ACA conference can bulk annuities be good value? Colin Parnell 26 - - PowerPoint PPT Presentation

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ACA conference can bulk annuities be good value? Colin Parnell 26 - - PowerPoint PPT Presentation

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ACA conference can bulk annuities be good value? Colin Parnell 26 January 2018 Commercial in Confidence 1 Summary 1. Why is insurance so expensive? 2. How can I assess value of buy-in or out? 3. Opportunities for savings 4. Risks that

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1 Commercial in Confidence

ACA conference – can bulk annuities be good value?

Colin Parnell

26 January 2018

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2 Commercial in Confidence

Summary

  • 1. Why is insurance so expensive?
  • 2. How can I assess value of buy-in or
  • ut?
  • 3. Opportunities for savings
  • 4. Risks that may seem expensive to

remove

  • 5. Which schemes are transacting and

how are they doing it?

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3 Commercial in Confidence

  • 1. Why is insurance so expensive
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4 Commercial in Confidence

Key definitions in the insurer balance sheet

Solvency Capital Requirement (SCR):

  • Capital insurers must hold under the Solvency II regulatory regime;
  • Circa 1 in 200 confidence level (annual probability of failure);
  • Breach this and the regulator will get involved;
  • Shut to new business and come up with a short term plan.

Minimum Capital requirement (MCR):

  • Absolute minimum, breach this and insurer “insolvent”;
  • PRA would take full regulatory control before breaching this.
  • Circa 1 in 85 level of confidence (annual probability of failure).

Risk Margin

  • Additional sum to pay a third party to take on insurer’s assets and liabilities;
  • Covers non-hedgeable risks eg mortality;
  • Can be volatile with changing long term interest rates.
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5 Commercial in Confidence

The prudence of insurers (reserving and protection)

Wider insurance group support PRA Insurance regime Corporate bonds, government bonds, equity release, infrastructure Surplus SCR MCR Risk Margin

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6 Commercial in Confidence

Summary of my buy-out assumptions

Asssumptions Non-retired discount rate Interest rate swaps curve - 0.4% Retired discount rate Interest rate swaps curve + 0.05% Inflation (RPI) RPI inflation swaps curve Inflation (CPI) RPI less 0.4% Mortality base table S2PA with adjustment for prudence Mortality future improvement CMI model with 1.75% pa future improvement

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7 Commercial in Confidence

  • 2. How to assess the feasibility of a buy-
  • ut
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8 Commercial in Confidence

Realistic Scheme Balance Sheet

PV of ongoing running costs much higher - circa £4m

COMMENT: Foreign parent company agreed to pay in an additional contribution to wind up scheme

“1 in 200” prudence Weak employer, “50/50” prudence?

£’000 £’000 Liability Values: Buy-out TPs ‘Best’ insurance price 37,500 24,600 Liability for GMP equalisation 400 350 Liability NRA equalisation 900 850 Correction of problem with pension increases 300 250 Fees associated with wind up/Ongoing expenses allowance 600 740 Estimated total liabilities 39,700 26,790 Asset Values: Scheme’s assets 14,000 14,000 Net current assets 900 900 Total assets 14,900 14,900 Surplus/(Deficit)

  • 24,800
  • 11,890

Estimated funding level 38% 56%

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9 Commercial in Confidence

Buy-out premium versus asset value

COMMENT: Improved funding may lead to a rush for the exit in 2018

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10 Commercial in Confidence

  • 2. How to assess the feasibility of a

pensioner buy-in?

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11 Commercial in Confidence

Funding effect of pensioner buy-in – Technical Provisions

funding strain £1.2m

COMMENT: Company agreed to pay in an additional contribution at the end of the Recovery Plan

Before annuity purchase After annuity purchase Liability Values:

Non-pensioners on TP basis £14.6m £14.6m Uninsured Pensioners £33.7m £34.9m

Total liability £48.3m £49.5m Asset Values:

Invested assets £43.5m £8.6m Additional bulk annuity policy £0.000m £34.9m Estimated expenses associated with transaction (not met by Employer) £0.000m (£0.15m)

Total Scheme assets £43.5m £43.35m Shortfall £4.8m £6.15m

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12 Commercial in Confidence

Pensioner buy-in cost versus gilt-based value

COMMENT: now seems like a good time to do a pensioner buy-in.

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13 Commercial in Confidence

Why would I insure, mortality improvements are slowing?

0.7% pa 1961-1975 1.8% pa 1975-2000 3.1% pa 2000-2011 0.7% pa 2011-2016

COMMENT: UK average improvement in longevity (ages 50-89) has been volatile (CMI 2017)

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14 Commercial in Confidence

Agree a price objective and assess regularly

COMMENT: agree legal contracts in advance and have a simple decision rule

Strike price

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15 Commercial in Confidence

Investment effect of a pensioner buy-in

Lower expected investment return post buy-in

COMMENT: Employer agreed that the lower investment return was acceptable as buy-out is the ultimate goal

Expected investment return above gilts Actual allocation (pre buy-in) Actual allocation (post buy-in) Global Equities 3.5% 16.0% 16.0% Diversified Growth Fund 3.0% 13.0% 3.0% Growth assets 29.0% 19.0% Over 10yr Active Corporate Bonds 0.9% 57.0%

  • Over 15yr Fixed Interest

Gilts 0.0% 14.0%

  • Bulk annuities ( Buy-In)

0.0%

  • 81.0%

Matching assets 71.0% 81.0% Expected return in excess of gilts (p.a.)

