prudential 10% Pension Insurance Corporation Rothesay Life (including Paternoster) Pension Insurance Corporation 27% Rothesay Life (including Paternoster) 21% Prudential Legal & General (including Lucida) The following chart provides a broad estimate of the total value of liabilities brought to market by sponsors/trustees seeking buy-in/buyout solutions. Value ( bn) Q Q Q Q Q Q Q Q Q Q Q Q Value of Buy-in/Buyout Quotations from 2008 Period 14

15 THE BIG DEALS The largest bulk annuity deals struck over the year ended 31 December 2013 are illustrated in the table below, with deals completed in the last quarter highlighted in blue: Scheme Date Value Insurer EMI Jul-13 1,500m PIC NCR Nov m PIC Philips* Oct m Rothesay Life InterContinental Hotels Sep m Rothesay Life Undisclosed Jul m Legal & General Undisclosed Q m Rothesay Life Cobham** Jul m Rothesay Life Undisclosed Mar m Legal & General Smith & Nephew Q m Rothesay Life First Quench Apr m PIC Smiths Group Sep m PIC JLT Sep m Prudential *Transacted in Q3 2013, but announced in October 2013 **Transacted in Q but announced in July 2013 The top 10 longevity swap deals struck since 2009 are illustrated in the following table with deals completed in 2013 highlighted in blue: Scheme Date Value Counterparty BAE Systems Feb bn Legal & General Rolls Royce Nov bn Deutsche Bank / Abbey Life BMW Feb bn Deutsche Bank / Abbey Life AstraZeneca Q bn Deutsche Bank RSA Jul bn Rothesay Life ITV Aug bn Credit Suisse Akzo Nobel May bn Swiss Re BA Q bn Rothesay Life Babcock International May bn Credit Suisse Carillion Dec bn Deutsche Bank In early March 2014, a further longevity swap was announced: the largest to date***. Three reinsurers (Munich Re, Scor and Swiss Re) transacted the deal with Aviva Life & Pensions UK Ltd to cover longevity liabilities relating to the Aviva Staff Pension Scheme. This transaction was reported to cover 19,000 lives with approximately 5 billion of liabilities. COMMENTARY The market for pension de-risking solutions saw a strong 2013, with recordbreaking transactions and innovative product development contributing to total business volumes in excess of 16bn. Trustees and sponsors are increasingly aware of the risks and uncertainties associated with defined benefit pension scheme liabilities and continue to see the economic value of those liabilities as the true price that must be paid. Insurers remain keen to transact and are reporting a healthy pipeline for In the bulk annuity market in 2013, almost 200 deals were completed covering over 7.4bn of pension scheme liabilities. There were significant transactions throughout the year, including the largest buyout to date***, at 1.5bn, for the EMI Group Pension Fund in July. This, together with a 670m buy-in for the NCR Pension Plan in November, saw Pension Insurance Corporation secure more than 50% of the premiums written over the year. Rothesay Life continued to successfully target large deals, yielding an average transaction size of 334m, while Legal & General maintained its strong position in the market by completing 93 cases (across 67 schemes). ***As at end March

