Managing illiquids during a BPA transaction: what are your options?
From deferring premium, making a secondary market sale through to delaying the time of a buy-out, there are many ways to remove illiquid assets before completing a buy-in or buy-out. But there is no perfect solution for all schemes.
Illiquid assets often represent a much larger proportion of asset strategies than expected for pensions schemes reaching buy-out affordability.?
This is due to an unexpected improvement in funding positions, primarily driven by rising interest rates shrinking pension scheme liabilities more sharply than the value of assets.
In fact, over the past year around 40% of schemes approaching the market had illiquid assets to manage.?
And most employee benefit consultants (EBCs) and professional trustee firms say that illiquids have delayed a transaction, according to research featured in our report, Managing illiquid assets during a bulk purchase annuity transaction .
Trustees therefore need to plan carefully for dealing with their illiquid assets before approaching the insurance market.
"Illiquid assets often represent a much larger proportion of asset strategies than expected for pensions schemes reaching buy-out affordability."
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Long-term objectives?
Most pension schemes have broadly selected one of two long-term objectives:?
Holding excess illiquid assets may present an issue in both scenarios.
For schemes planning to run-off with a low-risk strategy, too much illiquidity means it may take them longer to get to their desired low risk portfolio. They could also be running elevated levels of risk in the meantime.
For schemes aiming to buy-out, insurers may not accept some illiquid assets as part of a transaction, or would only accept them at a material haircut. Therefore, many schemes will have to remove their illiquid assets before completing a buy-in or buy-out.
All else being equal, this may make completing a partial buy-in much less attractive for many schemes. If the premium is funded by liquid assets, the remaining portfolio would have an even higher percentage allocation to illiquids, potentially amplifying this issue.?
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In practice, this means that a greater proportion of deals today are full scheme buy-ins rather than partial buy-ins.?
How schemes are managing illiquids
Below are the broad options we see schemes considering when deciding whether they can afford to insure benefits.
There is no perfect solution for all schemes – the right choice can vary depending on factors such as the sponsor covenant strength, the specific illiquid assets involved, and the scheme's funding level and appetite for complexity.
There is no ‘one-size-fits-all’ approach, and trustees will need to think carefully about which option suits the requirements of their scheme best. In some cases, a combination of these options could be suitable.?
For example, if an illiquid asset is due to fully roll off within the next three-to-six months and would incur a big haircut if sold on the secondary market, a scheme could arrange a deferred premium only on this asset and sell the remaining illiquid assets on the secondary market.
"There is no ‘one-size-fits-all’ approach, and trustees will need to think carefully about which option suits the requirements of their scheme best."
For schemes aiming to execute insurance transactions, however, managing illiquid assets will remain a key focus for some time.
It is therefore advisable for schemes to actively manage their position in the leadup to a transaction, shifting towards earlier engagement with insurers regarding potential options, and having a clear strategy heading into a broking process and eventual transaction.?
This should lead to better outcomes for schemes and reduce the frictional cost of execution.
Special thanks to Redington , in particular Joseph Evans, Senior Vice President, who contributed to this article and the full report.
This analysis is from Standard Life’s report, Managing illiquid assets during a bulk purchase annuity transaction.?