Private assets and preparing
for an insurance buyout 

When we work with schemes contemplating buyout who have illiquid holdings, we first look for solutions outside of the insurance contract – working with the sponsoring employer to trade the asset onto their balance sheet, structuring a loan against the asset, or approaching secondary market buyers. 

Before liquidating their private assets, however, schemes should appreciate that whilst buyout insurers’ appetite to receive private assets as part of a buyout insurance premium is limited, it isn’t necessarily zero. And in the highly competitive bulk annuity market, insurers may be increasingly flexible, especially in the larger transactions where private assets may be more prominent in schemes’ asset strategies.  

Bulk annuity insurance firms can digest private assets in various ways: 

• Insurers already have significant allocations to private assets in their asset portfolios. In ideal circumstances, the private assets of the scheme could simply be incorporated into the existing private asset portfolio of the insurer. However, this may not be as easy as it sounds. The assets that are held to back buyout insurers’ liabilities are subject to a lot of regulatory constraints (the Matching Adjustment (MA)) and supervisory scrutiny by the PRA. Whilst these constraints are being loosened somewhat by incoming insurance regulatory reforms (Solvency UK), private assets will still need to meet some demanding eligibility criteria to be held in the asset portfolios backing insurance reserves. 
   
• However, insurers hold capital well in excess of those required to meet current policyholder reserves. The insurer could opt to hold the private assets in those shareholder funds, which are not subject to the MA asset eligibility rules. They will have limited appetite for this though, as the assets will still generate regulatory capital requirements and won’t generate the regulatory MA benefit that is obtained when they are held in the asset portfolio backing policyholder reserves. 
   
• There is also a hybrid approach to allocating private assets between policyholder and shareholder funds – the assets can be re-structured by the insurer to create a less risky piece that can meet MA eligibility rules and hence can go in the assets backing reserves and generate MA benefit; and a riskier piece that can go in the shareholder fund. This approach creates some complexity and cost but it is an increasingly well-trodden path for insurers.  
   
• Insurers may accept private assets as part of the buyout premium when it has no intention of retaining the assets – in a highly competitive bulk annuity bidding process, the insurer may accept the role of liquidating the assets as part of the cost of doing business. However, pension scheme trustees should be aware that insurers are likely to apply a significant discount to the net-asset-value in this circumstance.  

Some of these options may also interact with the insurer’s reinsurance strategy. If the insurer is using a funded reinsurance strategy in the transaction, this could create some additional flexibility if the reinsurer is willing to accept some forms of private assets as part of their reinsurance premium.  

Additionally, even in cases where the insurer is not willing to accept the private assets as part of their insurance premium, they may offer some other forms of flexibility. In particular, the bulk annuity transaction could be structured such that a part of the premium is deferred for a period (say, two or three years). This would allow the pension scheme to execute the buyout transaction today, whilst providing time for the scheme to liquidate the private assets in an orderly and cost-effective fashion. As ever, there is a catch - the insurer’s appetite for the use of deferred premium is likely to be quite limited, as a deferred premium also defers the recognition of the regulatory MA benefit. This will have a negative impact on the capital efficiency of the deal that will probably need to be recognised in the buyout pricing terms. 

Finally, it is also possible for insurers to offer a mixture of the approaches outlined above. A deferred premium with an agreed ‘backstop’ price for the asset gives trustees the flexibility to sell the asset over the deferred premium period with the knowledge that if an attractive price cannot be found, the insurer has agreed to take the asset at a pre-agreed minimum price. Again, this approach brings some risks and costs for insurers that will very likely be reflected in the pricing terms.