Opportunities for schemes looking to do buy-ins and buy-outs of under £200m

David Stewart: Hello everyone and welcome to LCP and Gowling WLG's webinar specifically for those trustees and sponsors looking to do buy-in and buy-out transactions for under £200 million.

My name is David Stewart and I am a partner in our specialist insurance de-risking practice. I have a particular interest in helping smaller schemes complete these transactions and pioneered the bulk-annuity market for smaller schemes by coming up with the idea of streamline processes including enhanced pre-negotiated contracts we will be talking about today.

I have now put up the presentation slides and you should be able to see pictures of your presenters today. I will be presenting this webinar alongside my colleague Rachel Hirst together with Paul Feathers from the legal firm Gowling WLG.

Rachel is a consultant in de-risking practice. She has completed 20 transactions ranging in size from £25 million to £700 million with around half of these having transacted through LCP's streamlined service.

Paul Feathers is head of Gowling WLG's pensions risk transfer team and spends most of his time advising trustees and sponsors on these transactions. Paul is also the advisor to the bulk annuity insurer Rothesay Life. LCP worked alongside Paul to negotiate insurers' contracts with all the insurers that take part in the streamline process and his understanding of what can be reasonably acceptable to ensure his workings with Rosethay Life was invaluable to insurers.

So before we start on the presentation I just wanted to explain the screen. On the left hand side of the screen, you will see bios together with email addresses so if you do have any questions following the review of this webinar please do not hesitate to drop us an email. There is also a Q&A box you can put any questions in there if you prefer and we will come back to you directly with answers to these. On the page, there is also a current resource list on buy-in and buy-out topics as well as wider issues that LCP and Gowling WLG have recently commented on and I will be talking about some of these publications as we go through this webinar. At the bottom of the screen, there is also the important CPD certificate as well as a feedback form if you would like to provide any comments on this webinar. There is the option to talk of all these features by just clicking on the minimise button so you can focus on the slides if you prefer.

So for today's webinar I am going to be talking about potential opportunities that COVID-19 has created this year for trustees and sponsors who are wanting to do smaller transactions. Rachel will then be talking about LCP's streamlined service for buy-in and buy-outs and how it can help you get engagement and attractive pricing from insurers while Paul will be talking about the advantages of pre-negotiating bulk annuity contracts.

So let's start by setting the scene of what happened in 2019. This has been a record breaking year with the total bulk annuity sales reaching £43.8 billion of liability secured and this was dominated by ten transactions all in excess of £1 billion. This process was not surprising, we have mentioned in our previous insurance de-risking report that we identified 300 billion of pension scheme liability just from the FTSE 100 schemes all heading towards buy-out funding over the next ten years and with FTSE 100 schemes just being a proportion of the whole DB market this sort of volume was expected to be the new norm. Insurance companies have small sales teams, which have really struggled to cope with the demand from pension schemes. As the time and cost providing quotations and executing transactions for larger schemes is not materially more than the smaller schemes, insurers quite reasonably, focus on trying to win the larger transactions as this represented a larger volume of profit relative to the resources being used. You may have seen from our blogs and press releases over recent years we have been concerned that smaller transactions were getting crowded out of the market. Indeed over the last few years there has only been about 100 transactions a year under £100 million where if you look back over four years or more the typical volume is more like 150 a year. So at the beginning of this year we thought this year would follow suit however COVID-19 has changed this and we believe has created some attractive opportunities for those looking to do smaller transactions and are willing enough to take advantage of current opportunities.

So in terms of volumes of business we now believe that this year will be around half of last year's market volume. I have been speaking to insurers there are only a few large schemes currently approaching them for quotes. The lockdown has not prevented transactions from completing indeed at LCP we have helped our clients secure over £4 billion of liability with insurers since the start of lockdown, with the lower volume of business and fewer large schemes smaller transactions have the potential to get better engagement from insurers and we predict that this could lead to volumes for smaller schemes increasing by 25%25 this year.

One of the key drivers for schemes wanting to complete transactions since lockdown has been insurer pricing. The graph here shows the return available for a bulk annuity policy for a typical pensioner population relative to the year long gilts. The higher the line the better pricing is relative to holding gilts. Effectively when the line is above 0%25 schemes can exchange their gilt holdings for annuity policy without reducing the expected return in the scheme but add in all the interest rate, inflation and longevity protection that an annuity policy offers. This graph was discussed in detail in a previous webinar on 23 July and I would encourage you to review this to get a wider understanding of the impact of COVID-19 on the market.

