Route to settlement Spring 2014

Transcription

1 Route to settlement Spring 2014

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3 Route to settlement Contents The right notes in the right order Pensions Age February All-risks buyouts Pensions Age April Medical underwriting Pensions Age November Trigger-based pricing approaches being ready to act Engaged Investor May How could scarcity of liability hedging assets impact on pension schemes de-risking plans? Pensions Age December Changing times in the longevity market Pensions Age July I want it now Pensions Age February Introduction In 2013 a record volume of bulk annuity and longevity swap transactions were carried out. Most notably, the number of larger transactions and deals involving non-pensioners increased as employers and trustees looked to reduce their risks. Should DB schemes give members more options at retirement? Pensions Age October De-risking across the pond Pensions Age March Having digested the impact of the Code of Good Practice on Incentive Exercises, 2013 also saw increased interest in pension increase exchange (PIE) exercises and in offering members the ability to transfer their benefi ts at retirement using retirement transfer options (RTOs). It is evident that de-risking of defi ned benefi t (DB) pension schemes remains a high priority on the corporate and trustee agenda. In this publication, our experts consider how the bulk annuity and longevity swap markets are developing and what actions trustees and corporates should consider to be ready to take advantage of favourable opportunities. We also consider how schemes can decide which de-risking options are most appropriate for their circumstances when faced with a number of different options. All of the articles have been reproduced with the kind permission of their respective publishers.

4 The right notes in the right order Stewart Patterson Morecambe & Wise s 1971 Christmas Show included one of their most famous sketches and best-known punchlines. The sketch featured the principal conductor of the London Symphony Orchestra, André Previn. In the sketch, with some persuasion, Previn agreed to conduct an orchestra for a rendition of Grieg s Piano Concerto in A minor, with Eric Morecambe taking the piano solo. After missing Previn s cue at the fi rst two attempts, Eric began on time but played a quirky little tune that did not bear any resemblance to Grieg s Concerto. This led to an exacerbated Previn confronting him, saying he was playing all the wrong notes. Eric Morecambe grabbed Previn, and responded I m playing all the right notes but not necessarily in the right order. Was this famous sketch a prophecy for UK pension risk management in 2014? Perhaps not, but it makes a simple point about following a plan; knowing which notes to play is one thing, but playing them in the right order is what really counts. This principle is equally applicable to the range of options available to pension scheme sponsors and trustees to help manage risks in their schemes. Possible options cover plan design, investment strategy, insurance solutions and liability management (or member choice ) exercises. Which actions should be carried out, and in what order? How can the notes be arranged to play the right tune? 4 towerswatson.com

5 Below are some examples of how to get the notes in the right order for pension risk management: Many scheme sponsors and trustees are now looking to implement a retirement transfer option, where retiring members are given the choice to transfer from their defi ned benefi t scheme and purchase their preferred type of retirement income via the open market. Members doing this remove risk from the scheme, but the option is only available when members retire; so make sure to do this while your scheme still has a signifi cant non-pensioner population. If over the next year you plan to secure benefi ts with an insurer via a buy-in, then act now to improve the data on the existence and age of spouses. The insurance premium should be lower where more certainty over the benefi ts being insured can be demonstrated, saving you money on the deal. Address tracing should be carried out ahead of any attempts to run a pension increase exchange exercise, as members will only be able to receive the offer if they can be contacted. The right order in which to implement actions will depend on what position the scheme is in now, what the scheme sponsor and trustees are looking to achieve, and over what time frame. What tune do you want to play? A framework can be put in place to allow a scheme to consider the different ways to manage risks and form a prioritised action plan. Developing such a framework has proved successful for a growing number of pension schemes in the UK, and has been well received by sponsors and trustees alike. Proactive management of risk in an effective, prioritised way is of benefi t to both these groups. Clearly identifying quick wins and the actions that have the most impact against the agreed objectives, targets or measures means the correct arrangement of planned actions can be plotted. Most pension scheme trustees and sponsors will agree in principle that reducing risks within the scheme is desirable and most will have an awareness of some of the options that are available to help manage risk. But the list of potential actions is long, including closure to entrants or accrual, buy-ins, longevity swaps, liability-driven investment (LDI), investment hedging, enhanced transfer value (ETV) exercises and early retirement exercises to name but a few. With a structured, prioritised plan based on consistent criteria in place, schemes will have a musical score to follow, ensuring they not only know the right notes, but also know the right order in which to play them. Clearly identifying quick wins and the actions that have the most impact against the agreed objectives, targets or measures means the correct arrangement of planned actions can be plotted. Route to settlement 5

