Partial buy-in versus a long recovery plan for a weak sponsor
You advise the trustees of a £1.375bn defined benefit scheme with assets of £1.265bn, a funding level of 92% on a gilts-plus basis and a deficit of £110m. The sponsor is a mid-sized manufacturer with EBITDA of £140m and net debt of 3.2 times EBITDA; the next triennial valuation is due in 14 months. Pensioners are 60% of the liabilities. An insurer has quoted a buy-in of the pensioner section at 103% of the gilts-plus value, and the scheme holds £250m of property and private equity that would have to be sold at an estimated 6% discount to fund it. The sponsor proposes a 12-year recovery plan with £18m a year, arguing that the buy-in crystallises a loss and removes the scheme's best-performing assets. The trustees' alternative is an immediate buy-in of half the pensioners.
1. Evaluate the partial buy-in against the sponsor's recovery plan, using the figures provided.
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Sizing. Pensioner liabilities are 60% x £1.375bn = £825m; the full buy-in premium at 103% is £850m. Half the pensioners is £412.5m of liabilities and about £425m of premium. Selling the £250m of illiquid assets at a 6% discount realises £235m and crystallises a £15m loss.
Recovery plan. £18m a year for 12 years is £216m undiscounted, roughly £160m discounted at 5%. That exceeds the £110m deficit on paper, but it depends entirely on the sponsor surviving 12 years with leverage at 3.2 times EBITDA in a cyclical manufacturing sector. If the sponsor fails, the scheme enters the Pension Protection Fund with benefits cut and the trustees' decision is judged with hindsight.
Buy-in. The premium is a 3% cost, about £12m on half the pensioners, plus the £15m illiquid discount if those assets fund it. For that, longevity and investment risk on £412.5m of liabilities transfer to an insurer, and the scheme's risk concentration falls sharply. The insurer must be regulated and its credit quality assessed; buy-ins are not PPF-protected, so the trustees are swapping sponsor covenant risk for insurer credit risk.
Comparison. The buy-in costs roughly £27m of value against £160m of uncertain discounted contributions. The real question is whether the sponsor covenant is strong enough to underwrite £110m over 12 years. On 3.2 times leverage, I would not assume it is without further evidence.
2. What further information and protections would you require before recommending the trustees proceed, and how would you handle the illiquid asset sale?
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Covenant evidence. Obtain the sponsor's three-year cash-flow forecast, the debt covenant schedule and any change-of-control or dividend-lock provisions; commission an independent covenant review. Test whether the £18m annual contribution survives a 20% fall in EBITDA, and ask for security such as a parent guarantee, a charge over assets, or an accelerated contribution on any leverage increase above 3.5 times. Consider contingent assets, for example a letter of credit, to cover the first three years.
Buy-in due diligence. Check the insurer's capital position and rating, the policy documentation on benefit identification and data, the treatment of GMP equalisation and dependants' benefits, and the termination and assignment provisions. Confirm the trustee's power to enter the contract and whether the buy-in can later be converted to a buy-out.
Illiquid asset sale. The 6% discount is a real cost of £15m. Before selling, test whether the insurer will accept an in-specie transfer of the property or private equity units, which avoids the discount but may be resisted or priced for. If a sale is unavoidable, stagger it to avoid a fire-sale discount, and consider a deferred-premium structure where the insurer takes the assets later at an agreed price.
Governance. Present the buy-in as a risk-reduction decision, not an asset-return decision, with a comparison of the scheme's funding level under a sponsor-failure scenario. Document the reasoning and the trustee board's consideration of the employer covenant before the transaction is signed.