Insurance Risk transfer – Managing Covenant Risk

The Bulk Purchase Annuities (“BPA”) market is going from strength to strength, breaking records in terms of deal size and overall volumes transferred.

Buy-ins, buy-outs and (to a lesser extent) longevity swaps are becoming an increasingly important component of a toolkit available to a pension scheme. As trustees progress in their de-risking journey, counterparty risk becomes a prevalent risk factor for trustees to manage.

What is counterparty risk?

There are currently eight insurers active in the UK BPA market. As with all insurance products, bulk annuity policies offer a trade-off between the premium paid and the level of protection received. One of the most important decisions for scheme trustees during this process is deciding which of the active eight BPA providers to transact with. In this context, an important consideration is the assessment of counterparty risk, i.e. the risk that the insurance counterparty may not make good on its promise to deliver member benefits in full.

Why is this important for you to consider?

Although the Solvency II regulatory framework has introduced a new standard risk governance framework and reporting structure for European insurers, insurers retain flexibility in areas that shape their risk profile.  Therefore, no two insurers offer the same risk profile to its policyholders. This position has been reaffirmed in the UK through case law, e.g. 2019 High Court ruling in connection with the Part VII transfer in Prudential and Rothesay Life, and across other geographies, e.g. the Department of Labour’s 95-1 requirements (commonly referred to as “DOL 95-1”) in the United States, which stipulates that trustees must act in the best interest of its scheme’s members in selecting the insurer that can provide the “safest annuity available”.

Trustees will want to demonstrate that they have considered the trade-offs between price and security – after all, the insurer offering the cheapest quote may not necessarily be the most secure/robust. A timely assessment (e.g. following round one quotations) would enable trustees and sponsors to take strategic decisions on the basis of security relevant consideration, paving the way for a more smooth and cost-effective de-risking process.

These are some of the questions we see trustee’s wanting to address as part of their decision-making process:

1. How does the insurer’s overall risk profile compare to its market peers?

2. Is the transaction affordable? i.e. what will its solvency capital position look like post-transaction?

3. Are there any material areas of concern which could threaten the insurer’s ability to meet its obligations to policyholders, in full?

Why Lincoln Pensions?

From 2014 to date, we have advised on over £20bn of pensions de-risking transactions, with the sizes of the transactions ranging from £3m to £4bn. As the most active specialist provider in the market, we have developed an approach that:

  • is the most comprehensive in the market
  • is unique in enabling trustees to directly compare insurers across a range of key risk factors, and
  • provides clear advice by cutting through the insurance industry jargon.

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