16 CURRENT ISSUES AND REGULATIONS AFFECTING THE BUYOUT MARKET David Barratt Senior Consultant JLT Buyout Team If you thought pensions were boring, think again! George Osborne certainly caused a stir with his March 2014 budget announcements, aimed at giving individuals more flexibility over how they use their retirement savings. David Barratt comments on recent developments. THE BUDGET - MARCH 2014 The Budget 2014 will be remembered for a very long time, with reverberations being felt throughout the pension industry. Atretirement planning is the most affected, with a radical shake-up of how consumers chose to spend their pension funds. This has both direct and indirect consequences for the bulk annuity market: A number of bulk annuity providers currently write significant volumes of individual annuities, which will undoubtedly fall in the coming years. To what extent is unknown; however these insurers are likely to redistribute capital towards their bulk annuity businesses, thus increasing capacity in the bulk market, which could in turn contribute to downward pressure on pricing. It could also encourage new insurers to enter the market. Members of defined benefit schemes may also want flexibility at retirement if so, will the change in legislation encourage more transfers out of defined benefit schemes? The government has suggested legislation will be tightened to prevent transfers from public sector defined benefit schemes into defined contribution arrangements and that this could be extended to private schemes. If it is not, and more members transfer out, funding levels could improve and consequently buyout could become more affordable for some schemes. New thresholds for trivial commutations were announced the size of a single pension pot that can be taken as a lump sum has increased from 2,000 to 10,000, together with an increase in the overall size of pension savings that can be taken as a lump sum to 30,000. These should reduce the number of smaller liabilities within a scheme, and the costs linked to these, and should increase affordability of bulk annuity purchase. However, they do not apply to winding up lump sums. OTHER NEWS GMP reconciliations Following confirmation of the abolition of contracting-out of the State Pension, all schemes with a Guaranteed Minimum Pension liability (GMP) will be required to undertake a reconciliation exercise before April Schemes that have completed GMP reconciliation exercises are more attractive to insurers (as there is more certainty around the benefits due), and would therefore be better placed to complete a buyout. GMP equalisation further guidance is awaited from the government. It is widely accepted that schemes will be required to equalise GMPs, the main question is how? Certainly it will help schemes to identify their additional liability and whether a buyout is feasible, and, if so, extinguish their liabilities. Following a consultation, the PPF published its 2014/2015 levy determination earlier this year, with the rules and parameters unchanged from 2013/2014. Schemes that have completed a buy-in are able to write up the value of the bulk annuity policy when completing the stress testing calculations, which can result in a material reduction in their PPF levy, particularly for schemes with weaker sponsor covenants. Solvency II capital requirements for insurers still loom on the horizon, with the expected implementation date being January With capital requirements being tightened insurers may experience upward pressure on pricing, although most suggest this will be negligible as their current prices reflect the expected changes. In late March 2014, the European Commission published a proposal for a revised EU Pensions Directive. Earlier intentions to impose scheme solvency capital requirements (similar to Solvency II) have been dropped, but there has been no relaxation of the requirement for cross border schemes to be fully funded at all times. The latter could create funding problems in the event of a yes vote for Scottish independence. 16

17 JLT BUYOUT AFFORDABILITY INDEX Ruth Ward Senior Consultant JLT Buyout Team For sponsors of UK defined benefit pension schemes, the impact of a buy-in or buyout on their corporate balance sheet merits careful consideration. JLT monitors the relative affordability of such transactions against sponsors accounting liabilities and can provide detailed advice on individual cases. Ruth Ward describes recent trends in buyout affordability below. FINANCIAL HEALTH 110 We regularly track the funding position of UK private sector pension schemes under standard accounting measures (IAS19/ FRS17) used in company accounts. We compare this against indicative market-based buyout costs to monitor how relative prices are moving with changing financial conditions and to assess how attractive a buyout-type solution is at any given time. COMMENTARY Funding Level (%) IAS19/FRS17 Over Q4 2013, long-dated AA-rated corporate bond yields increased by around 0.1% p.a. and long-dated Gilt yields by around 0.2% - 0.3% p.a. As a result we saw both accounting liabilities and buyout premiums fall, although this was offset to a large extent by a corresponding rise in inflation expectations. We estimate that the relationship between accounting values and buyout premiums has narrowed over the quarter, which could in turn reduce the accounting strain from transacting a buy-in Year 2010 Buyout AFFORDABILITY INDEX 180% Our affordability index tracks prices in the buyout market against IAS19/FRS17 liability values and shows the relationship between average buyout premiums and accounting liabilities separately for deferred and pensioner members. 160% 140% 120% 100% COMMENTARY 80% Our results show a slight improvement in affordability for both deferred and pensioner members over Q Deferreds Pensioners 17

