Should you invest like an insurer ahead of buyout?
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Insurers might take on assets from very large schemes but for small schemes, deals are typically funded in cash – so should they bother to ‘invest like an insurer’?
In the past few weeks, news of multi-billion pound risk transfers have been chasing each other. The Asda Group Pension Scheme, National Grid UK Pension Scheme, Allied Domecq Pension Fund and telent’s GEC 1972 Plan all agreed deals, as did Tate & Lyle, the Rolls Royce UK Pension Fund and British American Tobacco.
Moving such huge schemes to an insurer is likely to involve the transition of existing assets. Trustees are often told that if they are looking for buyout, they should seek to align their portfolio with an insurer’s in order to be more attractive – but is this true?
‘Don’t try and match what we do’
Rothesay Life does not seem to agree. “Don’t go and try and match what we do,” the firm’s business development lead Sammy Cooper-Smith said at a Hymans Robertson seminar held in September.
“You’ll be told this is how the insurer wants it,” but the insurer more often than not will not be interested in taking on the assets, leaving the scheme “stuck” with it, said Cooper-Smith.
For example, certain corporate bonds are not eligible for insurers due to regulation, he pointed out – which might originally have been sold to schemes as having a yield pick-up because there is no competition from insurers. “Keep it as vanilla and simple as possible,” he said.
Illiquid assets – much touted as providing yield and cash flow – are also becoming more of an issue, it appears.
Head of origination structuring at Pension Insurance Corporation, Uzma Nazir, speaking at the same event, said: “Often we get asked by trustees, ‘Can you take on illiquid assets?’”
She noted that this can be a struggle especially where such assets involve bilateral arrangements, as the other party might not want to pass the asset on to the insurer. However, Nazir is hopeful that transitioning such investments will become more straightforward, as “over time the industry should develop, and it should become more liquid”.
Assets moving away from pricing can scupper a deal
But aligning a scheme’s portfolio is not just about an insurer taking on assets, said Adam Davis, managing director of derisking specialists K3 Advisory.
The chances of an insurance company taking on the assets of a small to medium sized scheme are low. Insurers are large organisations managing billions of pounds and “are just not interested in having small holdings of bits and bobs of assets”. Therefore, “It’s really difficult, certainly at the small and medium end of the market, to do anything other than a cash trade with the insurer,” he said.
Despite this, schemes nearing buyout should think about aligning their assets, as the last six months have shown that market movements can be dramatic, he said, “which has meant that schemes that were unhedged have moved significantly away from buyout”.
“Moving assets to align to where insurers price would be very sensible from that perspective,” he added.
Once they are in a position to trade, schemes should think about buying assets – typically gilts and corporate bonds – that immunise them against movements in insurer pricing, he believes, even if it might not be a perfect match.
Davis recalled a recent transaction with a £10m scheme where the price movement was locked into a basket of gilts for period of two to three weeks between selecting the insurer and signing the contract. “The scheme then had the ability to go and invest in those gilts and was absolutely perfectly immunised against how the insurer’s price was moving,” he said, adding that if this option could be obtained for a small scheme, it will be available to most schemes.
Lucy Barron, an investment partner at consulting firm Aon, agreed it is difficult to match insurers’ investments – in part because there is no uniform investment strategy between the eight insurers active in the buyout space.
“Looking at the different assets held in each insurer’s back book there are significant differences in the amount and split of gilts, corporate bonds and the type and size of allocation to illiquid asset classes,” said Barron. “This can make it challenging to match pricing ahead of knowing which insurer you will be transacting when you are a long way out from any transaction.”
In any case, their portfolio only tells you what assets they used to back deals historically – which is no guarantee that they will invest in the same assets in future.
But once schemes are around 12-18 months away from a buyout, they should increase liquid assets and ensure high interest rate and inflation hedging is in place, to ensure assets can either be sold easily and gilts and bonds transferred.
Even large schemes might want to adjust their investments; even though insurers are generally more ready to discuss asset transitions, “even for these larger transactions, whilst we have seen more flexibility and willingness to accept derivative holdings, the insurers can still be heavily constrained by the requirements of the Solvency II insurance regulations”.
How can schemes best prepare their portfolios for buyout?