BPA transactions: will insurers accept illiquid assets?

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How an insurer values an illiquid asset as part of a bulk annuity transaction might differ greatly from a trustee’s valuation. 

Many pension schemes have a higher asset allocation to illiquid assets than they expected at this stage of their journey plan.

In fact, over the past year around 40% of schemes approaching the market had illiquid assets to manage. These schemes need to find ways to manage these assets in order to efficiently complete a bulk purchase annuity (BPA) transaction.

Over the last 12–18 months we have frequently been asked whether we can accept illiquid assets. In the abstract, the answer should be yes – insurers invest in illiquid assets routinely. 

However, in practice this is only part of the information that a trustee needs. The question should focus more on what value an insurer will place on the assets. 

Here are some of the key considerations from an insurer’s perspective:

Regulation: a key, fundamental feature of the insurance regulatory regime is the requirement for close and highly certain matching of asset and liability cashflows. This approach underpins the financial soundness of regulated insurers. 

Adhering to these requirements also enables insurers to reflect the ‘Matching Adjustment’ (MA), an increased discount rate reflecting the long-term nature of their assets and liabilities expected to be held to term, and supporting the attractive pricing that makes BPA insurance viable.

As pension schemes are subject to different regulations, the illiquid assets held by schemes often don’t meet these requirements. In these circumstances, insurance regulation applies penal capital treatment to the asset, making it economically inefficient to take it on unless haircuts are applied. 

Structure: insurers generally require direct ownership of assets, largely because of the challenges with satisfying the MA eligibility criteria when investing in pooled fund structures. 

Onboarding challenges: each insurer will have its own credit underwriting processes, valuation approach, and governance requirements. The process of evaluating assets against these criteria is time- and resource-intensive. This can be a significant barrier where individual holdings are very small.

 

A natural fit?

Insurers are rarely a natural buyer for illiquids held by pension schemes. Although it may be possible, in theory, for an insurer to accept these assets, trustees should ask at what price this is possible. And if this is materially lower than the price they could obtain in the secondary market, they should question seriously whether this is the right thing to do. 

In rare circumstances where there is a compelling need to secure an annuity in a short timeframe, it may be the only option, but it is unlikely to be the best outcome economically.

As with everything, there are exceptions:

• Larger pension schemes are more likely to hold material assets in segregated or direct mandates. Being able to work with these funds is more likely.
• Where the individual illiquid assets are very small, there may in practice be no price that makes the operational complexity worthwhile to an insurer.

 

What should schemes consider?

Trustees may wish to consider the following steps:

• Engage early – an insurer should be happy to discuss how it sees your specific assets at an early stage, giving you time to plan.
• Understand the full suite of options.
• Ensure there is a clear, realistic plan for illiquid assets before formally requesting quotes. Insurers now see this as a key part of market preparation, as much as preparing the data or a benefit specification.

Managing illiquid assets will remain a key focus for schemes aiming to execute insurance transactions for some time. 

In due course, we expect schemes to more actively manage their position in the lead up to a transaction, shifting towards earlier engagement with insurers regarding potential options, and having a clearer strategy heading into a broking process and eventual transaction. 

We expect this will lead to better outcomes for schemes, reducing the frictional cost of execution. 

This analysis is from Standard Life’s report, Managing illiquid assets during a bulk purchase annuity transaction.