6 All-risks buyouts Ian Aley There has recently been an increase in the popularity of pension scheme buyout transactions where an all-risks approach is adopted. Here, in addition to the usual risks taken on under a buyout, namely mortality and investment risk, the insurer also covers further risks, such as incorrect data and errors in the benefi t specifi cation. The all-risks structure enables unknown as well as known liabilities to be transferred to an insurer thus minimising the risk of future costs in connection with the scheme. As expected, with greater cover, there is greater cost, the amount varying considerably depending on the quality of the scheme s data and governance processes yet for many schemes this premium is worth paying. The two main drivers for transacting on an all-risks basis are a desire: For certainty over future costs; or To complete the buyout and wind-up in a short time frame The all-risks approach achieves these objectives by avoiding the lengthy post-transaction data verifi cation and premium adjustment process that is typical of the traditional buyout. Examples of the risks that might be included in an all-risks transaction are: Data errors Missing benefi ciaries Legislative changes Reconciliation of Guaranteed Minimum Pensions (GMP) GMP equalisation Wind-up costs The level of due diligence that the insurer will undertake will be similar to that undertaken in an M&A transaction. Reviews of the scheme data, administration and scheme governance processes will occur prior to completing the transaction and the trustees will be expected to provide the insurer with access to all the scheme records and documentation. The premium charged will refl ect the quality and accuracy of the data and processes. In a few, albeit rare, instances, scheme records have been deemed of an unacceptable standard and insurers have declined to provide a quotation. 6 towerswatson.com

7 There are two models for transferring these risks to the insurer, which provide slightly different outcomes: The fi rst transaction of this type was completed some years ago by the EMAP pension schemes. This was achieved by the insurance company securing the liabilities of the schemes via a bulk transfer process whilst simultaneously becoming the schemes sponsoring employer. Prior to the transfer, EMAP topped up the schemes funding levels to the buyout cost, including a premium to refl ect the all-risks nature of the transfer. On completion, EMAP had fulfi lled their obligations to the scheme and the insurer took on responsibility for wind-up and meeting all risks including data changes, wind-up expenses and communications costs. In this case, achieving a clean-break in the quickest possible time was the key priority to enable M&A activity to take place. Whilst this approach provides for a comprehensive and rapid removal of all of the financial risks, the structure of the transaction was particularly complex and there are a number of barriers which need to be overcome. Recently transactions have completed all-risks transfers by specifi cally covering certain risks within the buyout policy. An example of this is the recent transaction completed by the Merchant Navy Offi cers Pension Fund (MNOPF). In this instance the buyout policy was structured so that the insurer is liable to cover risks such as data changes and missing members, but the responsibility for winding up (including expenses) lies with the trustees and employer. As with many schemes in this situation the need for the all-risks cover was driven by a desire to minimise the possibility of future funding contributions being required once the original buy-in had transacted. This all-risk buyout solution is a more straightforward approach than the bulk transfer example above. So is the additional premium associated with an all-risks buyout worth paying? The trustees will need to consider the particular circumstances of their scheme and the risks they may face over the period before winding up before entering into a contract. However, it is certainly an issue that is worthy of consideration when approaching a scheme buyout and is likely to be appropriate for a number of schemes. The all-risks structure enables unknown as well as known liabilities to be transferred to an insurer thus minimising the risk of future costs in connection with the scheme. Route to settlement 7