18 A VIEW FROM THE BENCH WHAT NOT TO MISS When entering into a pension insurance contract, it is not only the final price that matters. The contractual terms and strength of the insurance counterparty are also of paramount importance. For smaller trades, contractual terms on offer are typically the insurer s standard terms and the trustees main concern is to ensure these are fit for purpose and accurately reflect the benefits to be insured. Exceptions include (prenegotiated) enhanced terms arranged by the trustees buyout adviser, e.g. those available through JLT s Buy-inSure proposition (see pp ). For larger trades, the contractual terms can be pivotal to a deal going ahead. The size of the deals can be eye-watering and both parties will want to build in adequate protections. Madhu Jain, Linklaters LLP, describes options below which can help trustees mitigate counterparty risks in the contract for a large buy-in or buyout. Rob Lawrence, Pinsent Masons, also describes his top three considerations in negotiating on a large trade. COUNTERPARTY RISK Madhu Jain, Linklaters LLP Historically, when trustees of pension schemes entered into bulk annuity policies they accepted the counterparty risk arising in respect of their insurance counterparty without seeking any mitigation for this risk. However, counterparty exposure has increasingly become the subject of commercial focus on larger buy-in deals. In the main, such concerns stem from: a. The entry into the market of monoline insurers (which may not have the credit ratings of more established players and are exposed to less diversity of risk); b. the failure or bailout of large financial institutions as a result of the financial crisis; and c. the development of the longevity swaps market. Longevity swaps are generally collateralised even though there is an element of symmetrical counterparty risk (each party will have counterparty risk to the other to the extent that the swap is in the money to that party). Conversely, with a bulk annuity policy, where the premium is typically paid up front, it is effectively only the trustee who bears counterparty risk and yet generally this exposure is not collateralised. There are various options available to trustees to help mitigate such counterparty risk including: Termination rights such that the bulk annuity policy can be surrendered at the trustees option should the insurer s financial strength weaken materially. This may be linked, for example, to external credit ratings (if applicable) or to prudential capital (such as failing to maintain capital requirements plus a buffer) or regulatory intervention more generally. Calculation of a surrender payment will also need to comply with regulatory requirements applicable to the insurer, which in the UK includes the obligation on the insurer to treat customers fairly. Collateralisation either at the outset or upon triggers being met indicating that the insurer s financial strength is weakening. There are a variety of forms of collateral which can be used and advantages and disadvantages apply to each. In addition to the implications of collateral from a commercial perspective (including increased costs), factors that an insurer providing collateral may raise are whether or not the assets remain available to back its insurance liabilities and whether or not the assets are able to be treated as admissible assets for regulatory capital purposes. The ability to move to buyout. We have seen trustees become more comfortable with counterparty risk if the bulk annuity policy provides for a move to buyout within a relatively short timeframe. It is worth noting that the UK insurance prudential regime is generally considered to be robust given its focus on risk based capital (and will become arguably even more so with Solvency II, which is due to be introduced in 2016). In addition, the UK Financial Services Compensation Scheme regime is applicable to contracts of long term insurance, which in principle includes bulk annuity policies. 18

