Momentum Conference 2012: Review of Workshop C3: Buy-ins and buy-outs - doing deals in extreme market conditions

An insurer’s overview of bulk annuity pricing

Mark Cooper provided insight into the buy-in/buy-out process including:

• typical timelines for a project;
• the possible issues that can emerge; and
• the different areas that insurers can focus on when providing a scheme with a quotation.

 The key points were:

• Data quality - insurers may add on significant premiums if there are uncertainties in the data provided.  It is likely that they will also carry out an audit comparing the actual administration of the scheme to the benefit specifications and scheme rules.
• Mortality experience – the price may be inaccurate due to convexity effects. For example if using an average experience factor for an entire scheme rather than taking the average of the present values of two homogeneous groups (such as executives and non-executives) calculated using two specific experience factors.
• Other demographic assumptions – using standard assumptions for proportion married and age difference may not be appropriate.  For example, Mark showed some analysis from one scheme which showed that age difference may increase as the population ages.
• Inflation – using a flat rate assumption can produce a significantly different result to using the full yield curve (which the insurer is likely to use), and there may also be variances between insurer costs for hedging inflation volatility and those implied from Black-Scholes models.
• Interest rates – the majority of insurers will use swap based discount rates as opposed to gilt based.  When setting a discount rate the insurer will take a view on what proportion of the credit spread relates to default risk and this view may then change as credit spreads widen (unless the insurer has a credit-hedged strategy whereby they receive collateral to reflect the increased risk of default).

Having not previously been involved in a buy-in or buy-out project the session provided a useful insight (particularly from the insurer’s perspective) of the complexities involved in the pricing process and key issues to consider.