It seems that every company with a final salary pension scheme is looking at
the merits of buyouts. Recent months have seen big deals for Goldman Sachs,
Legal & General, Nor-wich Union and Paternoster, and the first FTSE-100
companies embracing the market including Friends Provident and Lonmin. But what
is all the excitement about?
The interest has been driven by the rapid growth in the buyout market since
late last year and by a gradual realisation that real de-risking opportunities
Lane Clark and Peacock’s Pension Buyouts 2008 report, Guide to eliminating
pension risk in the buy-out market, revealed that more than £4 billion of buyout
business was written over the six months to 31 March 2008, a seven-fold increase
on the previous six months.
Two main types of insured pension buyout have become popular: Pensioner
buyouts to reduce risk for continuing schemes, and full buyouts, designed to
give companies a clean break from pension liabilities.
A pensioner buyout (or ‘buy-in’) provides an attractive half-way house for
eliminating pension risk at a more affordable price than a full buyout.
What essentially happens is that the trustees change their investment
strategy to reduce the level of risk in the scheme. This is achieved as the
buyout policy exactly matches future pension payments from the scheme for
current pensioners all investment and longevity risks for these members are
passed to the insurer.
A key advantage of pensioner buyouts is that they can be structured to fit
with the ongoing running of the scheme, and with the same board of trustees and
company relationship continuing.
Several high profile pensioner buyouts have now been completed. We assisted
Hunting to complete the market’s first £100m-plus pensioner buyout in January
2007. More recent transactions include P&O’s £800m pensioner buyout with
Paternoster, Weir Group’s £240m pensioner buyout with Legal & General and
Morgan Cruciable’s £160m pensioner buyout with Lucida.
A key driver has been price. With insurers competing to gain or maintain
market share and movements in financial markets, partly due to the credit
crunch, the price of pensioner buyouts have become attractive.
For some schemes the price is now less than the assets in their funding
reserves. But, the pricing is volatile and as the credit crunch eases there are
signs of buyout prices rising.
There are other significant advantages of pensioner buyouts compared to the
traditional approach. They can be structured to fit in with the ongoing running
of the scheme, with the same board of trustees and the company relationship
continuing as before.
As the transaction can be completed at arm’s length from members so that they
notice no change, it can be appealing for many schemes and employers. This is
possible because the buyout contract is simply a trustee investment. It is often
seen as a way of ‘downsizing’ the scheme and suits a strategy of targeting
eventual wind-up in a number of years’ time, while taking advantage of the
current low prices.
The accounting treatment can also be helpful. Under UK and international
GAAP, as an investment of the scheme, any difference between the buyout price
and the liability held on the balance sheet will, in many cases, sweep outside
of the profit and loss rather than be recognised as a settlement charge, which
occurs for a full buyout.
The past 12 months has seen at least one deal involving a buyout of pensions
not in payment. In March 2008 we helped a client complete a buyout of active
members who were still in service with the employer and accruing new benefits.
Full buyouts: a clean break
Under a full buyout, all of a scheme’s liabilities are transferred to an
insurer. This is usually followed by the scheme winding-up. Although more
expensive than a pensioner buyout, and beyond the reach of most schemes, full
buyouts can solve problems in certain situations. For example, a company may be
willing to pay the necessary premium to remove a legacy issue, or prepare the
ground for a corporate restructuring or takeover.
Increasingly additional non-standard risks are being transferred to insurers
to provide employers with a clean break from any residual pension liabilities.
Recent full buyout transactions, such as Emap, Rank and M-Real, have included
structures to achieve this. The advantage is that the responsibility and
associated costs of winding up the schemes is transferred from the scheme
employer. The employer then benefits from a clean break, while the trustees and
members have the comfort that benefits are secured in full with an insurance
company regulated by the FSA.
Who is the ‘buyout’ for?
Typically the schemes and companies that can benefit most from a pension buyout
- Mature schemes with a high proportion of the liabilities relating to
pensions in payment;
- Schemes that are reasonably well funded and so can buy out some or all of
their liabilities at little (if any) extra cost to the employer;
- Companies/schemes that are keen to ‘de-risk’ and remove volatility in their
pension costs and balance sheet and;
- Companies involved in corporate restructurings/takeovers which are prepared
to pay to take pensions ‘off the table’.
Charlie Finch is a partner at Lane Clark & Peacock
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