8 Medical underwriting Will Griffiths When pricing bulk annuities, insurers have traditionally estimated life expectancy using information already held by the pension schemes such as sex, age and postcode. A more sophisticated approach is to collect information on the medical history, smoking habits and other lifestyle indicators of individual members. This medical underwriting has until recently only been used in the pricing of individual annuities. However, providers of these medically underwritten individual annuities, such as Partnership and Just Retirement, have now developed these propositions for the bulk annuity market. This potentially gives pension schemes the same choice which individuals have when purchasing an annuity with their defined contribution (DC) pot why let the insurer assume standard or even good health when, for a little extra work, the cost could be reduced signifi cantly to refl ect the true health status? For a small scheme (perhaps up to 200 pensioners) or a sub-group of a larger scheme, these insurers would seek to assess medical information from those members who represent the highest liabilities. Initially these members would receive a questionnaire which, depending on the answers provided, may then be followed up with a phone call to discuss in more detail. Trustees considering the purchase of a bulk annuity will need to think carefully about whether this form of underwriting is the best approach for them. For example, if underwriting reveals a healthier than expected population the trustees may face a higher price than would otherwise have been the case. If, as a result of these fi ndings, the trustees then decide to go down the conventional, non-underwritten route, at a later date they may well be required to disclose that they have previously investigated a medically underwritten transaction and to share the results with the new insurers. 8 towerswatson.com

9 Similarly, trustees must be aware of the consequences of cherry-picking if a scheme insures only impaired lives then it is likely to be harder and more expensive to insure the remaining members at a later date. Even underwriting a few key senior members could leave the rest of the scheme open to unattractive pricing in the future. This is because insurance companies currently price bulk annuities on the assumption that there are some impaired lives and some healthy lives in a scheme. If the impaired lives are insured separately then the price for remaining members is likely to go up. Along with health status, another key factor in whether a cheaper price can be achieved across the whole scheme may be simply scheme size. For a small scheme with some impaired lives, an overall 15% reduction in the overall cost is not unreasonable. This improvement arises because underwriting has identifi ed that this scheme is less healthy than average assumptions made by insurers. However, a larger scheme with more members is more likely to tend towards the overall population average. For schemes with the right characteristics, medically underwritten quotes provide trustees with a useful, additional option, but trustees should make sure they are fully aware of the challenges that going down this route may pose. Ideally, before obtaining quotes, trustees should combine their knowledge of the scheme membership with their advisers knowledge of the insurance market to consider whether this approach could be benefi cial for their scheme. At an industry level it is too early to say whether medical underwriting is likely to take root in the bulk annuity market in the way it has done for individual annuities. Non-underwritten annuities for individuals have already become more expensive, refl ecting the expected better than average health of the members who purchase them. Pension scheme trustees should keep a keen eye on whether the bulk annuity market develops in a similar way in coming years and weigh the benefi ts and risks of being an early adopter in this market. Inevitably, medical underwriting introduces a range of challenges for pension schemes and their trustees; do they feel comfortable requesting this information? How will such a request be managed? How will the data be stored? Will members even respond to a request for sensitive private information? Such concerns will need to be judged against the potential to make a bulk purchase annuity more affordable for the scheme. Route to settlement 9

10 Trigger-based pricing approaches being ready to act Sadie Hayes How does a trigger-based approach work? There is continued appetite from pension schemes for de-risking transactions at the right price and providers are keen to focus resources on completing transactions rather than quoting prices for deals that do not trade. Consequently, quotation processes increasingly involve trigger prices which allow both sides to meet these objectives. Initially, the price trigger and how this will move with market conditions is agreed the trigger may be relative to a scheme s technical provisions or based on the price the trustees are willing to pay to remove longevity and investment risk. So that the buy-in can transact when market conditions enable the trigger price to be met a provider is selected in advance and the legal contracts agreed. While this challenges the concept of using the very best priced insurer, in practice, the day on which a scheme transacts can often have more impact on the price than deciding which insurer to transact with. Trustees and sponsors are becoming increasingly comfortable with considering the price that meets their objectives, rather than choosing the cheapest provider on a particular day. Quotation processes increasingly involve trigger prices. What actions should a scheme take to make this approach successful? When asked for their views for the Towers Watson 2013 De-risking report, providers overwhelmingly indicated that schemes need to be able to react quickly should favourable conditions arise. This needs: High quality data Clearly stated and transparent triggers that are understood by all parties An understanding of the actions to be taken when a trigger is hit During the monitoring phase, the scheme needs to be able to regularly track the liabilities and the insurer price. A recent development is to use the provider to carry out the monitoring and considering their ability to do so as a factor in selecting the provider. This requires trust if the provider can see the trustees investing time on getting the legal documentation right and being committed to the deal they will be comfortable with carrying out the monitoring. What are the pitfalls of such an approach? It is important that triggers are not set at levels that are hard for the insurer to achieve. There is no value in running a competitive process when a scheme is a long way from reaching its target. Spending time to work closely with one or two insurers not only ensures that triggers are realistic, but also that they are based on accurate insurer pricing. By eliminating the need for a time-consuming quotation process after a trigger has been hit, the risk of missing the opportunity is lessened. Furthermore, having greater certainty of transacting means the provider can optimise their asset strategy and potentially reduce price. 10 towerswatson.com

