Are you ready for a seamless DB buyout?

Risk warning

The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.

Many of today’s defined benefit (DB) schemes are currently well-funded on a buyout basis. However, in a market where demand outstrips supply, funding level is only one piece of the puzzle when it comes to securing a favourable deal with an insurer.

If your objective of buyout is known, there are several actions you can take to boost your scheme’s bargaining power and achieve a smooth transaction with advantageous terms.

In previous articles, we’ve focused on how an investment strategy can be set to hedge insurer pricing more effectively and align with insurers’ credit investment principles.

Now let’s focus on how to prepare for a seamless DB buyout transaction.

What looks attractive to insurers?

Processing scheme buyouts can be time-consuming for insurers. With a queue of DB schemes looking to transact, insurers can afford to be choosy.

Make sure your deal looks easy to process. The following factors can help make due diligence less painful for insurers, and could help you secure a competitive quote:

A clear benefit structure
Clean data
Residual risk cover
Agreement between trustees and sponsor on areas such as surplus arrangements

Prepare your investment strategy

It’s well worth understanding what kind of assets insurers like to keep hold of, and aligning your investment strategy accordingly, with a view to an ‘in-specie’ transfer. This type of deal is more worthwhile for both parties because it means assets are transferred without being converted to cash.

For example, if you know your scheme’s heading for buyout, you could convert the public credit element of your portfolio into a set of insurer-friendly assets.

Understanding the type of assets insurers want to hold for the long term could help you secure a competitive quote.

This means you filter out bonds that don’t meet an insurer’s criteria (bonds which are not Matching Adjustment-eligible) and avoid holding excessive lines of stock. (You can learn more about Matching Adjustment and strategic credit for your path to buyout in this article. Or watch our video for further details.)

The key point here is that understanding the type of assets insurers want to hold for the long term could help you secure a competitive quote.

If your portfolio is made up of assets that insurers aren’t willing to hold over the long run, they may be willing to receive your portfolio, but they will sell the assets shortly after the transaction. This will be factored into your buyout price.

Price lock portfolios

A price lock portfolio is a common feature in the buyout process. Once a scheme has received a quote and agreed to transact with an insurer, the pricing terms are often agreed relative to a hypothetical portfolio, and the movement in the buyout premium will reflect the movement in the portfolio.

Aligning a scheme’s assets to the price-lock mechanism can help reduce execution risk.

The details of price-lock mechanisms vary from insurer to insurer and depend on the size of scheme involved.

Aligning a scheme’s assets to the price-lock mechanism can help reduce execution risk – i.e. the risk that the trustees can no longer afford the transaction.

Conclusion

Being fully funded on a buyout basis doesn’t guarantee that a scheme will obtain an insurance quote, or be able to secure a favourably priced one. Understanding the factors that make your scheme attractive to an insurer, and reducing the costs and risks associated with a transaction can provide your scheme with a framework for an efficient buyout.