Aon’s recently released Global Pension Risk Survey 2021/22 showed that more UK defined benefit (DB) pension schemes are now opting for buyout as their long-term target rather than just self-sufficiency. To prepare for that, schemes are ever more aware that they need to take steps such as data cleansing, providing benefit specifications or agreeing their governance structure. They also know these projects need to start well in advance of a transaction to ensure no delays when the right insurer pricing becomes available. Schemes are also seeing the benefit of taking the same approach with their assets - investing with the endgame of buyout in mind and starting the preparation as early as possible.
Lucy Barron, partner at Aon, said: “Whatever the timeframe they have in mind for reaching their scheme’s endgame, trustees need to think about the most efficient investment strategy that will allow them to reach it. There are several investment options to consider that give schemes the best opportunities. For example, ensuring liabilities are fully protected against movements in interest rates and inflation helps reduce the risk of assets moving in a different direction – something which is increasingly a consideration.
“Trustees will need a portfolio that is well-diversified so that it can navigate volatility and generate the returns needed but with the least risk possible. It also needs to give them the option of sufficient flexibility and liquidity to capture opportunities should they arise earlier. Similarly, holding credit can provide some protection against insurer pricing moves, as it is often an attractive asset for insurers.”
Through working on over £7.8 billion of transactions in 2021 alone, Aon’s Risk Settlement team has found that early investment preparation offers schemes several advantages, including:
• avoiding roadblocks, such as long dated illiquid assets, which can increase risk and cost;
• matching insurer pricing more effectively by allocating more to assets such as gilts, swaps and credit;
• reducing exposure to assets that insurers do not want, such as growth assets that increase volatility against insurer pricing; and
• taking the option to integrate buy-ins as part of the overall plan, in order to reduce risk and cost ahead of full buyout.
Lucy Barron said: “There are good reasons for taking this more holistic approach to reaching a scheme’s endgame. The ultimate aim is for the scheme to get to buyout with reduced risk and more certainty. That involves thinking about managing longevity, investment and other risks such as movements in insurer pricing. In a very busy market, insurers will always prioritise well-prepared schemes – and that equates to better pricing and lower cost.
“The more schemes can do to make themselves stand out, the more they can increase competitive tension among insurers - one of the many factors that can lead to better pricing outcomes.”
Lucy Barron continued: “It’s also clear that this is now a more mature market with schemes having a greater understanding of what’s needed to get them to their endgame. As advisers, we can help create a journey plan to buyout, which takes into consideration investment and longevity risks, including the use of buy-ins at the right time.
“We increasingly offer schemes a flexible toolkit – including using synthetic credit as a less expensive and more adaptable way of adjusting credit exposure and locking into insurer pricing. We are also helping schemes to set strategic targets for hedging and credit exposure, and then adjusting them based on insurer feedback and market conditions.
“But there is no substitute for market knowledge, so an understanding of insurer investment strategies allows schemes to make better decisions, either by having their investments aligned with those of insurers ahead of reaching full buyout funding, or by managing themselves out of illiquid assets with the least risk and cost.”
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