How small DB pension schemes should go about insuring their liabilities

How small DB pension schemes should go about insuring their liabilities

How small DB pension schemes should go about insuring their liabilities 1024 760 K3 Advisory

“I will prepare and someday my chance will come.”

Welcome to the third of our series of blogs on why small DB pension schemes should insure, and how they should go about doing it in order to get the best outcome.

The famous quote above by Abraham Lincoln unknowingly gives great advice to UK DB schemes. Having your scheme well prepared before trying to insure is advisable for schemes of any size but it is critical for small schemes.

£24bn of pension liabilities transferred to insurers in 2018 and this has already been surpassed in 2019. This step up in demand means that small schemes will struggle at the best of times to get insurers interested. Taking your scheme to market unprepared means you are even more likely to struggle to interest insurers.

I have been approached by numerous schemes who can’t get a single insurer to quote, and a fair number who can only get one insurer to quote. I recently helped a £10m scheme go out to the insurance market. We made sure, with the help of the scheme’s other advisers, that the scheme was well prepared and then we ran a very simple process. Simplicity and Certainty, you’ll hear me use those words a lot – I mention them continually with any scheme I work with. Every action we performed on that £10m scheme was designed to improve how Simple and how Certain it was to transact. The outcome? Three insurers bid. The gap between 1st and 3rd was 10% (£1 million), the gap between 2nd and 1st was 5% (£500k). What if that scheme had only attracted one insurer? This stuff matters. What should you be doing to get prepared? Here is a starter for ten.

Data: Insurers hold capital for the risk that their guesses (sorry assumptions) are wrong. By not making them guess at things they don’t need to you will almost certainly save money. So, collect spouses’ information, i.e. marital status and spouses’ dates of birth. Calculate the spouses’ pensions (don’t use the scheme actuary’s assumption that members took, say, 25% lump sum at retirement and roughly work them out). Do sample checks of benefits from the original file – concentrate on the members that matter, i.e. the ones with the highest liabilities. Have you done any recent existence checking? Do you know the members’ address information?

Benefits: This one is simple. Get the administrator to write down accurately how they administer the scheme. Then get the scheme’s legal advisor to review that against the scheme’s deeds and rules. If any differences come out then deal with them. Do this up-front not at the point of trying to transact.

Are there any benefits that will be hard to insure? An easy test of this is to ask yourself whether you can buy an asset that matches that benefit exactly or very closely. If not, then consider ways to change the benefit as it will be expensive to insure. A common example of this would be an underpin type benefit (i.e. where a member gets the better of two or more forms of benefits).

GMP Equalisation: You don’t need to have dealt with it, but you look more prepared if you have thought about it and have a plan of what you are going to do.

Affordability: Has someone told you roughly what insurance is likely to cost and what impact it will have on your key metrics, which might be funding impact, accounting impact, investment strategy, amount of risk removed….

Assets: If you think you can afford insurance then are your assets suitable for the job? Putting insurance in place takes several months and it is not helpful if the assets backing the transaction are moving around differently to the way insurers pricing moves as this poses a major risk to the transaction.

Governance: Do the Trustees have experience of doing insurance trades, can they meet at short notice, do you have a detailed project plan of how the insurance trade will evolve? Can decisions be made when needed?

If you do all of the above well then you will approach the insurance market with confidence that you are good business for them, and you will get more insurers interested and ultimately get a better outcome.

I hope you have found this blog useful. Doing the above will make your scheme appear simpler to insurers and more certain to transact. Our next blog will look at how you engage with insurers in a way that encourages them to quote.

If you want to read our first two blogs then the links are below:

Why small DB pension schemes should insure – economies of scale

Why small DB pension schemes should insure – longevity concentration risk