  • 1.5%

0.7% Hedge Ratio – interest rates

  • 41.0%

55.0%

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16 Commercial in Confidence

  • 3. Opportunities for savings
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17 Commercial in Confidence

Running costs fall with larger groups of members

Source: Defined benefit (DB) scheme running cost research (2014), tPR

QUESTION: how can scheme consolidation provide a more affordable solution than buy-out?

Average scheme running costs (£ per member per annum)

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18 Commercial in Confidence

Case study: retirements generate material savings

Retirement lump sums paid out £87,000 Commutation factors lower than the buy-out cost (factor circa £17 per £1 pa pension) Pensions paid £10,000 Small amount of pensions paid out before insurance purchased Premium reduction (£300,000) Insurer calculated premium £300k lower due to the four retirements Saving on retirements £203,000 Circa £200k savings generated by just four retirements

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19 Commercial in Confidence

Transfer values are typically lower than buy-out costs

QUESTION: As Scheme Actuary, knowing that buy-out is imminent, would you be willing to recommend transfer values at below the buy-out cost?

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20 Commercial in Confidence

How to identify where cost savings can be made

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21 Commercial in Confidence

Case study: unknown demographics

Marital status and age differences unknown at the outset Pensioner buy-in executed with assumed marital status – data collection delayed Collected marital information post deal All execs were married with much younger wives. Remaining members were more likely to be single or spouse similar age 10% rise in annuity premium post transaction once true demographics were known Learning point: best to fix costs up front

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22 Commercial in Confidence

  • 4. Risks that may seem expensive to

remove

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23 Commercial in Confidence

Compliance, legal and data – costs, risks and remedies

COMMENT: insurers take on very little data and benefit risk – remove, manage or insure

Stage 1 Stage 2 Stage 3 Stage 4

Pre pricing Price discovery Execute transaction Implementation

  • Data processing notices in

place

  • Minimal gaps
  • Legally reviewed benefits

in benefit specification

  • Ensure members are alive
  • Marital status obtained
  • Review benefits versus

admin practice and actuarial understanding

  • Decisions on discretions
  • Source estimates of

unquantified liabilities and benefits

  • Amend any benefits that

cannot be insured

  • Provide additional data

requested by insurers

  • Manage member

movements

  • Exclude members eg

WULS eligible members

  • Minimal changes
  • Finalise data and

definitions for transaction

  • Manage member

movements

  • Exclude members eg

WULS eligible members

  • Minimal changes
  • Complete gaps in data
  • Random sampling
  • Self certification
  • Manage member

movements

  • Complete options

exercises

  • GMP rec complete
  • GMP equalisation
  • Notice in newspapers
  • Parallel payroll
  • Balancing premium
  • Individual policies
  • Contractual deadline

12 weeks 1 to 2 years 2 weeks to 3 years

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24 Commercial in Confidence

Areas where insurance may seem expensive

Young and rich RPI/CPI gap Hard coded member

  • ptions

“Better of” or Money Purchase benefits Very wide eligibility criteria Unusual inflation indices

  • r high pension

increases

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25 Commercial in Confidence

  • 5. Which schemes are transacting?
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26 Commercial in Confidence

Which schemes are seeing value in insurance?

COMMENT: insurers take on very little data and benefit risk – remove, manage or insure

12 weeks 1 to 2 years 2 weeks to 3 years

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27 Commercial in Confidence

Looking good – how you can add value?

Make your pension scheme attractive to insurers

Clear, agreed price objective and transaction process Assets aligned to annuity price with liquid assets. Monitor closely Clean membership data and clear benefit description Company implications considered and clear transaction timeline Attractive demographic profile and simple benefits

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28 Commercial in Confidence

My conclusion

Bulk annuity insurers offer the best value, low risk solution for UK pensions:

  • Low risk regulatory regime
  • Huge scale drives efficiency
  • Experts in risk management
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29 Commercial in Confidence

Questions?

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30 Commercial in Confidence

Thank you

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31 Commercial in Confidence

Regulatory Statement

The purpose of this presentation is for presentation at the ACA Pensions Conference, Gatwick 2018. This presentation may be viewed by the attendees for the purposes of their Continuous Personal Development only. It may not be copied in whole or in part or passed to third parties that did not attend the conference. The views expressed are those of the speaker, not Capita This work is not being presented to any specific user and is not intended to prompt any specific action or be relied upon by the audience to make any decisions, it doesn’t fall within the definition of technical actuarial work and need not comply with TAS 100. The information contained within this presentation does not constitute financial advice. The information provided is based on our understanding of current law and taxation as at 26 January 2018. HMRC policy, practice, and legislation may change in the future. Capita Employee Benefits is a trading name of Capita Employee Benefits Limited and Capita Employee Benefits (Consulting)

  • Limited. Part of Capita plc. www.capita.co.uk. Capita Employee Benefits Limited and Capita Employee Benefits (Consulting)

Limited are registered in England & Wales No: 02260524 and 01860772 respectively. Registered Office: 17 Rochester Row, Westminster, London, SW1P 1QT. Separately authorised and regulated by the Financial Conduct Authority.

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32 Commercial in Confidence

Can bulk annuities be good value?

199 in 200 probability

  • f getting 100%

benefits Buy-in or out implies investment return of swaps

  • r swaps minus

Most small schemes running higher risk and higher returns but not efficient Large arrangements may be low risk and more efficient (PPF, BHS) Higher return and lower risk preferred