Activity in the smaller scheme corner of the UK’s pension risk transfer market has held up in the past 18 months, despite initial concerns of crowding out. Greg Winterton spoke to Adam Davis, Managing Director at K3 Advisory, to get his thoughts on the drivers of activity in this part of the country’s booming bulk purchase annuity space.
GW: Adam, first off, what is the main reason – or reasons – that activity in the smaller scheme space has held up well recently?
AD: It is important to remember that, in terms of large schemes, there are not that many of them. The outcome for an insurer is binary – you win the bid, or you lose it. On the flip side, there are many, many smaller schemes – around 75% of schemes are sub-£100m in size. So, there is plenty of potential activity in the smaller scheme part of the market, whereas there are simply not as many larger schemes to transact with.
Additionally, smaller schemes give insurers a better flow of deals which helps them with managing resources, and they have also probably seen the best improvements in terms of their funding position on average because they were probably less well hedged and less sophisticated in terms of their investment strategy before interest rates began to rise.
And lastly, there have been some new entrants into the market in the past year – not new insurance companies per se, existing insurance companies that are now participating in the market – and these firms are going to target smaller schemes deliberately, because smaller schemes are less complex, and new participants can test processes and systems, and build credibility with smaller schemes generally.
GW: One interesting trend seems to be one of insurers curating a specific solution for smaller schemes. What are some of the features of this new ‘off the shelf’ solution and what are the benefits and potential concerns for trustees?
AD: A lot of it needed to be off the shelf, to be honest. A lot of contracts are well negotiated, and we do have something close to a market standard. If you are a trustee for a £10m scheme, you are taking off the shelf contracts.
And this development has made the process more efficient. The insurers currently offering this service have developed standard data templates where you import the pension benefits data, and the quote process is somewhat automated. That’s to be applauded.
There is a potential pitfall, which is that there are now different systems in which to input data. Brokers and trustees don’t want to end up with 10 or 11 different templates that we have to complete to get a quote. There is likely a happy medium to be had somewhere, however, which satisfies both trustee/broker and insurer.
GW: PRT consulting firms constantly beat the data drum in the sense that they urge schemes looking to complete a buy-out solution to get their data in order. What specifically are insurers looking for data-wise? What grabs their attention?
AD: It’s as imperative for the trustees to be confident about their scheme’s benefits and data, as not being is simply reckless. BPA contracts are un-surrenderable, so we work with the trustee to ensure they do understand fully their data and benefits. If it’s wrong, the change to the premium could be a lot higher and the insurer would then ask the sponsor for a material extra contribution. When we run broking processes, we’re up front immediately with clients; you don’t need to cross every t and dot every i initially, but we need to know that materially, the trustees are on top of this stuff. When I show a trustee a balance sheet with the cost to buy-in and buy-out, it needs to be materially right.
But ensuring that the benefits data is correct is also helpful in generating the best price. Making insurers guess means they are taking risks and they have to hold capital – which is expensive for them – and that in turn impacts the price to the scheme. It’s critical to ensure that schemes do not make the insurer guess.
Lastly, the worse the data is, the more work and resources are needed between buy-in to buy-out and we need as an industry to avoid wasting valuable resource.
GW: Is there any reason that a scheme should consider a buy-in as opposed to a buy-out if they are fully funded and are there any misconceptions about the differences between the two for smaller scheme trustees?
AD: It’s important to stress that running a pension schemes comes with a cost. Schemes still need to be administered, perform valuations, etc. The scheme would be paying ongoing fees when it can transfer entirely to an insurer. So, it is unlikely to be attractive in the small scheme space to run on with a full buy-in in place.
Buy-ins tend to be seen in the larger space when a scheme wants to insure a partial slice of the scheme. You might have a situation where the sponsor has a very strong covenant, which means that the trustees might like the best of both worlds and maintain the link to the sponsor, but I still believe not many sponsors will be happy with such an approach, especially if they are also writing a cheque to make the initial full buy-in feasible.
GW: Lastly, Adam, what’s the outlook for smaller scheme activity in the coming 12-18 months? Will these off-the-shelf solutions help increase activity? Will the crowding-out risk ever actually materialise?
AD: I’m more bullish than ever. The streamlined services we discussed previously are supporting activity and there are plenty of schemes which are in a funding position to enter into a BPA transaction.
The only thing that makes me a little nervous is the data quality topic. A lot of schemes have moved forward rapidly. They can afford this solution, but their data is not ready. If a scheme wants to get to a buy-out solution, and get a good price, they have to do their bit first.
That said, as an industry, we’ll solve this challenge. It is imperative that we continue to work hard to make the market open to small schemes. The Pension Protection Fund’s Purple Book says that 75% of small schemes are sub-£100m and 30% are less than £10m in assets. Plenty of these schemes are at or nearly at readiness for an insurance solution. The smaller end of the market should continue to see lots of activity in the coming years.
Adam Davis is Managing Director at K3 Advisory
