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Speaker
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Transcript
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Chris Brown, Director, Burges Salmon
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Hello and welcome to episode two of season two of the Burges Salmon pensions podcast. Before the Jubilee weekend we looked at GMP equalisation, you can find that episode and all the episodes from season one on our website.
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Helen Cracknell, Solicitor, Burges Salmon
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Hi everyone, it's Helen Cracknell here. On today's episode we're joined by Michael Hayles, a partner in our pensions team who's a specialist in pension liability buy-ins and buyouts and also liability managing projects in the context of restructuring. Hi Michael.
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Michael Hayles, Partner, Burges Salmon
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Hi everyone, I'm very pleased to join this. I'm Michael Hayles, I'm a partner advising trustees, employers, public sector organisations but with that particular focus on risk transfer and build communities.
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Helen
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So this week we're discussing end game options for DB schemes including DB consolidation.
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Chris
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So Michael we are obviously awaiting the next consultation on the revised funding code but we know that there will be and has already been a a formalisation of a focus on long-term objectives and then that's coming formally by way of a of a long-term funding target, so in this episode we'll look at the different end-game solutions or targets for schemes in turn. So let's start with a more traditional one, buying in and buying out with an insurer. Could you briefly describe what this is and tell us your perception of the latest in the market please.
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Michael
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Thanks Chris. Well I'm sure many listeners will know that a bulk annuity contract firstly is an agreement between trustees of a defined benefit scheme and an insurance company to make payments based on the insured scheme liabilities.
So a bulk annuity contract when it's first bought is an investment decision and that contract is held as an investment scheme and that investment provides an income stream hopefully matched identically to the scheme liabilities that is insured the trustees were then during the buy-in phase make the onward payment to pensioners from the scheme and then on a buyout that's the process whereby usually in connection with a scheme wind-up the bulk annuity contract is converted into individual policies whereby the insurer then has a direct payment obligation to the member and the scheme can then wind up so on that transition from buy-in to buyout the members are then issued with individual policies rather than having a right to benefits in the scheme, so they have that link to the insurance company and then the scheme can progress to wind up and be terminated.
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Chris
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That's really helpful, thank you and what's the state of the market at the moment?
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Michael
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Well, having literally just returned from the Westminster & City Bulk Annuities Conference, it seems very clear that we have a very busy market across all the insurers, so I think each of the insurers were currently busy, they were bullish around the pipeline, they see that volumes are only likely to increase.
I think that was the general takeaway but the key takeaways for me, in that context were, I suppose really as ever, that the trick is to make sure that a scheme has got it's ducks in a row. It's really important that trustees and also the employer, if they're going to the market together, is that they're ready to transact so that they look credible and attractive because in a busy market insurers will pick and choose those transactions which they think are more likely to proceed and also of course those that they think their pricing point will be most attractive to. So some insurers won't necessarily transact to all levels and some insurers will tend not to engage unless the deal sizes at a particular level so there's a kind of mix in terms of the insurer appetite.
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Chris
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Thank you. I think it's absolutely right to say that the market is very busy and was also active during last year as well and we saw across the team some clients not rushing but working to get buy-ins done, in compressed time scales, to take advantage of attractive pricing and certainly I can think of a couple of entities that were coming out of COVID, businesses were recovering, and they were using that as a reason to take advantage of attractive pricing and get UK pension scheme liabilities off the books, so yeah it makes sense that that conference you were saying it's a very busy market.
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Helen
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Definitely going to echo that Chris, obviously one of the buy-ins I'm doing at the moment is really compressed time scales and it's just really important to get everything together in readiness for that.
I think something Michael, as you mentioned, that's really important for schemes is to be buy out or buy-in ready comfortably in advance of when you think you might enter into these contracts. So we're seeing more and more schemes nowadays, several years away from buyout, starting to do the leg work now. So getting their data in order, looking at their benefits particularly as if there are benefit issues you really might not be as close to buy out as you think, so it's really important and you want to be in a position to move quickly when the opportunity presents itself and the pricing is right.
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Michael
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I think that's a really good point Helen and one of the messages that did come out the conference and that we've seen insurers and others talk about separately has also been some schemes might actually be surprised that they're in a position quicker than they thought to be able to transact, so some of the ways in which market pricing has gone would suggest that some schemes who might thought a buy-in contract might have been some years away, actually might be that target and ambition might be nearer than they would originally thought, so absolutely it's if you can get your benefit specification and data right ahead of time then it means that you're more nimble as a scheme to hit the market when you're ready.
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Helen
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Definitely and an upside to all that hard work. So consolidation trends tends to refer to DB super funds which the regulator defines as a model that allows for the severance of an employer's liability towards a db scheme and then several other conditions applying. Michael, could you tell us more about superfunds please?
