Within bulk purchase annuity (BPA) transactions, complex features typically fall into two categories: those which an insurer must accept and manage as part of doing business, and those which are potentially up for negotiation. For example, short of a Pension Increase Exchange (PIE) exercise, insurers must be prepared to accept complex inflation linkages if they are part of the rules of the scheme, whereas some deal features such as a deferral of premium may have some room for negotiation of terms. Insurers seek to offer these negotiable features, often requested by large schemes, to remain competitive and win business, whilst not exposing themselves to unnecessary risk. Given expectations of more mega deals being written in the near future (i.e. deals with premiums in excess of £1 billion), insurers must appropriately determine their risk appetites for writing deals with these unusual features. This will involve carrying out thorough analysis and due diligence prior to accepting the combinations of risks arising within complex transactions.

Termination clauses

Larger schemes may request termination clauses within a buy-in contract as a further layer of security. In these cases, if an insurer is unwilling to offer termination rights of some form then it’s likely they would not be competitive and therefore would probably have to choose to not quote on the scheme.

Trigger events are carefully defined, often based on an insurer’s solvency ratio percentage, at which point the scheme can request that the insurer transfers back an agreed amount of assets that is typically linked to technical provisions. This brings about several material aspects for insurers to consider: the trigger level that the insurer is comfortable with, the terms regarding the level of termination payment and the termination asset portfolio, as well as the required steps if the trigger level is reached and a termination requested.

If the insurer has offered termination rights on several deals, then it would need to consider what would happen should several of these schemes request termination in quick succession and the impact it could have on the insurer’s ability to financially recover in a stressed scenario. Insurers must also consider the evolution of their asset portfolios in scenarios where termination rights are triggered, including both what assets would form the termination payment and the residual asset portfolio after the payments have been made.

Unusual inflation linkages or nonstandard benefits

There are certain complex aspects within BPA transactions that, for the most part, insurers have to accept as part of doing business. They include the inflation types that benefits are linked to both pre-retirement and postretirement, which can have nonstandard caps and floors and as a result be more difficult or costly to hedge. Each pension scheme is unique and there are several nonstandard benefit types or rules which the insurer must be comfortable modelling for pricing and reserving purposes (or develop a suitable proxy or approximation), but also be able to administer once the business has been written, for example bridging pensions. Firms also need to check whether there are benefits which might not be matching adjustment (MA)-compliant and therefore that this part of the liability and backing assets would sit outside of the MA fund.

In specie assets

With many schemes investing in illiquid assets, and being in buyout surplus sooner than anticipated, insurers are increasingly being asked to consider accepting in specie assets—particularly, illiquid (or non-traded) assets. Sometimes in specie assets might also include derivatives. As part of price negotiation, accepting in specie assets might come with additional costs. Therefore, this might not be an optimal solution for a scheme, and other options would need to be considered, such as selling or restructuring these assets.

Where insurers accept in specie assets, transitioning them from a scheme is by no means straightforward. Illiquid assets can exhibit significant complexities, such as valuation, risk exposures or asset novation, and insurers need to get comfortable that they meet eligibility conditions before transferring these assets into MA portfolios. One way to manage these complexities is through timely sharing of information between parties, something for which schemes are generally getting better prepared now (in part this is driven by trustees’ proactive engagement with employee benefit consultant firms). Apart from these complexities, insurers will also need to determine whether they have the relevant specialist expertise and operational capabilities to onboard and manage these assets.

Derivatives also come with their unique challenges—perhaps a critical aspect is how difficult novating a derivative can be. Solutions are being developed, including either wrapping derivatives with underlying assets or ensuring that novation is specified and allowed up-front.

Deferred premiums

Some schemes request to defer a proportion of the premium for a specified period. Insurers need to be comfortable with both the amount deferred and length of time proposed, and the implications should the scheme ultimately be unable to pay the deferred premium. The key questions for the insurer to consider will often be the reasons underlying the requested deferral and the strength of the scheme sponsor. A common reason for requesting a deferral of premium is that the scheme needs to trade out of assets which the insurer would not accept in specie, sometimes due to being ready to transact sooner than anticipated. Ultimately, should a scheme fail to pay the proportion of premium deferred, the insurer will have agreed the option to scale down benefits. However, this may reflect poorly from a reputational perspective and perhaps lead to legal complexity. Therefore, to minimise the probability of such a situation occurring, insurers will wish to only offer deferrals of premium for amounts, durations and on other terms that are in line with their chosen risk appetite. It also will be important to consider the total exposure to deferrals across different schemes, given that many will depend on trading out of illiquid assets.

All-risks cover

All-risks or residual risks cover to insure against risks including future claims and data errors is nothing new in the BPA space but continues to be frequently requested. Most claims arising under such policies are not material in comparison to the size of the scheme, for example missing beneficiaries or individual claims. However, there are risks covered by these policies which are remote in likelihood but could be severe in impact, including those potentially affecting multiple schemes, such as changes in law. Insurers will want to carefully consider that they are appropriately pricing and reserving for this cover, assessing appropriately the likelihood and impact of the full range of covered risks. Another way for insurers to manage the risks attached to all-risks cover such that they are in line with their risk appetites is to include limitations to the cover, including caps, time limits and exclusions. Firms should look to review their offerings periodically from both a risk and competitiveness perspective.