Does full insurance remain a sensible end game target for pension schemes post Covid-19?

The Covid-19 pandemic has reinforced two of our key beliefs

• Full insurance remains an appropriate long term aim for many Pension Schemes
• Schemes who are on the front foot when it comes to preparing for insurance can benefit in an environment where others struggle.

Full insurance as a long term target in the context of Covid-19

The disruption caused by Covid-19 has amplified the challenges that many pension schemes face. Currently, the trustee of a typical scheme may be juggling understanding the impact of volatile markets on assets and complex liability structures with monitoring the financial strength of a sponsoring employer against a rapidly shifting economic backdrop. To help navigate these challenges, most trustees assess decisions in the context of a long term strategy centred around a long term objective. For many schemes, insuring benefits is part of the long term objective and to us, the rationale supporting this objective has been reinforced by the Covid-19.

Why? Contrast the situation described above with that of a Trustee of a scheme that has insured all or a significant portion of member benefits. The main concern for this Trustee is around gaining comfort that an insurer can continue to pay member benefits and insurers have weathered the storm to date well from both a financial and operational perspective. With reduced or relinquished reliance on sponsor covenant, and funding and investment decisions now in the insurer’s court, an economic crisis is a timely reminder of the benefits of buy-ins and buy-outs.

Benefiting from being on the front foot

Some key learnings on how to incorporate buy-ins and buy-outs into long term strategy have emerged from the Covid-19 crisis.

Insurer pricing evolved as the Covid-19 pandemic developed. In mid- to late- March a spike in credit spreads led to a significant improvement in pricing (as credit spreads are key component of insurer pricing). Since then, credit spreads have contracted, but are still at higher rates than would have been considered “normal” pre-Covid-19. This has resulted in insurer pricing settling at attractive levels when considered vs pre-Covid-19.

Schemes that were part way through an insurance transaction in mid-March were perhaps in the “right place at the right time” and could make the most of the short lived spike in credit spreads (and for some this could have been more by luck than by skill). However, in the market environment that is emerging, it is the schemes that are on the front foot when it comes to integrating buy-ins and buy-outs into the long term plan that will be in a position to benefit from current favourable market conditions (i.e. more by skill than by luck) and lock-in improved pricing.

So what does that mean in practice? i.e. what does it mean to be on the front foot when it comes to integrating buy-ins and buy-outs into your long term plan? To us, it means having a strategy in place centred around the following five key principles:

1. A clear estimate of the cost of full insurance informed by ongoing market pricing (in our experience this is often significantly less than the wind-up figures quoted in an actuarial valuation report).
2. A robust projection built around this estimate, incorporating expected contributions, investment returns, and developing maturity profile.
3. A low risk investment strategy that aims to largely neutralise the key risks that affect buy-in pricing such as interest rates, inflation and credit spreads, whilst targeting an expected return consistent with the estimated cost of full insurance. Barriers to transacting, for example around illiquid assets are minimised.
4. Consideration of giving members flexibility in relation to their options (either as a trustee or company initiated exercise) as a means of reducing risk, improving the funding position and ultimately reducing the time to full insurance.
5. Putting in place an effective governance framework – not only to monitor buy-in pricing, but to work actively with insurers to give the ability to lock into market opportunities as and when they arise. This includes building understanding and consensus with key stakeholders and planning around the practicalities of full insurance, for example ensuring benefit data is ‘clean’ and understanding accounting implications.

Now more than ever, it important to revisit long term objectives and in doing so incorporate learnings from Covid-19. Covid-19 shouldn’t result in abandoning long term plans, it has showed us that preparing sooner for the bulk annuity market and incorporating these five principles in your long term plan will put you ahead of the rest, in a position to reap the rewards in future.