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Michael
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please? Absolutely! So of course super funds have been a concept that's been talked about for now quite a few years and we've got one authorised superfund in Clara and our understanding is that Clara went through a pretty rigorous process with the pension regulator to get to that position. Now we might expect of course the pension super fund does follow Clara and that may happen sooner or later, it's hard to know, but again they will have to go through a rigorous process.
But if we think firstly about Clara. Now Clara is essentially a bridge to buy out and listening to Clara talk about their proposition it is very clear that you know they still see insurance as being the gold standard so they recognise that Clara is not there to replace essentially a full buyout over time but it's a mechanism whereby employers and trustees can essentially transition to Clara in that immediate step with the ambition that then the funding position will get to such a point that that Clara can then transact with insurers so it's very much about a bridge to buy out.
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Helen
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What kind of schemes do you think Clara are looking for?
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Michael
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So my impression from what Clara themselves have said is that they need a few factors to come together. So I think they would say that with a scheme that is well funded and actually could get to buy out maybe in a few years that's not for them but it'll be a scheme where funding is in a relatively good position you're probably at least four or five years away from a buy-in buy-out situation but also I think that the mix of members is important to them so you would need a good mix of defers and pensioner members so a scheme that was you know clearly any scheme that's close to a cruel is maturing but one which isn't at the very mature end so I think that they need the time to together with their capital buffer and the and the other scheme assets to get to a position where they're funded enough to essentially buy in and then buy out um but then with a I suppose a surplus that can then potentially be returned to it so they so their proposition I think is intended to be a good option for employers that might struggle to get to buy out within that time frame but also where they think they can make money on the transaction.
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Chris
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Thanks Michael, that's really helpful and it's probably worth drawing out the distinctions if you don't mind between the Clara model and as you say that's the only approved super fund at the moment and the model for the pension super fund which works in a different way doesn't it?
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Michael
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Yeah that's our understanding so I suppose one key structural point is that Clara is sectionalised so essentially the assets and liabilities between each Clara sectional or scheme that transfers into it are kept entirely separate so there's no co-mingling of assets and liabilities and that's very important to their structure whereas our understanding is that the pension superfund doesn't operate on that that sectionalised basis so they therefore have a you know a different model and a different underlying covenant for trustees and others to consider as and when the pension sleep and fund does get that approval.
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Chris
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Yeah absolutely and whilst Clara aims at that that bridge to buying out I think our understanding as well is that on a non-sectionalised basis the pension super fund more aims to run schemes on rather than to transact within you know around five years as you were saying with an insurer as the Clara model is seeking to do. So yeah as you say quite a different proposition.
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Michael
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One point to mention is that with Clara there's potentially there could potentially be interest with ppf plus cases so for example where a pension scheme has fallen into ppf assessment following a sponsor insolvency it may well be that the scheme is too well funded to transfer to the ppf so assets are greater than ppf liabilities. So in those cases and again with the right funding and member mix, a super fund might provide a better outcome than immediately buying out benefits so that that seemed to be a particular sweet spot in the market.
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Helen
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Thanks Michael that makes sense.
Just to move on to a completely different option for DB schemes, there's obviously DB master trusts. So similar but quite different as the employer stays rather than being severed from the scheme could you tell us more about those?
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Michael
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Yeah, absolutely thanks Helen. You're quite right the I suppose the key distinction is that yeah that employer covenant that employer link remains so if you're if your classic DB master trust, essentially it's a single occupational pension scheme run by trustees. Typically they would be they would be fully sectionalised so each scheme that that transfers into that master trust has its own section and then it maintains its funding position but also the employer covenant, unless something is changed as part of the project, that would remain as for the position prior to the transfer into a DB master trust.
So I suppose the maybe the key attractiveness is that there's the opportunity for lowering costs because there may be economies of scale with cost savings for the other providers who are out for the trustees for bd master trust potentially the opportunity for greater scale of investment with pooled assets and the charges that that relate to those investments so the primary benefit may well be the economies of scale from an employer perspective they may also think about well their view might be that there's a stronger governance arrangement standing behind that that master trust and those master trusts will need to be authorised by TPR but the view might be that there's a stronger governance in place but also again on the economy scale basis that that governance cost is shared across all of the schemes rather than in that single scheme with the employer.
So there's probably two things it's the economies of scale and it's potentially what might be perceived as improvements in governance too.
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Helen
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So another really good option for trustees and employers to consider when they're thinking about endgame I guess. Of course people use the word consolidation to refer to other options that aren't really endgame or risk transfer solutions could you tell our listeners a bit more about that?