11 How could scarcity of liability hedging assets impact on pension schemes de-risking plans? Alasdair Macdonald Increasingly DB pension schemes are closed to new entrants or even new accrual and are, therefore, planning to reduce risk over time as their funding position improves. Many schemes are targeting a very low-risk investment strategy within a 20-year time horizon. However, these plans are predicated on the ready availability of suitable low-risk assets. Our research indicates that the future supply of index-linked gilts may not be able to match demand from pension schemes until 2040 that is in around 30 years. As a result schemes will have to compete for index-linked gilts in order to reach a fully de-risked position, with the losers ultimately being forced to take investment risk for longer than desired. The supply of and demand for index-linked gilts For many schemes, the ultimate low-risk strategy will involve a large allocation to fixed and index-linked gilts. As there is a broader set of markets in fixed-income assets, it is the limited supply of index-linked gilts that is initially likely to impact on the ability of pension schemes to de-risk. Pension scheme demand for index-linked gilts is primarily driven by the size of the liabilities and the proportion of the liabilities linked to inflation. As the majority of schemes are currently less than 100% funded, demand is suppressed with schemes preferring to allocate funds to growth assets in search of return rather than low-risk, low-yielding, liability-matching gilts. As funding positions improve over time, many schemes are planning to bank the gains through gradual de-risking, leading to an increasing demand for index-linked gilts. As an extreme illustration, if all schemes were to immediately de-risk, our analysis indicates that there would currently be around a 650 billion gap between the supply and demand for index-linked gilts. This gap is expected to reduce over time as demand slowly falls due to declining inflation-linked liability values. Additionally, supply is expected to grow as the national debt expands in line with GDP growth. As a result, the evolution of the economy is linked to the time taken for supply to meet demand. If the economy was to recover rapidly, it could potentially exacerbate the imbalance as schemes become better funded than expected and look to de-risk at a time when less index-linked gilts would be issued. What actions can a scheme take to avoid being caught out? How each pension scheme plans to react to a potential future shortage of index-linked gilts is a function of their current funding position, maturity, governance and sponsor covenant. Some schemes may have a higher tolerance to run investment risk over a longer period and therefore be less motivated to act. These may include schemes backed by a sponsor with a very strong covenant, or those with an immature membership. Additionally, many schemes may choose (actively or not) to measure their position relative to peers over the lifetime of the de-risking plan and take de-risking steps in line with the herd. Higher governance or more mature schemes may be incentivised to react early in order to gain the upper hand in the supply demand mismatch. Such schemes can use now well-established exercises to change the size and shape of their liabilities in order to reduce their individual demand for index-linked gilts. Such exercises include ETVs, PIEs and offering RTOs, although the ability to reshape the liabilities will be restricted by legislation and member take-up. Schemes could also drive down their demand for index-linked gilts by backing inflation-linked liabilities with alternative inflation-linked assets. There are asset classes that, whilst not affording the precise inflation protection offered by index-linked gilts, would be expected to provide a reasonable amount of protection. Infrastructure would be one such asset class, with recent innovations such as long-lease inflation-linked property funds and ground rents, providing further opportunities. Ultimately there is likely to be relative value in the form of a shorter de-risking journey for schemes that are willing to act dynamically, thinking and moving ahead of the crowd. Route to settlement 11