In summary, they explain that due to an increase in yields and corporate bonds, in both the UK and the US, insurers were able to offer reductions in their premiums relative to the levels before lockdown when measured relative to gilt yields. This attractive level of pricing to some extent has reduced a little but still remains.

So for schemes that are holding gilts and other matching assets to match their pensioner liabilities buy-ins are at historically attractive levels suggesting that these schemes may wish to investigate pensioner buy-ins for some or all of their pensioner members whilst those schemes looking to buy-out in the near term who were heavily invested in matching assets they may now find themselves far closer or even at buy-out funding.

I have been asked by trustees and sponsors why do a buy-in or a buy-out at the time of a pandemic as insurers would benefit rather than the scheme from the heavier mortality. Well I considered this in my blog that I wrote with Lydia Button. In that blog I highlighted that there had been around 60,000 excess deaths relative to a typical year and this has shown in the blue line relative to the five year average in gold on this graph. This is a material increase in the number of deaths however a material increase in one year does not necessarily result in a material reduction in pension scheme liabilities. In the blog, I showed that even if there were 100,000 excess deaths in the year this could only reduce a typical pensioner liability by about half of 1%25, whereas the current reduction in pricing of 3%25 - 5%25 due to economic conditions clearly exceeds this. My view is that the current pandemic should not deter you as the first wave of deaths will already be incorporated as reductions in your liability and any second wave is unlikely to be material enough to outweigh the current reduction in pricing due to economic conditions. So in summary I think there is significant opportunity this year for schemes that are nimble and I am going to hand over to Rachel now to tell you about how you can get engagement from insurers and complete a transaction quickly and efficiently through using the LCP streamline service for buy-ins and buy-outs.

Rachel Hirst: Thanks Dave. So firstly I will just cover off what the streamlined process is and give a little bit of background on LCP's streamlined service before going on to talk about how a streamlined service can benefit you.

So a streamlined service is a process where the contracts have been pre-negotiated with the insurers and this process has been designed to be as efficient as possible hence minimising trustee time and involvement in order to get the deal done. We designed our streamline service in conjunction with Gowling WLG back in 2011 and we were the first consultancy to bring this type of offering to the market. It was initially designed for pensioner buy-ins of under £100 million in size and the first transaction was completed for Swedish Match around nine years ago. Since then we have expanded the service so it now also works for buy-outs as well as buy-ins and includes transactions for insolvent employers which are known as PPF plus transactions and the streamlined service can now be used for transactions up to around £200 million in size.

So just to give a few stats on the service so since 2011 our streamline service has proven to be robust and successful with us completing over 50 transactions under the streamline service and with £1.6 billion of liabilities being secured with the insurers over this period. In terms of the schemes that have transacted under our service these range in size from around £2 million up to £140 million and we also now have all eight of the active insurers in the market participating in the process.

I will now move on to how a streamline process can help you. So the streamline benefit has four key benefits for trustees. The first one being in terms of better contractual terms so Paul will touch on this in more detail later on in his section on the legal aspects but just to give you a quick summary using a pre-negotiated contact allows you to access better terms than you would usually be able to achieve with smaller transactions. What we have agreed with the insurers is that these pre-negotiated contracts will be used for a number of transactions so can essentially be thought of as a stream of transactions rather than one standalone small deal and this allows them to give us access to some of the terms that they would usually only reserve for the larger deals in the market.

The streamline process is designed to help increase the attractiveness of your schemes to the insurers and this includes by the structure of the transaction, setting up the clear governance structure and also giving the insurers clarity around the data and benefits. I will touch on the key areas where we can bring you value through the streamline process on the next slide but in terms of the key benefits this brings competitive pricing from insurers and also increased insurer engagement. Insurers know how the process works and are confident that a transaction is likely to go ahead under the streamline service which means they are engaged and therefore likely to put forward attractive pricing. The final benefit that I just wanted to touch on was around timescales. So the streamline processes are tried and tested which means that they run smoothly. The pre-negotiated contracts also mean that there will not be protracted legal negotiations in the final stages of the transaction and as a result typically transactions take around three months from the point it has decided to approach the market to the point at which you are signing the contract with your chosen insurer.