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Michael
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Absolutely. So consolidation might have a have a broad a broad meaning but I suppose one kind of alternative which isn't really consolidation is that streamlined running of schemes so again it's employers and trustees looking at economies of scale but also how can they streamline their governance and advisory teams so sometimes within a group structure you will you'll have you know maybe three four five or more pension schemes you know query if you can actually improve both governance and your opportunities with investments if those schemes are merged together and of course all schemes are quite different so there can be quite a bit of complexity in that but actually once the merger is achieved then that can help with that that streamlining and Chris I think we're going to touch on the trustee model
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Chris
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Well just to add Michael that, would you agree that we're seeing a growing number of schemes also considering sole trustee models where there's a single trustee single professional trustee in place is that is that something you're seeing across schemes that you're involved with?
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Michael
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Yeah there's absolutely been a growing trend. I mean of course over the last well probably you know 15, 20 years there's been a great trend to professional trustees being involved but certainly I think over the last maybe three or four years in particular we've seen more of a trend to sole trustee models you know that that won't necessarily be feel like the right the right thing to do in all situations but I think where you can see the advantages that it's where potentially either you're struggling to find people to volunteer to be trustees whether that's employer nominated or member nominated but also sometimes maybe in particular if you're going through a transaction decisions will have to be made potentially more quickly that sole trustee model you can you can really see work in that in that situation.
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Chris
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Yeah absolutely. OK, thank you very much. So the other thing I suppose we wanted to touch on what was of course that there is no obligation on a scheme or an employer to transact with a third party I suppose and one option for a long-term objective for a scheme is for the employer and trustees to run the scheme on so there's no need to pay an insurer a buyout premium and to find section 75 level of funding you know at the present point of time and there's no need to make a cash injection to facilitate a transfer to a super fund so a number of schemes when they're considering their long-term objective if they're comfortable with the covenant and the funding position and investment strategy is right and is appropriate then you know of course the scheme can be run on until the last benefit is paid and we're seeing you know discussions around whether this is appropriate happening now because even though the long-term funding and investment strategy is not yet law it's right and I think the regulator is keen that the trustees are thinking now in their valuations as to what the long-term objective of the scheme should be, so you know, trustees should be clear what they're aiming for even if that's running the scheme on.
I just we wanted to wrap up by asking you about some of the innovative solutions in the market please and there's a couple of different options you know beyond buyers buyout super funds and the other things that we've discussed could you just tell us a bit about you know some of the more you know some of the innovation that's out there.
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Michael
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Yes so we're conscious that it might be partly reaction to see the establishment of super funds and you know we do have Clara being authorised now but the expectation would be that there'll be more that follow in the market and whilst you might not see a kind of rush of those, you'd expect that the market does develop with a number of different options there so in reaction to that as I said that I think insurers are potentially looking at ways in which they can become engaged in a pension scheme but potentially ahead of a time when the scheme is actually funded to a level that it can be fully bought in and then and then bought out. So there are some options in the market where insurers are potentially looking at setting up a structure whereby they're involved and engaged and in some form contracted to a pension scheme, so there's an improvement in covenant or covenant support but ahead of the time where actually there's a bulk annuity policy in place so we haven't seen that model come through yet but conscious that there are some discussions in play.
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Chris
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Yeah thank you, that's really interesting and a really interesting model for you know the insurers potentially getting involved with schemes before that insurance transaction and to add we've also seen another type of innovation which is essentially a capital backed journey plan so I've had experience of considering it in a distressed scheme situation and again it didn't it didn't come through there although I'm aware of cases in the market where essentially a capital provider injects cash to boost the assets of the scheme and to provide a capital buffer and agrees to buy out within a set period of time and then and then the idea is that the buffer is there to help the scheme buy out and if the buffer is not needed then that can be returned and the capital provider may be able to make a bit of money as well if there's material materially excess assets you know perhaps on a very prudent calculation basis that that means that the scheme you know can weather the capital provider taking takings you know having a release of funds. So definitely there are all sorts of innovative solutions out there along with the more traditional routes for pension schemes.
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Helen
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I guess it just remains to be seen how the market will receive these new options and whether the regulator will want to bless them or whether it will consider them differently in compared to the other ones.
So I hope this gives everyone a helpful overview of all the different options there are available in the market. We aimed this both employers and trustees so hope you found it interesting.
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Chris
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Thank you everyone for listening to the Burges Salmon pensions pod. If you would like to know more about our pensions team and how our experts can work with you, then you can contact myself, Michael Helen or any of the team via our website. This episode is the second of our season two of the Burges Salmon pensions pod and all of our episodes including season one are available on Apple, Spotify or wherever you listen to your podcasts. Please do subscribe and thank for listening.
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