An increasing number of schemes are focusing on their investment approach in a bid to be ‘settlement ready’ according to Aon.
According to Aon’s Global Pension Risk Survey 2021/22, more UK defined benefit (DB) pension schemes are opting for buyout rather than self-sufficiency as their long-term goal. Schemes are increasingly conscious that they must take efforts such as data cleansing, releasing benefit specifications, and agreeing on their governance structure in order to prepare for this. They also understand that these projects must begin far in advance of a transaction in order to avoid any delays when the appropriate insurer price becomes available.
Schemes are realising the benefits of taking a similar strategy with their assets, investing with the endpoint of a buyout in mind and beginning the preparatory process as soon as possible.
Aon’s risk settlement team has also found that early investment preparation offers schemes several advantages, including avoiding roadblocks such as long-dated illiquid assets, which can increase risk and cost; better matching insurer pricing by allocating more to assets such as gilts, swaps, and credit; and reducing exposure to assets that insurers do not want, such as growth assets, which increase volatility.
Aon partner Lucy Barron says: “Whatever the timeframe they have in mind for reaching their scheme’s endgame, trustees need to think about the most efficient investment strategy that will allow them to reach it. There are several investment options to consider that give schemes the best opportunities. For example, ensuring liabilities are fully protected against movements in interest rates and inflation helps reduce the risk of assets moving in a different direction – something which is increasingly a consideration.
“Trustees will need a portfolio that is well-diversified so that it can navigate volatility and generate the returns needed but with the least risk possible. It also needs to give them the option of sufficient flexibility and liquidity to capture opportunities should they arise earlier. Similarly, holding credit can provide some protection against insurer pricing moves, as it is often an attractive asset for insurers.”
Barron adds: “There are good reasons for taking this more holistic approach to reaching a scheme’s endgame. The ultimate aim is for the scheme to get to buyout with reduced risk and more certainty. That involves thinking about managing longevity, investment and other risks such as movements in insurer pricing. In a very busy market, insurers will always prioritise well-prepared schemes – and that equates to better pricing and lower cost.
“The more schemes can do to make themselves stand out, the more they can increase competitive tension among insurers – one of the many factors that can lead to better pricing outcomes. It’s also clear that this is now a more mature market with schemes having a greater understanding of what’s needed to get them to their endgame. As advisers, we can help create a journey plan to buyout, which takes into consideration investment and longevity risks, including the use of buy-ins at the right time.
“We increasingly offer schemes a flexible toolkit – including using synthetic credit as a less expensive and more adaptable way of adjusting credit exposure and locking into insurer pricing. We are also helping schemes to set strategic targets for hedging and credit exposure, and then adjusting them based on insurer feedback and market conditions.
“But there is no substitute for market knowledge, so an understanding of insurer investment strategies allows schemes to make better decisions, either by having their investments aligned with those of insurers ahead of reaching full buyout funding, or by managing themselves out of illiquid assets with the least risk and cost.”