12 Changing times in the longevity market Ian Aley Demand for longevity risk transfer from pension schemes has increased over the same period as reinsurers appetite for this type of business has grown. Hedging of longevity risk has moved up trustees agenda due to an increasing recognition that they will need to reduce the demographic risks the scheme faces to achieve self-sufficiency. Also as the level of investment de-risking in a scheme increases, longevity risk becomes more and more significant. Reinsurers currently have appetite for longevity risk as it provides diversification from the other risks they write. It is therefore unsurprising that the reinsurance market has grown both in terms of the number of participants and the level of business those participants are prepared to write as they have become more comfortable with this type of risk. Pension schemes, however, are not able to write business directly with reinsurers, so both parties transact with an insurance company or bank which facilitates the transaction, at a price. The original middle men were investment banks but following the withdrawal of a number of these from this market, how can pension schemes continue to access the reinsurance market? 12 towerswatson.com

13 The tried and tested approach The current approach of using banks and insurance companies as intermediaries between the schemes and reinsurers is tried and tested with the intermediaries bringing considerable structuring capability to the process. These banks and insurance companies have access to a wide pool of reinsurers ensuring competitive price tension in the process and arguably have greater purchasing power than a single pension scheme. A number of the investment banks that had been structuring these transactions have withdrawn from the market citing Basel III capital requirements. Insurance companies are showing more interest in stepping into this role so this approach remains a possible solution but pension schemes are exploring whether more efficient approaches could be used. The way forward There are various alternative ways to access the reinsurance market each of these has slightly different characteristics which need to be considered in the context of each scheme s circumstances. Transact with a reinsurer s own insurance company. While a number of reinsurers own insurance subsidiaries, to date only one has used this for longevity risk transactions. While other reinsurers are investigating this approach, it is likely to restrict access to only a few reinsurers, reducing competitive tension. However, if competitive tension can be maintained, the efficiencies of dealing directly with a reinsurer s own subsidiary could lead to improved pricing opportunities for pension schemes. Create your own insurance company (often called a captive) which can transact with a reinsurer. Under this approach, the pension scheme (or the scheme sponsor) creates an insurance company purely to facilitate longevity risk transactions with the reinsurance market. While there are governance and structural challenges associated with this approach, the costs of establishing and maintaining such an insurance company may compare favourably to the other approaches, particularly for larger transactions. Once established, the structure can be used for multiple transactions. What should trustees do next? Longevity risk hedging is an area which continues to evolve with new options being developed and significant changes taking place in the provider space. Trustee boards need to ensure that this topic is on their governance agenda and that they are regularly monitoring both: The impact that longevity risk has on their scheme, including its relationship with other risks; and The latest developments in solutions for hedging longevity risk This is a complex area where specialist advice is necessary if trustees are going to choose the most appropriate way for them to reduce their demographic risk and move closer to their target of achieving self-sufficiency. Longevity risk hedging is an area which continues to evolve with new options being developed and significant changes taking place in the provider space. Route to settlement 13

14 I want it now The impact of today s now culture on pension scheme data Phil Titchener In today s world, everything moves at a fast pace. We want things now and at a press of a button. It is fair to say that for many pension schemes their data has struggled to keep up with the demands of this new world. Now that schemes and sponsors have begun to tackle sorting out their data, will they take the next step of embracing technology so that they can meet the increasing demands of members, sponsors and trustees? When do I want it? Yesterday Demands to use pension scheme data are greater than ever before and increasingly the desire is for reliable real-time electronic data: Trustees and sponsors are monitoring their funding position for multiple purposes: buyout, funding and accounting. They want to be able to track the position regularly. The days of waiting 6-9 months for an assessment of the financial position of the scheme are over. Sponsors want to be able to act quickly if they decide to de-risk. It can come as a shock that they cannot readily access all the information they need and that they might need to wait 3-6 months to clean data and potentially incur significant additional cost. Bespoke bulk extracts are needed with greater frequency for a multitude of projects. The world has moved on from just needing a standard data extract. Increasingly, members want to be able to review their pension scheme benefits at their own convenience, rather than when a benefit statement is issued once a year. It is fair to say that these demands present most pension schemes with a problem. For historic reasons, many processes are not automated and a significant amount of key data is not available or stored electronically as it is only held on paper or fiche. As the Pensions Regulator s guidance has put data firmly on the agenda of trustees and sponsors, it is potentially also the time to think about the next steps to make data fit to meet today s demands. 14 towerswatson.com

