Out-Law Analysis 4 min. read

Pensions risk transfer: material change

In the context of pension scheme buy-ins, there may be a need for trustees and insurers to negotiate contract terms to reflect the potential for insurance premiums quoted to be adjusted following the data cleanse exercise.

Trustees and insurers will commonly have different perspectives on these ‘material change’ terms and when they should be triggered.

Material change – what is it?

Buy-ins involve the trustees paying an initial premium quoted by an insurer. After that, the trustees will complete a data cleansing process to correct any inaccuracies in the quotation data.

At the end of the data cleanse, the insurer recalculates the premium payable to secure the benefits based on the corrected data. If the liabilities have gone up as a result of the correction, an additional premium will be payable. If the liabilities have gone down, a refund may be due to the trustees.

From the trustees’ perspective, they will want as much certainty as possible regarding how this premium adjustment process will work. Ideally, they will want the insurer to use the original quotation pricing basis wherever possible so that they can plan in advance for any extra costs.

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The insurer’s perspective is different. The insurer will want to be protected against a scenario in which there has been a “material change” in the nature, quantum or duration of the liabilities it is being asked to insure following the data cleanse. If things do look materially different after the data cleanse, the insurer might argue that it would have used a different basis for pricing the deal had it known the correct position all along and that the quotation pricing basis is no longer appropriate. In those circumstances, the insurer will want various remedies where a “material change” of this nature has occurred.

There are a number of strands to these “material change” terms that can generate negotiations between trustees and insurers during the buy-in process.

Material change triggers

A material change will usually arise if, for example, the final premium is more than a certain percentage outside the quotation premium. Many insurers’ standard terms say that a material change will be triggered where the final premium is greater than 105% of the quotation premium or lower than 95% of the quotation premium.

One of the trustees’ aims during negotiations will be to limit the circumstances in which a material change will occur. They may try to negotiate a wider material change corridor – for example, greater than 110% and lower than 90%. Even where trustees manage to negotiate preferential material change terms, they should be confident that the triggers are unlikely to be met given the potential cost consequences if a material change occurs.

If a trigger does occur, the insurer will have more options regarding how it adjusts the premium. This could end up costing the scheme, and potentially the employer, a significant amount.

Material change remedies

In terms of remedies, the insurer will want the option to recalculate the balancing payment due post-data cleanse based on its prevailing pricing basis for new business. This may be more costly for the trustees.

Trustees will typically argue that the prevailing pricing basis should only apply to the slice of the liabilities that falls outside of the material change corridor. For example, if the material change corridor goes up to 105% of the quotation premium, and the final premium ends up being 108%, the trustees will only want the insurer to be able to apply the prevailing pricing basis to the 3% excess above 105%.

The insurer may not necessarily be able to agree to this because its approach to pricing cannot easily be applied in this way. Quite often the practical compromise is to agree to widen the corridor so that the trustees can be confident the remedy will not be triggered in the first place.

Material change exclusions

There are certain specific types of corrections to the quotation data that trustees will often know they will have to make during the data cleansing period. For example, they may expect to make corrections to benefits flowing from any GMP equalisation or reconciliation exercise, or they may plan on completing a project to check spouse’s dates of birth and the martial status of members.

The trustees’ stance will often be that as long as they have been transparent with the insurer about their plans any data corrections to do with these exercises should be carved out of the material change test altogether. There will often be some commercial negotiation about what the insurer can accept here.

Transparency over insurer calculations, commercially sensitive information, and disclosure to the expert

There is a tension between the trustees’ need to ‘kick the tyres’ on an insurer’s calculations and the insurer’s desire not to disclose commercially sensitive information. Under the terms of the buy-in, insurers may agree to disclose this information to an independent expert to assess whether the insurer’s calculations are reasonable and made in accordance with the bulk purchase annuity contract. This can offer the trustees some comfort that calculations are being carried out correctly even if the trustees do not have a right to see the calculations.

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