19 KEY LEGAL ISSUES IN A LARGER BULK ANNUITY TRADE Rob Lawrence, Pinsent Masons 1. Selecting the right deal structure There are a number of different deal structures available for large transactions including: all-risks buyouts, deferred premium payment options and deferred pension commencement mechanisms. Trustees should engage with their advisers at the outset to find the most suitable structure for their scheme s particular set of circumstances. Different structures create different legal risks for the trustees. For example, proceeding with an all-risks buyout may provide the trustees with protection against unidentified beneficiaries and incorrect scheme benefits; however, in return for providing this cover the insurer will want to undertake its own extensive legal due diligence in respect of the scheme prior to signing. This will cover, amongst other things, the scheme s historic documentation and governance processes. 2. Heads of terms Whilst trustees and sponsoring employers will be working towards a common objective, namely entering into a bulk purchase annuity with an insurer, there are a number of hurdles to overcome before that position is reached and the parties might not necessarily agree on how they will overcome them. It is a sensible starting point to put in place a heads of terms document between the trustees and the sponsoring employer. This isn t a legally binding document but it does serve to capture on paper the parties objectives and approach for the transaction. It might cover, for example, the proposed transaction timeline, the level of sponsoring employer involvement in any discussions with the insurer and the trigger-point at which the sponsoring employer provides any cash injection required. There are a number of hurdles to overcome before that position is reached and the parties might not necessarily agree on how they will overcome them 3. Adjustments to cover Within a bulk purchase annuity policy there are likely to be provisions allowing the insurer to adjust the level of liabilities it is covering under the policy or the level of premium payable by the trustees to the insurer, in the event of certain circumstances arising. These might include, for example, where the pension scheme ceases to be registered or where significant differences in the data have been unearthed during the data cleansing process, which materially impact on the price quoted by the insurer. The trustees should take legal advice as to the scope of these adjustment provisions, what the consequences would be of any such adjustment arising and what practical steps the trustees can take in advance of signing to mitigate the associated risks. Our thanks to both our contributors. 19

20 2014 BUILDING ON THE MOMENTUM AND LOOKING TO THE FUTURE James Staveley-Wadham Principal JLT Buyout Team Already this year we ve seen the largest ever longevity swap transaction for a pension scheme* and a combined 3.6bn buy-in for another scheme. What else does 2014 have in store for us? James Staveley-Wadham shares his thoughts on the year ahead was the year that the annuity purchase market in the UK came of age. The overall volume of transactions and the size of individual deals reflected a collective desire to de-risk, rather than a response to significant market opportunities, (e.g. due to extreme market stresses or periods of high equity returns). The concept of annuitisation is one that both sponsors and trustees are increasingly more comfortable with and see as a way of managing and exiting risk. As larger transactions come to market and the underlying frequency of activity increases, there is a realisation that by continuing to wait, opportunities might be missed. Aspiration has been replaced by opportunism and schemes continue to work hard to ensure they can take advantage of opportunities to de-risk some or all of their liabilities. Insurers remain committed to the market and continue to look at ways of increasing capacity. The adviser community now has significant experience of managing efficient processes and implementing well-designed deal structures. Prior to the Chancellor s budget announcements on 19 March 2014, the market would no doubt have continued to grow and evolve. However, the decision to provide greater flexibility to people s retirement savings is inevitably going to have a significant impact on retirement provision in the UK but what will this mean for defined benefit schemes and de-risking? Whilst the full impact of the changes is still being absorbed, we believe that the primary implications of these will be: Bulk annuity capacity will increase within those insurers who previously had significant exposures to the individual annuity market together with a bulk annuity offering. The changes announced will be used to help schemes reduce their overall liabilities and insure the residual liabilities. Increased capacity will result in more competition, innovation and better pricing opportunities. It may lead to more insurers entering the market, as they react to the changing landscape of pension and savings products in the UK. Schemes should take advantage of the greater flexibility of member choice exercises, along with the increased level of member engagement, as members are given greater access to their savings. Giving members more choice and flexibility could reduce the cost of buying a bulk annuity, so both these elements of the de-risking approach should be brought closer together. The use of technology will be another development which should gain greater prominence during the course of The importance of accurate data as part of a transaction is well rehearsed. The better use of technology in storing, providing and interrogating data will result in better pricing, due to less uncertainty; give more certainty on what the final premium will be and allow swifter transactions. This should also come with an understanding that, like the investment portfolio, member data is on a similar journey from the scheme to an insurer and what needs to happen is to make this journey as efficient as possible. All of these significant benefits should provide the motivation for schemes to engage well in advance of the process of preparing for a transaction. The ongoing desire for sponsors and trustees to reduce their risk exposures, coupled with greater market capacity should result in a very active * As at end March

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