Prudential: Experience the difference – Greg Wenzerul

Corporates considering a pension buy-in need to tread cautiously, being careful both to optimise the financial terms of the transaction and also ensure they are transacting with a trusted and secure counterparty. Greg Wenzerul of Prudential explains why the company's proven market experience is key to optimising solutions.

Defined benefit pension schemes are no longer the catch-all pension solution of years gone by. Faced with increased longevity, as well as the challenges posed by the financial markets, many schemes have been left running large deficits. Ultimately, the long-term trend is towards either winding down and running off such schemes, or aiming to secure the liabilities with an insurer. In the meantime, there is a balance to be struck - mitigating the cost of the pension scheme to the employer while managing the risks that the trustees and pension scheme members are exposed to.

For corporates seeking solutions, securing a pension buy-in can seem an enticing proposition. With the market taking off in the mid-2000s, an annuity buy-in involves purchasing an insurance policy that exactly matches the liabilities of the scheme.

The advantages of a buy-in are evident; the burden of risk is passed to the insurer, so the employer is insulated against longevity risk and market volatility, and scheme members benefit from increased security and peace of mind. On the flipside, the cost of the buy-in can be a problem and corporates may need to inject capital into the scheme to support a transaction. Furthermore, if the corporate does commit to a transaction there are several crucial points to keep in mind, particularly regarding the financial strength of the insurer that they are dealing with.

"When entering into a long-term contract with an insurance company, the most important thing to consider is exactly that, that it's a long-term contract which may last 50-60 years," points out Greg Wenzerul of Prudential. "Trustees should consider the counterparty risk (i.e. of the insurer) over that time, being mindful of the likelihood of that insurer being around over that timeframe. So they need to be as comfortable as possible with the decision and the risks they are taking."

Staying secure

Clearly it is to be expected that the counterparty will evolve in the decades to come. Small insurers will grow, or close to new business and be bought, and large providers will also have to adapt in response to differing market conditions. Security, then, is of paramount concern, and trustees should transact with a company whose strength is clearly evidenced.

"The business robustness of the insurer is a key consideration," says Wenzerul. "From Prudential's perspective, there is a very large pool of assets, a healthy IGD surplus and global diversification of liabilities, which puts it in a very strong position."

"Most successful transactions are the ones where the trustees work in tandem with the employer with agreed goals and criteria."

Of course, a company's track record can only take you so far, and trustees should ensure they also have a back-up plan in place. "For a larger transaction, the insurer may provide separate, ring-fenced collateral - funds set aside which provide protection for the scheme were the insurer to run into difficulties," Wenzerul continues. "There are numerous different structures including where the trustees retain the actual legal ownership of such ring-fenced assets."

A further topic to bear in mind is the counterparty's administrative strength. Since the onus is on the insurer to make timely payments - allowing the trustees in turn to pay their pensioners - there can be no room for operational failures in dealing with complex administrative structures.

This also applies specifically to schemes where the trustee is already thinking ahead to winding up the scheme. Should that be the case, it's important to transact with an experienced provider that understands these processes and keeps costs transparent.

Collaboration is key

Once the project to de-risk is underway, the emphasis shifts to maximising buy-in efficiency. Trustees can achieve this aim by reacting quickly, having the appropriate governance in place, and retaining an ethos of collaboration.

"From our experience, the most successful transactions are the ones where the trustees work in tandem with the employer with agreed goals and criteria," says Wenzerul. "This allows them to quickly evaluate opportunities and react to those opportunities when they're attractive."

While many buy-ins are time-consuming, taking between six and nine months, Prudential believes that with the appropriate preparation, this can be slashed to six to ten weeks. This is largely a matter of establishing strong links with administrators and ensuring the data is finalised prior to seeking a quotation. Many insurers do allow data to be amended post-transaction, but the process can be shortened significantly if the information is already in a serviceable condition.

"The data doesn't need to be absolutely perfect but it does need to supply the key elements to allow insurers to accurately price the risks," points out Wenzerul. "It's also important to ensure the data extracts are reliable and suitable for the exercise in question."

As the scheme prepares to transfer over suitable assets to the insurer, pricing can sometimes be guaranteed based on the assets to be transferred: i.e. the price can be locked down based on the nominal assets being transferred. This will be on a case-by-case basis, looking at the assets in question, and the state of the market up to the point of transaction, but can provide significant transactional certainty.

For a provider like Prudential, it is easier to lock into pricing for smaller schemes, although assistance can be provided in preparing the larger schemes for asset transitioning. Adopting the right asset strategy can reduce the market volatility risk in the weeks/months leading up to a transaction.

Value judgements

Even though the last 18 months have seen extremely attractive pricing when compared to gilt holdings, buy-ins are not right for all pension schemes and corporates. While they do give good value compared with a number of measures, the scheme's funding level may not be sufficient for any given scheme to proceed. In these instances, trustees would need to look into the array of alternative options available. For instance, there is the possibility of doing smaller buy-ins in tranches. Because some insurers may be able to provide a cheaper price for different membership groups, trustees could target the insurer's most competitive tranche, thus optimising pricing.

"Prudential has a history of writing larger, more complex transactions and building security."

Other options in the market include deferred premium solutions - the ability to de-risk now and pay later. Prudential's Future Premium Product (FPP) solution deals with precisely that. Suitable for many schemes, the FPP leaves the scheme retaining the rewarded investment risk for a period of perhaps ten years or more, whilst removing all the other risks from outset.

Furthermore, there are of course solutions that don't involve a counterparty at all, but which may be the right decision for the scheme. "There are non-insurance solutions and considerations such as whether to target a more aggressive investment policy to improve the funding situation in the long term, but at a greater risk," explains Wenzerul. "Clearly any action will need to be within the risk appetite of the trustee, and robustly analysed and recommended by their advisers."

The key point, however, is that each employer has highly specific requirements, and should they decide to work with an insurer, it is vital that they select one with the capacity to work towards their individual needs.

"Experience is vital within this market," says Wenzerul. "Prudential has a history of writing larger and more complex transactions, and building security. We are able to bespoke the offering, in order to sit well with the requirements of the trustees and the sponsoring employer."

Prudential's innovations team works to develop flexible and finely tuned solutions. Alongside the FPP, these include a range of with-profits-based pension risk-sharing solutions, and the possibility of additional security options for certain larger schemes.

A nuanced range of approaches is critical - this is one field in which a one-size-fits-all mentality will not suffice. But more than simply developing these approaches, a trustworthy counterparty should be able to work with trustees to provide them with the simple toolkit required to build their solution.

"The process relies upon the knowledge of the broker, and trustees should ensure they get ongoing feedback from the broker so that they know the market and when the right time is to de-risk. "There's a history of failed transactions over the last five years due to the inability to seize opportunities effectively and efficiently. Many look back at lost opportunities with regret."

Greg Wenzerul of Prudential.