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Illiquid assets, and how to dispose of them, remains one of the biggest challenges to the insurer buy-in process.
This topic, and the role of illiquid assets in getting pension schemes into a fully-funded position, were discussed at the annual Pensions and Lifetime Savings Association (PLSA) conference in Liverpool last week.
In one of the conference’s final discussion sessions “The power of three: Successful de-risking with the trustee, sponsor and insurer”, delegates were taken step-by-step through a successful buy-in. The topic was one that would be relevant to many insurance investment teams and their future asset allocation and investment strategies.
Justin Ray, Head of Defined Benefit LGPS and investment at the PLSA explained the challenges involved. “The Defined Benefit (DB) market we know is changing rapidly and their improved financial position has increased the number of end- game options for defined benefit schemes,” he said.
Delegates were talked through the buy-in experience of one scheme, Coats, from the initial decision to make the move through to completion from the perspective of the sponsor, the employer, the trustee, and the end game provider.
In September the trustee of Coats UK Pension Scheme completed a £1.3 billion buy-in with Pension Insurance Corporation (PIC). The scheme had also signed a £350 million buy-in deal with Aviva in 2022; the latest translation meant the pension benefits of all 18,042 scheme members were secured.
Ray said he hoped discussion of the experience would be helpful for those going through other considerations in terms of how the process is going to work.
“Pension schemes typically go through a long journey before they reach a point where they can secure benefits with an insurer,” he said.
Chris Martin, Chair of Trustees at Pace, the Co-op’s pension scheme, and the executive chairman of Independent Governance Group, said the scheme had a long and complicated history and was one of three schemes, one of which went back to the 1950s. The total liabilities of the three were worth more than the size of the sponsoring company.
Martin said this presented operational hurdles which made decision-making difficult.
A £255 million settlement with The Pensions Regulator (TPR) in 2016 safeguarded the benefits of 24,000 and made things logistically easier.
Slimming down the number of trustees meant conversations could be had around key areas including the decision to de-risk.
One of the conversations included the issue of illiquid assets.
“Harvesting the illiquidity premium was a very good way of diversifying away
from equity and other risks, so it was perfectly appropriate for the time."
Martin explained the illiquids held in the Coats in the scheme were invested in “many years ago, and at that time, so we weren't engaging with a sponsor or on a risk transfer journey”.
“In fact, we weren't engaging with the sponsor at all, and the schemes were materially underfunded,” he said.
Martin said the assets had proved useful in bringing the scheme to be buy-in ready. “Harvesting the illiquidity premium was a very good way of diversifying away from equity and other risks, so it was perfectly appropriate for the time,” he said. “Obviously, the journey [to buy-in] accelerated over the last few years and the liquid markets had become more challenging.”
Martin added that one of the reasons why the scheme is better funded now is because the illiquids had done their job. “Are they right for a risk transfer? Probably no,” he said. “It's probably worth [saying] that one of the questions we always get asked is about illiquid assets. And people go, insurers invest in liquid assets: why can't you just take the schemes’s liquid assets?
Jackie Callaway, Chief Financial Officer on the Board of Directors at Coats Pension Trustee, joined the Coats board in December 2020. “When we listed the company back on the stock exchange in the UK it was seen as basically a pension scheme with a small industrial business on the side,” she said.
“The trustees were wanting to move forward with a longer term de-risking strategy, but the company was worried about what this might do to our profit and loss account,” Callaway said.
Deepash Amin, Head of New Business Strategy at Pension Insurance Corporation (PIC) explained the role and challenges of the scheme’s illiquid assets.
“Illiquid assets are very complex in their very nature. They don't have a market value, so you need to agree on a valuation for them,” he said. “The amount of diligence an insurer needs to do to understand the illiquid asset, people underestimate that. You need to get lawyers involved; you need to get investment expertise involved.”
He said PIC’s role was to support the scheme in finding the most efficient way to use those assets and make sure they were fairly priced.
“You want to do your due diligence in what the underlying asset is
and what you're investing in, does it meet all your criteria?”
Amin said one of the narratives he had heard during the PLSA conference was that pension funds did not want to take on illiquid assets. “It is possible to take on illiquids, but it's a challenge and there are quite a lot of steps involved,” he said.
Amin added that when an insurer looks at a private debt or illiquid assets there are many things they need to consider. “One of the main things is, the regulatory regime and what they can invest in.” He said some insurers will have their own risk appetites in terms of counterparty risk and who to invest in.
“You want to do your due diligence in what the underlying asset is and what you're investing in, does it meet all your criteria?” he added. “When you put all those criteria together, inevitably, a lot of illiquid assets that a scheme might invest in may not fit that profile.”
He said from PIC’s perspective illiquid assets fell in three buckets.
“The first one is it is something we want to invest in. It's something we already invest in or would like more of, and then that's brilliant, because we can take it on, and there might even be a positive price impact, because we don't have to source it ourselves.”
“We will reflect potential haircut on the value, and then,
and then say, we can take it on."
The second bucket is, he said, whether it is something that they can hold on to on their books. “But it's not something we want to hold long term, so we then have to look at what value we will get whenever, inevitably, in the short term if we're going to sell it,” he said,
“We will reflect potential haircut on the value, and then, and then say, we can take it on. Then the scheme will do their own analysis in terms of what they can get on the market, and look at whether that is value for money in terms of getting the transaction over the line?”
“The last bucket is whether we can even hold it on our books,” he said.
Because of this, he said, the scheme would need to look for an alternative route to disinvest that asset, and they may need time to do that. Alternative solutions may be needed to support that, rather than having the scheme lose out on doing the buying, and it may be informed by a deferred premium or other mechanism, to ensure that there's an efficient and well thought way of de-risking the investment.
