What do pension trustees need to consider with reinsurance?

Written by James Duggan, Client Director, Vidett

Earlier this year we hosted our Vidett Risk Transfer Conference, bringing together industry experts. We were joined by Phoenix Group, Just and Hymans Robertson for a session on reinsurance to explore the latest trends and key things pension trustees need to know.

The market is growing, with no signs of stopping!

The bulk purchase annuity (BPA) market – whereby UK defined benefit (DB) pension schemes secure liabilities with specialist insurers – continues to expand. Predictions say the UK life insurance industry could onboard more than £500 billion of pension liabilities and associated assets over the coming decade.

When a trustee board enters into a bulk annuity transaction buy in or buy out), they’re managing risk by passing longevity, investment, inflation and interest rate exposure to the insurer. Reinsurance involves the insurer passing some, or all, of these risks on to a third party. Most common are:

• Longevity reinsurance – typically standardised with the insurer and reinsurer agreeing fixed demographic assumptions for the life of the contract in advance.
• Funded reinsurance – usually a bespoke solution, with both investment and longevity risks being transferred. A portion of the buy-in/buy-out premium received from the pension scheme is passed to the reinsurer often, but not necessarily, overseas. The reinsurer is then responsible for providing monthly benefit payments to the insurer, which are passed onto the pension scheme or (following buy-out) the pensioners directly. It is similar to the insurer entering into its own buy in arrangement.

Most insurers look to reinsure most of their longevity risk to optimise capital and manage the overall risks on their balance sheet. It enables them to price bulk purchase annuities better and increase capacity for taking on more business.

What do pension trustees need to consider?

• Pricing – reinsurance is a fundamental part of pricing for bulk annuity transactions and trustees should expect it to be a key factor. Particularly for smaller deals, insurers may have pre-agreed terms with the reinsurer which can remove some of the bespoke pricing.
• Process – insurers increasingly need to build reinsurance into their process, which can add time to completing a deal for agreeing pricing, data sharing etc.
• Security issues – trustees need to get comfortable with reinsurance, particularly funded reinsurance, as a concept and whether there are security implications to consider. A bulk annuity purchase is typically one of the biggest decisions for a trustee in the pension scheme’s life cycle, so the security of the contract is fundamentally important.

Trends in reinsurance

There are a couple of growing trends in the market:

• More reinsurers are becoming comfortable with deferred risk. A few years ago, most would look at pensioner-only deals, now the whole reinsurance market is looking at deals involving deferred members too, albeit with different levels of appetite.
• Insurers and reinsurers are interested in moving towards funded reinsurance, which can be done in lots of different ways. This prompted the Prudential Regulatory Authority (PRA) to publish a letter to bulk annuity insurers about their use of this reinsurance as it identified potential shortcomings with funded reinsurance arrangements. Pension trustees need to be aware and watch out for developments as insurers respond.

Insurers need to be selective and pick the right firm and structure for each transaction. Likewise, trustees need to understand the process and ask questions if they are unsure about anything related to pricing and reinsurance.

An evolving market that brings challenges

Reinsurance pricing is critical to the price offered to pension schemes looking at a bulk annuity transaction. It is a very competitive and evolving market with an increasing number of firms in in both the longevity and funded reinsurance space.

When obtaining insurer prices, pension trustees must check if the price of reinsurance has been factored in. Many reinsurance firms are unwilling to provide a quote for the first round of bulk annuity quotations, so they don’t often know if they’re comparing like with like.

Also, it can be challenging for pension schemes to have a clear idea of what contingencies go into insurer pricing. This is where advisers can help, deep diving into all the different areas and assumptions the bulk annuity pricing is based on to ensure trustees fully understand the quotation. This can make it easier to compare insurers and make recommendations to the scheme sponsor on who to take through to the next stage.

Pension trustees: be ready

Trustees will always want to undertake due diligence on the insurer they wish to transact with and be comfortable with the insurer’s covenant. However, looking through to reinsurance is not traditionally part of this process. For pension schemes considering a bulk purchase annuity, the larger the deal the more scrutiny is needed.

It comes back to the following three principles:

• be buy in ready
• have data ready
• be open to scrutiny

Pension trustees, along with their advisers, need to look at the deal and be confident they have done everything they can to understand what the insurer is offering and have the right protections in place. Understanding the reinsurance arrangements should form a key element of this analysis.