Despite recent market volatility, a combination of strong long-term returns across growth assets, company contributions and, latterly, real interest rate increases have resulted in improvements across the funding levels of many defined benefit pension schemes on an endgame basis. With the endgame now in sight, trustees have begun to turn their attention to what a suitable target might be and how to get there.
For lots of schemes, buyout is seen as the ultimate endgame objective. But how do you decide whether it’s right for your scheme and what the next steps are once you have? In this blog series, we’ll be guiding you through the six steps to buyout to help you navigate your journey. If you need any support along the way, please get in touch.
Step 2: Beginning your journey to buyout
If and when you’ve agreed that buyout is the most suitable endgame objective for your scheme (Step 1: deciding whether buyout is right for your scheme), the next step is deciding when you’re ready. When should you start engaging insurers, how do you go about that and what should you do with your assets in the meantime?
When should you start preparing?
As the saying goes, “the early bird catches the worm”. A buyout-ready portfolio will differ from that of a scheme targeting low dependency, even when you’re five-plus years away from your target. For a full buyout, insurers typically look for certainty around assets being sufficiently liquid and aligned to liabilities (typically gilts and cash by the very end), so it’s important you have a plan in place to transition to this type of portfolio over time. This will also influence the type of assets you hold in your portfolio now – for example, if you’re a few years off from buyout, you should steer clear of illiquid assets. Importantly, a scheme’s funding position can improve faster than anticipated and so buyout may be feasible sooner than planned.
While we advise our clients to tailor their portfolios to their target endgame, we appreciate that sometimes targets change. Therefore it can be helpful for any strategy you implement to give the scheme appropriate flexibility in this respect.
How can you monitor your progress towards buyout?
At Redington, our approach is to set up a tailored ‘Buyout Risk Management Framework’ (BRMF), which is a one-page dashboard that allows you to monitor key metrics along your journey towards buyout, guiding your investment decision-making. We’ll share more on our BRMF in a later blog.
When should you get insurers involved?
Based on our modelling, we can estimate the probability of your scheme achieving buyout within the next three years from a range of assumed buyout basis funding levels. This can facilitate a discussion around when to begin engaging with insurers. We recommend most schemes start to discuss prices with insurers once their buyout basis funding level reaches 95% or more, reflecting the time it can take to complete such a transaction and the variations often observed between insurers’ pricing, which can be several percentage points. For larger schemes, we’d suggest engaging with insurers slightly earlier due to insurance market capacity considerations.
Now you’ve seen some quotes, what’s next?
Receiving a quote is the easy bit – insurers have detailed requirements regarding the quality and description of your liability data and the nature of the assets held in your portfolio. The drawing up of this liability information usually requires the input of your legal adviser as well as your actuary. Our next two blogs will focus on how you can begin to prepare your portfolio for insurers, starting with LDI and moving on to growth assets.
Unless indicated, these are the views of the author and may differ from those of the firm.