Buyouts remain a popular derisking strategy for defined benefit schemes. Aon Hewitt's Martin Bird looks at how the medically underwritten option is gaining ground in this burgeoning market.
Action points
Medically underwritten bulk annuity deals are no longer the preserve of small schemes; all trustees can consider this option.
Pricing is attractive at the moment; now could be the time to explore.
Data has to be in order. Make sure records are up to date and sensitive information is dealt with appropriately.
Since 2013 medically underwritten annuities have become a core part of the pensions derisking toolkit, after their launch by specialist providers Just Retirement and Partnership, which were quickly followed by the more traditional annuity providers adding to their offerings.
Last year was a record breaker for the medically underwritten market, with a sevenfold increase in the amount of liabilities insured compared with 2013, and the largest deal to date marked by Taylor Wimpey's £206m transaction with Partnership.
Pricing consistently proved to be materially more attractive than in the traditional market, with savings of 5-10 per cent achieved.
The first half of 2015 has continued this trend, with increasing interest from schemes of all sizes, and completed transactions close to £1bn.
Eighteen months ago the medically underwritten market seemed to be an exclusive club for small schemes, but things have moved on quickly.
The truth is every scheme has some form of concentration risk among the largest pensions and so schemes of any size may wish to investigate further
A lot of current market activity is taking place among larger schemes where data is only collected for the largest liabilities.
The truth is every scheme has some form of concentration risk among the largest pensions and so schemes of any size may wish to investigate further.
Attractive pricing
The main appeal for schemes is the attractive pricing.
Most schemes compare bulk annuity pricing to existing funding reserves to determine how much extra cash contribution will be required to purchase the insurance protection.
However, with pricing remaining around 10 per cent cheaper than traditional, non-underwritten deals, many schemes are faced with the enviable prospect of offloading risk to the insurance market at a cost less than the funding reserves already set aside.
There are various reasons for the attractive pricing:
Providing greater certainty to the insurers helps to improve pricing. This is true of marital information, spouses' dates of birth and data on the health or lifestyle of individual members;
Asset opportunities exist within the businesses of some insurers, with yields that currently support attractive deal pricing;
For larger liabilities, the potential benefit from medical data showing an illness is generally greater than the risk that the member is healthy. In other words, the potential impact of health data is skewed in the scheme’s favour for some populations;
Many insurers are still trying to grow their businesses, particularly in light of the rapid decline in the volumes of business in the retail annuity market following the pension freedom reforms, meaning continued competitive pricing.
Data collection is critical for pricing
There are three elements critical to the effective collection of member data.
First is a clear communication strategy to help members understand the exercise can increase the security of their benefits and provide comfort that the collection process is not lengthy or too intrusive.
Second is an efficient means of transmitting data to the insurance market to enable quick and accurate pricing.
Finally trustees need robust data protection procedures to ensure sensitive information is dealt with appropriately.
Given the pace at which the medically underwritten annuity market has developed, and the opportunities that are available both in collecting member data effectively and securing attractive deals, it is no surprise that more trustees are showing an interest.
Martin Bird is senior partner and head of risk settlement at Aon Hewitt