15 What can be done? The response to the now culture is the same for pension scheme data as other areas of everyday life: new technology. Having largely met the Regulator s basic requirements, schemes should continue to fi ll the other gaps in their data. Leading specialist data agencies are rolling out the technology to check existence, addresses and contingent spouse s data in a matter of days, not weeks, providing the required results at a fraction of the cost which the scheme administrator might incur. Even where data is not on the electronic record, it may be transferred relatively painlessly using the latest data mining software. Web-based browsers are available for large and small companies alike. As well as looking at their scheme benefi ts, members can use these to review and update their own data and so help the administrator. It is important to keep on top of data and ensure that it does not degrade over time. Modern analytics systems that interface with a variety of administration platforms and check data easily can help to provide trustees with regular monitoring of the state of their scheme s data. Ultimately, as with mobile phones and televisions, an upgrade may become desirable. More modern administration platforms may be more fl exible and better supported, helping to free up scarce administrator resources. Help is at hand Making pension scheme data meet the rigorous demands of the modern world is a daunting prospect and resources are scarce. However, there is no doubt a lot of money is currently spent on tackling data issues as and when they arise. An independent data specialist with a broader knowledge of how schemes use their data can help provide that all important path through the technology jungle. The answer to I want it now can be OK rather than Ummm. As the Pensions Regulator s guidance has put data firmly on the agenda of trustees and sponsors, it is potentially also the time to think about the next steps to make data fit to meet today s demands. Route to settlement 15

16 Should DB schemes give members more options at retirement? Fiona Matthews There has been a significant amount of focus in the pensions press in recent years on the advantages of DB schemes over DC schemes. But arguably some of the advantages of DC schemes, such as the additional flexibility for members surrounding their choice of benefits, have not been as well publicised. Options such as PIEs, which have now become fully integrated into the pensions landscape, have given members of DB schemes some choice over the form of their retirement benefits but this is limited to the option to swap (for a flat pension) the parts of their inflationary-linked pensions that built up before April Unless members are prepared to transfer their benefits some years prior to their retirement to a DC pot (and accept the associated risk in relation to investment returns), they will not have any choice about the form of the spouse s benefits or the ability to exchange increases on post-1997 pensions. One option that DB schemes are beginning to consider is to go beyond their statutory obligations and allow members to transfer their benefits in the year before retirement. This provides the necessary flexibility but does not bring with it years of pre-retirement investment risk for the member. One additional attraction for the member is that the tax-free cash sum available under the DC scheme is often higher than available under the DB scheme. The cash sum can be further boosted for those members who meet the new Minimum Income Requirement (MIR). For members in poor health or who are smokers, the DC route will also provide the option to purchase an enhanced annuity. 16 towerswatson.com

17 One option that DB schemes are beginning to consider is to go beyond their statutory obligations and allow members to transfer their benefits in the year before retirement. Of course, from the employer s perspective, this is an attractive proposition too. The transfer of benefits from the scheme means the removal of the mortality and investment risk associated with those members. In addition, if members transfer rather than draw their pension from the scheme, the term of the pensioner liabilities will be reduced and it should be easier for schemes to find bonds of the necessary duration to match these liabilities. For the increasing number of schemes where the end point of a long-term journey plan is to buy out their liabilities with an insurance company, this represents a step along the road to achieving this goal and can potentially bring the end point closer. Indeed, it can provide a neat fit with other risk management exercises, such as an early retirement exercise. Finally, the transfer of members is likely to have a knock-on downward impact on the scheme-based PPF levy and future administration costs. That is not to say that there are not a number of considerations that the trustees and employer need to carefully work through in order to decide that this is an appropriate option to offer to the scheme s membership. They will need to be happy that the members selecting this option will not just be those in poor health, leading to selection against the scheme, which may ultimately increase costs and potentially make the scheme less attractive from an insurer s perspective. Our initial impressions are that, if carefully communicated, such options are likely to appeal to the whole pension population, not just a specific subset of the membership. In particular those who satisfy the MIR may be attracted by the ability to access a series of taxable cash sums as and when they are wanted. These members account for a disproportionate share of the scheme s liabilities and longevity risk and will help to offset the impact of smokers leaving. Inevitably, the pension due under the DB scheme rules will be a powerful reference point and sticking with what I have will be the default choice for many members. Choices can be confusing and so the provision of independent financial advice to members should be a critical part of any such offer at retirement. Not only will it satisfy the trustees that the at-retirement options meet the principles of the Code of Good Practice, but by helping to educate members on the options available outside of the DB scheme the proportion of members who transfer, to get benefits which suit their circumstances better, is likely to be increased. Route to settlement 17