So on this slide I have just set out a typical timeline for a transaction under LCP streamlined service and the bit highlighted in orange in the middle, there is the typical three month window between agreeing to approach the market and the point of signing the contract with the insurer. Just to link this back to Dave's point earlier about 2020 providing smaller schemes with a good opportunity to secure attractive pricing, this three month timeframe means that there is still time for you to complete the transaction before the end of this year. Rather than go through this timeline and the process in detail I was just going to highlight some of the key areas where our process adds value for you.

The process is structured around the three key meetings which means the process is efficient and also minimises the trustees' time and involvement needed in order to get the transaction done. At the first of these meetings is where the trustees make the decision to approach the market. At the second meeting, they will review the insurer quotations and begin the formal insurer selection process and the third meeting is where the contract is signed. Before we approach the market we will review the scheme's data and benefits in detail to ensure that they are of appropriate quality for providing to the insurers. This detailed review allows us to identify any gaps in the data and also bring out any potential benefit issues within the scheme. This means there is unlikely to be anything that comes out of the woodwork later on in the process, which could potentially derail the project. Insurers know that we do this work up front, so this results in them being more engaged in the process and helps them to put forward more competitive pricing because they have confidence in the underlying data and benefits that they have been provided with.

We will also agree a project plan up front in and put in place a clear governance process. Having a structured and clear project plan means that the insurers know exactly when the transactions are going to occur so they can line up their governance and source the assets they need for the transaction. The governance plan also shows the insurers you are serious about getting the transaction done and therefore increases their engagement because they are able to get traction internally for the transaction as well.

After writing out to the insurers, there is roughly a two month period where the insurers are calculating their quotations. Once we get these quotes back from the insurers we then begin a very robust selection process so that the trustees can be confident that they are selecting the best insurer for them when the time comes this not only involves assessing price but also involves looking at other things such as the insurers financial strength and their administration capabilities.

On a recent case we worked on, we worked for the trustees, the company and their other advisors at the outset of the project to set clear pricing criteria. This meant that as soon as we had the quotes in from the insurers we immediately knew whether the pricing met the trustees criteria we were then able to lock into that pricing and move forward with the transaction quickly.

Once the preferred insurer has been selected, the pre-negotiated contracts mean you can move quickly to complete the transaction and just to give you an example of one of the terms that we have negotiated under these contracts, one example would be around the marital data and having the insurer stand behind the assumptions that they use for this. So on a lot of the transactions that we work on and in particular one that we worked on recently we carried out a marital data exercise in the preparation phase of the project.

Providing this data to the insurers meant that they were then able to stand behind their pricing and the assumptions that they have used. Meaning that the trustees had certainty on the pricing up front when they paid the premium across at the point of signing and, therefore did not have an unexpected premium coming their way post-transaction after the data cleanse has been completed as a result of changes in this underlying data.

At this point, we will also put in place a price lock with the insurer, which means that the economics and the affordability of the transaction do not move away from you in the period between getting the final quotations from insurers and signing the contracts. For a typical pensioner buy-in, this is generally linked to gilts so as to provide certainty on the funding impact of the transaction. However if you are doing a buy-out it may be more appropriate for this to be linked to the schemes asset holdings.

A recent transaction we worked on completing the transaction was contingent on receiving a contribution from the employer and this contribution was of a limited amount due to affordability constraints. So what we did in this case was negotiate with the insurer so that the price lock was linked to the assets held by the scheme but also incorporated the cash top up that would be coming from the employer. As a result, the employer had certainty of the top up that was going to be required from them and they could be confident transacting whilst in a volatile market. Finally, once the deal completes we are still there to provide you with additional support as and when you need it. So for example, one of things that we will do and the majority of our cases is that we will hold a meeting with the schemes administrators and the insurer to talk through how the administration process will work moving forwards. This means that all parties know exactly what is expected of them and when and just helps things to run smoothly in the period immediately after the deal is signed.

So in summary the process has been designed to be efficient whilst also adding value for trustees. I will now hand over to Paul just to talk through some of the legal aspects of the streamline service.

Paul Feathers: Thanks Rachel. So the areas that I want to talk about in terms of benefits of a streamlined approach and legal aspects are both summarised on the slide there so in headline terms we have no hidden or additional negotiating costs. We have no negotiating delays, trustees benefit from increased negotiating leverage.

