ACA conference – can bulk annuities be good value? Colin Parnell 26 January 2018 Commercial in Confidence 1
Summary 1. Why is insurance so expensive? 2. How can I assess value of buy-in or out? 3. Opportunities for savings 4. Risks that may seem expensive to remove 5. Which schemes are transacting and how are they doing it? Commercial in Confidence 2
1. Why is insurance so expensive Commercial in Confidence 3
Key definitions in the insurer balance sheet Solvency Capital Requirement (SCR): • Capital insurers must hold under the Solvency II regulatory regime; • Circa 1 in 200 confidence level (annual probability of failure); • Breach this and the regulator will get involved; • Shut to new business and come up with a short term plan. Minimum Capital requirement (MCR): • Absolute minimum, breach this and insurer “insolvent”; • PRA would take full regulatory control before breaching this. • Circa 1 in 85 level of confidence (annual probability of failure). Risk Margin • Additional sum to pay a third party to take on insurer’s assets and liabilities; • Covers non-hedgeable risks eg mortality; • Can be volatile with changing long term interest rates. Commercial in Confidence 4
The prudence of insurers (reserving and protection) PRA Insurance regime Wider insurance group support Surplus SCR MCR Corporate Risk bonds, Margin government bonds, equity release, infrastructure Commercial in Confidence 5
Summary of my buy-out assumptions Asssumptions Non-retired discount rate Interest rate swaps curve - 0.4% Retired discount rate Interest rate swaps curve + 0.05% Inflation (RPI) RPI inflation swaps curve Inflation (CPI) RPI less 0.4% Mortality base table S2PA with adjustment for prudence Mortality future CMI model with 1.75% pa future improvement improvement Commercial in Confidence 6
2. How to assess the feasibility of a buy- out Commercial in Confidence 7
“1 in 200” Realistic Scheme Balance Sheet prudence Weak employer, £’000 £’000 “50/50” Liability Values: Buy-out TPs prudence? ‘Best’ insurance price 37,500 24,600 Liability for GMP equalisation 400 350 Liability NRA equalisation 900 850 Correction of problem with pension increases 300 250 PV of ongoing Fees associated with wind up/Ongoing expenses allowance 600 740 running costs Estimated total liabilities 39,700 26,790 much higher - circa £4m Asset Values: Scheme’s assets 14,000 14,000 Net current assets 900 900 Total assets 14,900 14,900 Surplus/(Deficit) -24,800 -11,890 Estimated funding level 38% 56% COMMENT: Foreign parent company agreed to pay in an additional contribution to wind up scheme Commercial in Confidence 8
Buy-out premium versus asset value COMMENT: Improved funding may lead to a rush for the exit in 2018 Commercial in Confidence 9
2. How to assess the feasibility of a pensioner buy-in? Commercial in Confidence 10
Funding effect of pensioner buy-in – Technical Provisions Before After annuity annuity purchase purchase Liability Values: Non-pensioners on TP basis £14.6m £14.6m Uninsured Pensioners £33.7m £34.9m funding Total liability £48.3m £49.5m strain £1.2m Asset Values: Invested assets £43.5m £8.6m Additional bulk annuity policy £0.000m £34.9m Estimated expenses associated with £0.000m (£0.15m) transaction (not met by Employer) Total Scheme assets £43.5m £43.35m Shortfall £4.8m £6.15m COMMENT: Company agreed to pay in an additional contribution at the end of the Recovery Plan Commercial in Confidence 11
Pensioner buy-in cost versus gilt-based value COMMENT: now seems like a good time to do a pensioner buy-in. Commercial in Confidence 12
Why would I insure, mortality improvements are slowing? 0.7% pa 1961-1975 1.8% pa 1975-2000 3.1% pa 2000-2011 0.7% pa 2011-2016 COMMENT: UK average improvement in longevity (ages 50-89) has been volatile (CMI 2017) Commercial in Confidence 13
Agree a price objective and assess regularly Strike price COMMENT: agree legal contracts in advance and have a simple decision rule Commercial in Confidence 14
Investment effect of a pensioner buy-in Expected Actual Actual investment return allocation allocation above gilts (pre buy-in) (post buy-in) Global Equities 3.5% 16.0% 16.0% Diversified Growth Fund 3.0% 13.0% 3.0% Lower expected Growth assets 29.0% 19.0% investment Over 10yr Active Corporate 0.9% 57.0% - return post Bonds buy-in Over 15yr Fixed Interest 0.0% 14.0% - Gilts Bulk annuities ( Buy-In) 0.0% - 81.0% Matching assets 71.0% 81.0% Expected return in - 1.5% 0.7% excess of gilts (p.a.) Hedge Ratio – interest - 41.0% 55.0% rates COMMENT: Employer agreed that the lower investment return was acceptable as buy-out is the ultimate goal Commercial in Confidence 15