18 De-risking across the pond Stewart Patterson De-risking initiatives in the UK are familiar to us all, as UK DB pension schemes look to move to self-sufficiency, or to reduce their reliance on the sponsor. However, in 2012, it was pension scheme de-risking exercises in the US that grabbed the headlines with multi-billion dollar deals. This could signal a new trend for similar US exercises in the future and may mean that US parent companies look across the Atlantic for similar opportunities in their UK subsidiaries. Prior to 2012, the de-risking focus in the US was on plan design projects, and modifying funding or investment strategies. However, during 2012 attention switched to the possibility of transferring liabilities, either to members (via lump sum payments) or to the insurance market (via an annuity purchase exercise). Changes in the relevant legislation and favourable market conditions meant that the number of US schemes offering lump sums to members in exchange for their pension promise during 2012 was far higher than previously. These lump sum offers allow schemes to completely remove their DB liabilities and give members cash in their hands rather than a pension. Around 150 companies made this type of offer, with total payouts of over $15 billion. The lump sum option has proved to be very attractive to US members, with voluntary acceptance rates typically in the range of 50% to 65%. Schemes looking to de-risk either in the UK or the US will need to make sure they are well prepared in terms of sponsor and trustee understanding, suitability of membership data and that they are actively monitoring market opportunities. 18 towerswatson.com

19 Although these offers were generally made to members who have not yet retired, there were also high profile offers during 2012 to retired members. Legislative and tax complications had meant this was largely an unexplored area. However, the US Internal Revenue Service (IRS) provided specific approval to Ford and General Motors enabling them to make lump sum settlement offers to retirees. It is anticipated that these ground-breaking cases may pave the way for more US schemes to make offers to retirees in future. Unlike in the UK, until recently US schemes have not embraced annuity purchase. 2012, however, may be the turning point with two high profile cases General Motors and Verizon which between them accounted for over $30 billion of liabilities being transferred to insurance companies. These big deals were facilitated by insurers showing an increased demand and capacity for annuity purchases, resulting in attractive pricing for pension schemes. This presented an ideal opportunity for schemes looking to significantly reduce the size and risk profile of their liabilities. Having dipped their toes into this particular market, will US insurers appetite continue and will the splash created develop into a wave throughout the US? Historically US parent companies have not had a strong appetite for de-risking exercises for their UK schemes, partly because of the scarcity of such exercises in the US. Now that there are real-life examples in their home market, US companies may wish to learn more about what they can do in the UK and we are already seeing evidence of this. Ensuring that US executives are aware of the different legislative and tax environment in the UK will be important in these discussions. Schemes looking to de-risk either in the UK or the US will need to make sure they are well prepared in terms of sponsor and trustee understanding, suitability of membership data and that they are actively monitoring market opportunities. Market conditions which make some exercises less attractive may create opportunities for other de-risking initiatives. Those who are geared up to spot these opportunities and respond swiftly will be able to capitalise. Those who are not prepared may have to read in 2014 about what passed them by in 2013! The high profile nature of the ground-breaking de-risking activity in the US recently will undoubtedly have grabbed the attention of many other US pension schemes and sponsors and the expectation is that the trend will be for increased activity in the US around transferring pension liabilities. Route to settlement 19

20 About Towers Watson Towers Watson is a leading global professional services company that helps organisations improve performance through effective people, risk and financial management. With more than 14,000 associates around the world, we offer consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management. Towers Watson 21 Tothill Street Westminster London SW1H 9LL Towers Watson is represented in the UK by Towers Watson Limited. The information in this publication is of general interest and guidance. Action should not be taken on the basis of any article without seeking specific advice. To unsubscribe, eu.unsubscribe@towerswatson.com with the publication name as the subject and include your name, title and company address. Copyright 2014 Towers Watson. All rights reserved. TW-EU May towerswatson.com