We think there is a really important governance aspect here as well, we think that it is consistent with good governance and trustee decision-making to factor in consideration around the contractual aspects of the insurers offerings at the right time, in other words before you have selected an insurer, and to do that through clear comparative analysis and that is what we offer.

Then for me, the most important of all of those points on the slide is it is just easier from a trustee perspective. Transacting with transfer trades can be complicated time consuming and fairly intense for trustees and the whole of their advisory team we want to try and make life as easy as possible for trustees and we think that following a streamline process helps us to do that.

So a little bit more on each of those points. First one: no negotiating costs What do I mean when I say that? The starting point is I am not going to pretend for a moment that well advised trustees could not obtain some of the concessions that we have obtained in a standalone negotiation with an insurer in relation to a standalone small scheme transaction. That could be the case, the issue though is for trustees and for their advisors negotiating takes time and I will also not pretend that lawyers' time is anything other than expensive. We know it certainly is not cheap. Whilst there is a cost element all pre-negotiating the contracts, the associated intellectual capital within the fees that streamlined structures tend to charge it is by no means the same level of costs that you would incur as trustees were you negotiating on a standalone basis and you also have the negotiating costs factored in up front such that you also obtain cost certainty.

So that is costs, how about delay? There are no delays due to negotiations, again negotiating takes time. Negotiations can delay transactions now you might say well we expect to have some negotiation during a transaction so does that really matter? I think it can, in worst case scenario I think that a delay can actually affect a transaction's economics. For that, it is very clearly the wrong outcome. The legal documentation should not get in the way of the trade it is absolutely the case that the legal documentation is intended to facilitate the agreed commercial position not to get in the way or frustrate it. I think another point just worth mentioning is, because we have pre-negotiated all of the contracts, we have carried out those negotiations in circumstances where we are not under time constraint rather than in the context of a live transaction or under pressure. Our experience is that has made for better decision making by all the parties concerned and frankly better outcomes in terms of the concessions that we have been able to achieve.

The next point I think it is an important one, it is one that Rachel touched on. We need to bear in mind that even though the LCP's streamline process for example considers transactions for schemes of up to £200 million. In the grand scheme of things, that is a relatively low value trade from an insurer's perspective. You will remember some of the big numbers that Dave started off with in terms of setting the scene.

So the important thing from our perspective is that we engage with the insurers and we persuaded them at the very outset that they really needed to enter into the negotiations on the contractual position looking at the bigger picture. They needed to look at the potential deal flowing through the whole of the streamline process and as Rachel already indicated really to approach this negotiation looking at the total value of liabilities that might transact through the streamline process rather than looking in isolation at the size of any particular transaction.

As a consequence of encouraging the insurers to adopt that mind-set we got to a position where the insurers are generally more prepared to make concessions than would be the case for an individual transaction that they would regard as a small trade. I am not just saying that, I know this is the case as Dave said in the introduction I spend most of my time working on advising either insurance companies or trustees in relation to its transfer transactions. I am not fortunate enough to always work with Dave and Rachel so I do work with other consultants, I do work on transactions outside of small schemes process and I have had circumstances where insurers have said to me when I have requested a particular position "we know that we have given you that in relation to the LCP streamline position Paul, but all bets are off with this transaction it is not the same this is an isolated individual transaction we are not prepared to give the same concession". So I know from experience that that does happen.

Just to give you a bit of context of the sort of areas where we have obtained concessions for the streamlined process, which are routinely readily available outside of it. There was a point that Rachel touched on in terms of data cleansing, the extent to which insurers would stand behind their demographic assumptions notwithstanding the outcome of claims. There are wider issues on data cleansing too. So particularly for pensioner buy-ins we are very clear that we would quite like trustees to be able to undertake a minimal level of data cleansing should they so desire on the basis that they would correct any mismatch between issue of benefits and scheme benefits at a later date prior to winding up. That is not normally insurers' preferred starting point but they have been far more accommodating on that particular point in my experience than the streamlined process than they typically would.

Flexibility in terms of cleansing or changes goes further than that too because we have also persuaded most of the insurers that participate to be very flexible in terms of making further changes at some point down the line in the life of a transaction after the initial data cleanse and in particular we have been able to negotiate favourable terms as to how those requests for further changes might operate.

