Maggie Williams examines how the Vickers Group insured all 11,000 members of its scheme with Legal and General
Solvency II. Low interest rates. Market volatility. Brexit. The US election. Five good reasons why now would seem the be the worst possible time to carry out any pension scheme buyout, let alone one worth £1.1bn.
But that’s exactly what the 11,000 member Vickers Group pension scheme, part of the Rolls-Royce group, completed in November 2016 with Legal & General (L&G) as insurer and Mercer as adviser.
This marked a new venture for the trustees and the company
Vickers Group’s relationship with Legal and General Investment Management (LGIM), the investment arm of L&G, goes back to 2007. At that point, Rolls-Royce agreed to make increased contributions, enabling the trustees to reduce risk by moving 90% of the scheme’s assets to a liability-driven investment (LDI) strategy. “This marked a new venture for the trustees and the company,” says Joel Griffin, head of pensions at Rolls-Royce Group. But it was a “critical point in the history of the scheme”, marking a move away from the its previous traditional equity/bond split. “The LDI strategy ensured that subsequent reductions in interest rates did not have any negative impact on funding,” adds Griffin.
Between 2007 and the buyout this year, Griffin says all of the parties associated with the Vickers scheme worked closely to “deliver a positive return against the liability benchmark, but in a risk controlled way”.
As a trustee board, Vickers Group has been focused on risk management
“As a trustee board, Vickers Group has been focused on risk management – and they have a company behind them that is prepared to put money into the pension scheme. The combination of those two things and our support through the risk management process allowed the scheme to get to buyout,” says Phill Beach, head of core pension risk and transfer at Legal & General.
When L&G received an initial request from Vickers in late spring this year, “the feeling at that point was that it would be a pensioner-only transaction,” says Beach. “The board and the sponsor weren’t sure that full buyout would be achievable. But we went through the process of pricing up the full scheme and coming up with a strategy that worked, based on the liabilities that they have.”
Sometimes there is a perception that buyout is not achievable, but it’s worth testing
“Sometimes there is a perception that buyout is not achievable, but it’s worth testing that – you may be closer than you think. That was exactly the case here.”
“I can’t emphasise enough the power of understanding what the actual economics of your pension plan are,” says David Ellis UK leader, bulk pensions insurance advisory at Mercer, the broker and strategic adviser on the deal. While an obvious starting point is a desktop estimate from the scheme actuary on measures such as ongoing funding, or a solvency estimate, Ellis cautions, “that might not be your actual plan finances. You only get to that when you start to work on a deal and get pricing from insurers.” While it’s clear that a 60% funded scheme isn’t going to get an unexpectedly pleasant surprise, for those with 85-90% scheme funding, Ellis recommends “don’t be unduly swayed by what you think the capital injection required might be – it could be very different.”
I would strongly advocate that schemes get the right information direct from insurance companies
He adds: “The pension will have had more scrutiny than ever before at that point, but it nearly always yields positive results and people can make a deal work. I would strongly advocate that schemes that are getting close to buyout get the right information direct from insurance companies.”
Over the summer, the proposal was put to competitive tender. “When it became apparent that Vickers had selected L&G, we put in place a sophisticated price lock for the transaction period,” says Beach. The fact that L&G already understood and were involved with the scheme’s investment strategy was a major advantage. “By working together with LGIM, we [L&G] really understood the scheme’s assets. With the trustees and Mercer we were able to put something really creative in place that would ensure a slick transition with a lot of certainty. That was really important from the trustees’ perspective.”
The asset strategy must be thoughtfully positioned to control risks for all parties
Griffin is clear on the vital role that collaboration plays in deals of this type. “To maximise the chances of success, the trustees and company need to work together. The asset strategy must be thoughtfully positioned to control risks for all parties – and not least for scheme members.”
“No-one pays over a billion pounds of assets to another party without understanding in advance how that [process] is actually going to work,” says Ellis. “It’s not a case of simply liquidating for cash.” He emphasises the importance of understanding “how the asset premium payment mechanism will work before signing the contract”.
The biggest priorities are the premium payment and making sure the scope and extent of the insurance is correct
Ellis adds that the biggest priorities in arranging a buyout are the premium payment and making sure the scope and extent of the insurance is correct. Those need to be established long before the contract is signed. “That’s not to belittle the liabilities to individual pensioners, but most pressing initially is how to pay the premium and to make sure the transaction doesn’t run away with you if financial conditions change.”
It’s about relationships
As well as demonstrating the importance and reassurance of a price-lock over the transaction period, Vickers Group’s deal shows that buyout is about long-term relationships between trustees, sponsors, advisers and insurers. “Where there’s a will there’s often a way,” says Ellis. “We are in the business of financial engineering and we can usually make things work.”
here is no need to wait for interest rates to increase or markets to hit a certain level before taking action
Griffin has some clear guidance for other trustee boards in a similar position: “Fully understand the risks which are inherent in the investment strategy, look at the full range of options, and agree a strategy for achieving a long-term target with all stakeholders. There is no need to wait for interest rates to increase or markets to hit a certain level before taking a de-risking action.”