Out-Law Analysis 5 min. read
19 May 2023, 2:51 pm
Pensions risk transfer deals vary considerably. Some will be modest little things, others will be all-consuming beasts.
But whatever the shape, size and temperament of the deal, they have one thing in common: they need proper structure and planning, lest they become unruly. Good governance is vital.
In this guide, we explore how to get governance right on a risk transfer transaction.
As the demand for risk transfer solutions grows, insurers are having to make careful decisions about how they prioritise resources. To get the right level of engagement from the insurers, and the best pricing, it is important for trustees to be able to demonstrate that their scheme is genuinely ready to transact.
Preparation is important in this regard. Trustees should develop clearly defined purchasing criteria for a successful transaction, which will help them to decide quickly whether or not to proceed with a quotation. Some work may well be needed to get the scheme’s data into the best possible condition. Plans should be put in place for correcting any material gaps or inconsistencies. The more accurate the data, the sharper the pricing and the easier it will be to provide the data warranties requested by the insurer.
Trustees should also be thinking about the benefits to be insured and arranging for their lawyers, consultants and administrators to prepare a full benefit specification, not just a high level version used for brokering purposes. This can reveal the occasional discrepancy between the benefits and rules which needs to be ironed out before a transaction can progress, and certain tricky benefits that may be difficult to insure.
Trustees should also consider any benefits which involve an element of trustee discretion – how should these operate during the buy-in phase, what will the pricing impact be, and will it be legally possible to buy-out benefits on that basis?
Begin with the basics – whose decision is it to enter into the transaction? For a buy-in, the decision is an investment decision and ultimately rests with the trustees. However, the sponsoring employer must be consulted, and many trustees are understandably reluctant to proceed without sponsor support. For a buy-out, the position will depend on the powers in the trust deed and rules. These should always be checked, to ensure the trustees have appropriate powers to enter into the transaction and that there are no other formalities or restrictions which need to be considered.
Where the support of the sponsoring employer is required, the parties should agree their requirements at an early stage, along with the process and timetable for the sponsor to reach a firm decision. This will help to avoid any late surprises – the accounting impact for the sponsor is an issue that should be considered as early as possible.
It is now common for trustees and employers to collaborate using joint working groups. This can be a very effective way of ensuring that the needs of both the trustee and the employer are met. Care must be taken, however, to ensure that the roles of the various advisers are defined clearly at the outset, to avoid any duplication and to ensure that the trustees’ advisers can provide the advice the trustees need to approve the deal.
Where trustees delegate powers to a joint working group or a trustee sub-committee, the scope of that delegation should be considered carefully. The transaction timetable needs to allow a suitable window for the trustees to consider their professional advice and reach a decision, in good time ahead of the relevant dealing dates for the payment of the premium. The insurers also have their own approvals processes which need to be factored into the timetable.
Because the bulk annuity market is currently very busy, trustees’ bargaining power will be limited to a degree. Trustees should therefore consider how to make best use of any competitive tension they can generate, to secure a deal which fully meets their particular requirements.
Pricing is crucial, but it is not the only factor that trustees should consider. The insurer’s reputation, administration capabilities, solvency, and business model all merit consideration, as do the insurer’s proposed terms for the bulk annuity policy. This is because, whilst the pricing dictates what the trustees will be spending, the legal terms dictate what they will receive in return.
In many cases, trustees should draw up a “heads of terms” or requested contractual terms (RCTs) list for the bulk annuity contract. The insurers can then confirm the extent to which they would be prepared to meet these requirements, as part of the tender process. The insurers’ responses can then be graded, giving the trustees an overview of each insurer’s proposition relative to the others. For smaller deals, the core requirements can be set out in the ‘request for quotation’ document.
This helps the trustees to identify any potential deal-breakers at an early stage, and to lock-in agreement on the main points before the contract negotiations commence, while the trustees have maximum leverage. It also gives trustees invaluable insight to the insurer’s approach to partnering with them, at the start of what will usually be a long-term relationship. From the insurer’s perspective, it should lead to a smoother and quicker negotiation around the terms of the contract, reducing the risk of slippage or, in a worst case scenario, the parties being unable to agree terms.
Pensions risk transfer deals are seldom straightforward. Even for ‘vanilla’ deals, the legal terms can be complex. Trustees will therefore rely on their professional advisers to confirm that the deal is right for the scheme, and that the terms are reasonable.
This sounds straightforward, but in practice there can be a lot of overlap between the investment consulting, actuarial and legal aspects, and this can lead to a blurring of accountability. We would encourage trustees to sit down with their advisers at the outset and draw up a simple checklist of the advice that will be needed, and to allocate the responsibility for that advice to the appropriate person(s).
Trustees are also likely to require some assurances from their advisers and administrators, to support the various warranties the trustees are required to provide and their duty under the 2015 Insurance Act to make a fair presentation of risk to the insurer. The scheme’s lawyers should begin this process as soon as possible. The administrator should also be asked to confirm that no member of its staff would be in line for a TUPE transfer to the insurer, were the payroll function to be transferred. This is rarely an issue for smaller schemes, but it does crop up from time to time, resulting in the need for further negotiations with the insurer and the administrator.