Now the reason that those types of concessions can be difficult for insurers is not because they are being unreasonable but insurers sometimes have concerns about implications on the capital they need to hold or making commitments to enable trustees to make further changes later and so usually what you tend to find is provisions like this might find their way into the overall agreement with a trustee, either through a separate policy, usually called a gap policy or a through a side letter and you can imagine that if you are the insurer, and you have a standalone one off small transaction, it isn't necessarily attractive to you to have to invest the time and the effort in negotiating additional documentation to sit alongside the policy. The difference here is if we can negotiate a gap policy to achieve that or a side letter to achieve the sort of concession I am talking about we will then use that for subsequent transactions or the same insurer for the streamline process so we have had much more engagement and willingness from the insurers to be much more flexible in terms of what they can offer.

Some of the insurers are prepared to write contracts based on the trustee's own benefit specification rather than doing what insurers tend to prefer to do which is take the trustees benefit specification that the trustees have paid their advisors as something they need to prepare, and then we write to them in insurer speak. We understand why insurers want to do that they want absolute clarity as to the obligations they are assuming, the insurance that they are writing. That is quite challenging though from a trustee's perspective particularly for a small scheme because essentially you are then paying your advisors to review a replay of the work they have already done and charged you for in order to ensure that nothing has gone awry in that process of replay. Now if we can take that replay requirement away, I should emphasise that not all insurers that participate will agree to that and will. It is potentially a cost saving and a time saving feature for the streamline process.

I should also mention we have certainly obtained from a number of the participating insurers significantly more flexibility than we often see for PPF plus type cases so that is the case where a scheme is winding up but it has insufficient assets to fund the liabilities in full. The sort of areas where we obtained a good degree of flexibility are for changes to the shape of benefit between the point of which you originally pay your premium when you finish your data cleanse and also more flexibility than we might typically see in terms of whether the trustees might be able to pay subsequent additional premiums or for example they are waiting for further recoveries from the insolvency of their employer. So that is just some examples of why we are firmly of the view that the additional negotiating leverage about the streamline process offers can deliver real benefits to the trustees.

Then you recall that the other point I mentioned at the outset was that we think there is a really important governance benefit too. We all know that price is a key consideration for trustees, and so it should be, but we also think it is reasonable and proper that trustees also take into account the wider contractual framework that each insurer is offering in their selection process especially if the pricing is close. The pricing can be closer on smaller schemes than it occasionally is on larger transactions.

In a traditional structure, trustees would not normally have a chance to have a really good look at an insurer's contractual terms until they have entered into a period of exclusivity with that insurer. I argue that is a bit late really to start looking at contractual terms, because there are a couple of good reasons for that, first of all, there is only one horse left in the race you have lost your leverage to change those terms. Secondly you are not able to review those terms comparatively against terms that another insurer would offer because you have made your choice by then. The streamline approach enables the trustees to compare the insurers relative positions on a number of contractual terms that Gowling WLG and LCP have agreed that are really important. We do it on a comparative basis and we also do it on a basis that is relatively easy for trustees to absorb. The final slide I would just like to show you gives you an indication of how we actually convey the comparative insurer positions. You will see on this slide that there are lots of green flags, green is good, some amber flags not quite so compliable with the requested contractual term and occasionally you will also see a red flag which means that an insurer will not accommodate our preferred position at all on a particular term. Not to suggest that trustees could not possibly enter into a contract with that insurer.

So that is as I say just to give a bit of an example as to how we report on the insurers positions and to demonstrate that it is not a case of insurers having to read a 40, 50 page legal report going line by line through a whole series of different insurance policies.

So that is all I really wanted to say on the legal aspects so I will hand back over to Dave to wrap up. Thank you.

David: Thank you Paul. So, to close off this webinar I wanted to leave you with some key takeaways. I believe that the later part of this year offers some real opportunities for those trustees and companies wanting to do smaller buy-in or buy-out transactions. Really, because of the lower demand from large schemes and the historically attractive pricing that we have at the moment. Those schemes that are minimal still can take advantage of this through a streamline process that will allow you to transact quickly and efficiently and ensure engagement from insurers. I believe the LCP's streamline service for buy-in and buy-outs is ideal for this.

Thank you for watching this webinar and goodbye.