Pensions & Investments Jargon Buster
All Risks Transfer
A full buyout transaction where the insurance company assumes responsibility for all the risks borne by the scheme - such as incorrect data risk, GMP equalisation risk and other legislative risks
Auction Process
A competitive process where insurance companies bid to enter into exclusive negotiations with the trustees for a buyout or buy-in contract.
Bespoke Longevity Swap
A swap that is linked to the longevity experience of the actual scheme membership. The counterparty will pay the additional pension payroll if the underlying members live longer than expected; the scheme will pay the additional pension payroll if the underlying members die sooner than expected.
Bulk Annuity
Describes a contract between a pension scheme and an insurance company, whereby an insurance company insures some or all of the liabilities of the pension scheme. Depending on whether the short-term intention is to transfer policies into the names of individual scheme members, bulk annuity contracts are referred to as buyouts or buy-ins.
Buyout
A bulk annuity contract where the short-term intention is to transfer policies into the names of individual scheme members. Once transferred, the trustees are generally discharged of any future obligations to those members.
Buy-in
A bulk annuity contract where the policyholder is the trustee of a pension scheme. Buy-in policies are typically held by trustees as part of a strategy to reduce risk. The trustees retain the responsibility of ensuring members receive their benefits.
Buyout Market
A term to encompass the range of solutions available to transfer risk from a pension scheme to another institution, usually a Financial Services Authority (FSA) regulated insurance company. Risk transfer is typically achieved through a bulk annuity contract or a longevity swap contract. The term is sometimes taken to include non-insured buyouts.
Collateral
Assets specifically set aside to reimburse one party for the default of a counterparty (e.g. an insurance company or bank). Collateral is sometimes built into the structure of larger buy-in contracts and swaps to provide additional protection to the trustees.
Counterparty Risk
The risk for a given party that the other party defaults on its obligations. Mechanisms such as posting collateral can sometimes be negotiated to reduce the potential impact of this risk.
DIY Buyout
The process whereby a scheme purchases inflation, interest rate and longevity swaps to achieve similar levels of risk transfer to a buy-in or buyout.
Financial Services Compensation Scheme
A statutory compensation scheme funded on a pay-as-you-go basis by an annual levy on the financial services industry. It is expected to provide broadly 90% compensation on annuity contracts in the event of an insurer defaulting.
Full Buyout
A buyout contract covering all known liabilities in a pension scheme, usually followed by the scheme winding up.
GMP Equalisation
The process of adjusting scheme benefits to allow for the inequality in the definition of guaranteed minimum pensions (GMPs) between males and females. Some insurance companies will provide an indemnity against a future legal requirement to equalise GMPs as part of a bulk annuity transaction.
Hedging
Purchasing assets that have similar characteristics to the scheme's liabilities, so that if the value of the liabilities rises/falls this is matched by a similar rise/fall in the value of the assets.
Index-based longevity swap
A swap where the actual payout is linked to a standard population. For example, the counterparty may pay out to the scheme if the longevity of the standard population improves faster than anticipated. Index-based swaps are flexible, but provide only partial longevity protection against actual scheme experience.
In-Specie Asset Transfer
The transfer of some or all of the scheme's assets directly to the insurer to pay the premium for the buy-in or buyout contract. This can sometimes provide a saving compared to paying the premium in cash owing to the reduced transaction costs involved.
Liability-Driven Investment (LDI)
A specialised investment (usually made up of cash and swaps) designed to have a similar cash flow profile to a pension scheme's liabilities. So, if the value of the liabilities increases the value of the investment also increases.
Liability Management
The process of taking active steps to manage the risk involved with a pension scheme's liabilities. Practical examples include transfer value exercises, scheme closure or conducting a trivial commutation exercise.
Longevity Swap
A tool to enable pension schemes to transfer the risk of members living longer than expected to a third party (the counterparty), while retaining direct control of the assets. The two main ways of hedging longevity risk, other than buying annuities, are to use a bespoke longevity swap or an index-based longevity swap.
Mono-Line Insurer
An insurance company offering products within a single business line, such as bulk annuities.
Multi-Line Insurer
An insurance company that writes business across a range of lines of business, for example investment management and other insurance products.
Non-Insured Buyout
A transaction that transfers risk by changing the relationship between the pension scheme and the current sponsoring company. Non-insured buyouts do not involve insurance companies and so do not benefit from the associated protections of the insurance regime. Due to lower capital requirements they can be more affordable than a bulk annuity or longevity swap.
Partial Buy-in / Buyout
A buy-in or buyout covering only a proportion of a scheme's liabilities. The most common type is a pensioner buy-in.
Pensioner Buy-in
A buy-in that covers payments to current pensioners and their dependants.
Pensioner Existence Exercise
An exercise to ensure that all the people the scheme is paying pensions to are still alive. This can either be done by writing to members or through a specialist agency.
Pricing Basis
The basis used by insurers to price buy-ins or buyouts. Contrast to reserving basis.
Profit Share
A provision in a bulk annuity contact for the insurance company to make payments to the trustees, or to an agreed third party, if the experience under the contract is better than anticipated in the insurance company's pricing.
Progressive or Staged Risk Transfer
A buyout or buy-in transaction that is completed in several stages, often as part of a predetermined premium payment plan based on asset performance. This allows risk to be transferred when the scheme can afford to do so.
Reserving Basis
The basis used by insurers to calculate the reserves they must hold. These will generally be based on prudent assumptions and will have regard to FSA rules. It will generally be much stronger than the pricing basis.
Residual Longevity Risk
The risk of members living longer than expected that is not covered by an index based longevity swap. The residual risk is due to differences between the scheme membership and the standard population.
Ring-Fencing
A type of security arrangement under a buy-in, where certain assets backing a scheme's liabilities are only available for the benefit of that scheme rather than other policyholders.
Scheme Closure
An action to restrict the future build-up of liabilities in a pension scheme. It could be restricted to closing the scheme to new members or be extended to stopping accrual. Stopping accrual usually means that current active members become deferred members, sometimes with a link to future increases in their salary.
Solvency Capital
The additional capital that an insurance company must set aside, in addition to the premium paid, when writing a buyout or buy-in. This provides a buffer against adverse future experience.
Standard Population
The underlying population used to determine the payouts under an index-based longevity swap - for example the population of England and Wales.
Swap
An agreement with a counterparty (often an investment bank) to 'swap' types of liability exposure. For example, under an inflation swap a scheme pays the bank if inflation falls compared to expectations, but the bank pays the scheme money if inflation rises. This hedges the scheme's inflation risk.
Transfer Value Exercise
An exercise where deferred members (and sometimes active members) are given the opportunity to transfer their benefits out of the pension scheme. An enhancement is often offered above the scheme's standard transfer terms, either to the transfer value itself or as a cash payment outside the scheme, to make it more attractive for members to transfer.
Trivial commutation exercise
An exercise to commute small pensions in the scheme for a cash lump sum. This can both reduce risk and save on future administration costs.