3. Opportunities for savings Commercial in Confidence 16
Running costs fall with larger groups of members Average scheme running costs (£ per member per annum) Source: Defined benefit (DB) scheme running cost research (2014), tPR QUESTION: how can scheme consolidation provide a more affordable solution than buy-out? Commercial in Confidence 17
Case study: retirements generate material savings Retirement lump sums paid out £87,000 Commutation factors lower than the buy-out cost (factor circa £17 per £1 pa pension) Pensions paid £10,000 Small amount of pensions paid out before insurance purchased Premium reduction (£300,000) Insurer calculated premium £300k lower due to the four retirements Saving on retirements £203,000 Circa £200k savings generated by just four retirements Commercial in Confidence 18
Transfer values are typically lower than buy-out costs QUESTION: As Scheme Actuary, knowing that buy-out is imminent, would you be willing to recommend transfer values at below the buy-out cost? Commercial in Confidence 19
How to identify where cost savings can be made Commercial in Confidence 20
Case study: unknown demographics Marital status and age Pensioner buy-in Collected marital differences unknown at executed with information post deal the outset assumed marital status – data collection delayed All execs were married with 10% rise in annuity Learning point: best to fix costs much younger wives. premium post up front Remaining members were transaction once more likely to be single or true demographics spouse similar age were known Commercial in Confidence 21
4. Risks that may seem expensive to remove Commercial in Confidence 22
Compliance, legal and data – costs, risks and remedies Stage 1 Stage 2 Stage 3 Stage 4 2 weeks to 3 years 1 to 2 years 12 weeks Pre pricing Price discovery Execute transaction Implementation • • • • Data processing notices in Provide additional data Finalise data and Complete gaps in data place requested by insurers definitions for transaction • Random sampling • • • Minimal gaps Manage member Manage member • Self certification movements movements • Legally reviewed benefits • • • Manage member in benefit specification Exclude members eg Exclude members eg movements WULS eligible members WULS eligible members • Ensure members are alive • • • Complete options Minimal changes Minimal changes • Marital status obtained exercises • • Review benefits versus GMP rec complete admin practice and • GMP equalisation actuarial understanding • • Notice in newspapers Decisions on discretions • • Parallel payroll Source estimates of unquantified liabilities and • Balancing premium benefits • Individual policies • Amend any benefits that cannot be insured • Contractual deadline COMMENT: insurers take on very little data and benefit risk – remove, manage or insure Commercial in Confidence 23
Areas where insurance may seem expensive Young and RPI/CPI Unusual rich gap inflation indices or high pension increases “Better of” or Very wide Hard coded Money eligibility member Purchase criteria options benefits Commercial in Confidence 24
5. Which schemes are transacting? Commercial in Confidence 25
Which schemes are seeing value in insurance? 2 weeks to 3 years 1 to 2 years 12 weeks COMMENT: insurers take on very little data and benefit risk – remove, manage or insure Commercial in Confidence 26
Looking good – how you can add value? Make your pension Clear, agreed scheme attractive price objective and transaction to insurers process Assets aligned to annuity price with Company implications liquid assets. considered and clear Monitor closely transaction timeline Attractive Clean membership demographic profile data and clear benefit and simple benefits description Commercial in Confidence 27
My conclusion Bulk annuity insurers offer the best value, low risk solution for UK pensions: • Low risk regulatory regime • Huge scale drives efficiency • Experts in risk management Commercial in Confidence 28
Questions? Commercial in Confidence 29
Thank you Commercial in Confidence 30
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