Aviva: The Long Good Buy – Nick Johnson

This year, pension buy-outs have risen on a tide of million and billion-pound deals. Aviva’s Nick Johnson uncovers the story behind the trend, advises on Solvency II and discusses gradual de-risking, another trend edging into the buy-out market.

The steady flow of headlines about multi-million pound pension buy-outs highlights a trend in the market. First came a £500m buy-in for Cadbury’s pension fund; next, a £100m buy-out between the Merchant Navy Officers pension fund and Lucida. But these stories were trumped by the £1.3bn buy-out between BA and Goldman Sachs’ insurance arm.

Nick Johnson, head of defined benefit (DB) risk management at Aviva, disagrees that the trend is based on new thinking. Instead it expresses the first wave of confidence following the economic downturn. The market grew rapidly in 2007 and spiked at £8bn in 2008, but dwindled to a mere £1.5bn in 2009 as the global financial crisis curbed business.

"The big surge in scheme transacting reflects the fact that it takes a year to 18 months to prepare a buy-out," Johnson explains. "It’s the culmination of a lot of hard work behind the scenes. Confidence in financial institutions has meant that transactions can now come through."

Timing is everything

In 2008, the pension buy-out market moved much faster than it does today. The market changed from having two or three big players to between ten and 15, and pension funds often managed to attract strong offers.

Johnson adds that the financial risk involved in buy-out transacting has been hard to ignore. "In the last two or three years, a lot of schemes closed and others began to run risk management," he says. "As they unravelled, the market took off again."

"Confidence in financial institutions has meant that transactions can now come through."

He predicts that the trend for buy-outs will continue now that the financial climate has improved, though trustees can take as long as two years to make a move into the market. Rather than advisors sitting down to work out a transaction on their own, we encourage companies to do due diligence and pick an insurer to work with them," Johnson says.

It can take between 18 months and two years to pick the best time to transact a buy-out. At a competitive auction, an insurer might knock 1% or 2% off the price. "But if you sweet-spot the market over a six- or 12-month period, the financial conditions being cheaper on a given date might take between 4% and 6% off," Johnson explains.

"You’re not guaranteed the best price on a particular day but by being able to transact at the best price, you get yourself a better deal in the long-term." Schemes may be keen to transact before new legislation ups the price of a buy-out.

In demand

Solvency II, the second round of legislation for insurers, will introduce new rules regarding solvency capital requirements for EU insurance firms at the end of 2012. Johnson predicts that it will make prices more complex and risks easier to understand.

One category that is not afraid to join the DB buy-out market is small pension schemes. In 2009 Aviva wrote over 40 schemes, most of which were worth less than £10m. The company has even had to turn clients away due to high demand. Johnson points out that it takes almost as long to work out a quote for a £1m fund as it does for a £10m fund.

He also points out that pension scheme funding is moving towards the insurance funding model. "It’s a way off," he says, "but if the accounting treatment of pension schemes is coming our way then a lot of lessons we learn, they will learn as well."

According to Johnson, the only true way to reduce pension liability is with a buy-out: "Funding on an accounting basis rather than a buy-out basis is an artificial sense of security." Trustees and insurers alike know the volatility of the market. With any luck, buy-out funding may soon become the industry standard.

Nick Johnson, head of defined benefit risk management at Aviva.