Insurer Due Diligence

14th October, 2021

  • I have sat through a vast number of investment manager “beauty parades” over the years. Sometimes these are in connection with the investment of a small proportion of the scheme assets and, in any event, it is for an investment which could be undone if circumstances required. I am, therefore, disappointed and concerned when Trustee Boards turn down the opportunity to carry out a due diligence analysis on the bulk annuity market prior to selecting a counterparty for a bulk annuity transaction. The usual reasoning is that the trustees are happy to rely on the regulatory regime under which insurers operate, so that there is limited “added value” to a formal due diligence review.

    While there is some truth in this (the insurance market is tightly regulated and statutory reports run into many hundreds of pages), I believe it is safer for trustees to do as much research as possible before irrevocably handing over a large proportion, or all, of their scheme assets, for an insurer to administer for the next 40+ years.   

    Due diligence analysis

    The first aspect trustees should consider is the regulatory regime itself:

    • what are the key risks insurers are expected to manage?
    • what mitigations can be put in place?
    • which metrics can be analysed as a measurable proxy for the various risks?

    This is necessary so that insurers can be compared in a meaningful way.  In addition, regulation should be considered in the wider economic and financial context, and trustees should be aware of any ongoing reviews and expected future changes, particularly as these can impact different insurers in different ways.

    The next step in the due diligence analysis is to look at an insurer’s financial strength. Insurers differ in a number of ways – key aspects are: company structure and ownership, size, investment strategy, business plans, ability to raise new capital, distributions to shareholders and approach to reinsurance. The financial metrics which insurers report should not be considered in isolation, but in the context of the wider market and variations over time should be reconciled. A solvency ratio which may look odd in isolation could be a result of a large transaction being written at the point the assessment is made, or a recent capital raise. Understanding the different sensitivities to the various categories of risks is also useful as a measure of the insurer’s ability to withstand financial shocks. The interaction of multiple changes in financial conditions is even more important, but the impact on insurers is harder to assess.   

    Understanding the administration model

    Virtually all bulk annuity transactions will result in the administration of a scheme benefits to be transferred to the insurer at some point, and it is a huge responsibility for trustees to pass this duty to another party for a period that is expected to span many decades in the future. Quality of administration is an aspect of the due diligence process which is especially retrospective. However, it is useful for trustees to understand and assess the insurer’s administration model:

    • in house or third party?
    • what are the key service level metrics?
    • is the model flexible?
    • what is the review and assessment process?
    • how are complaints dealt with?
    • staffing levels and ability to acquire further staff if needed?

    Consideration should be given to how the model has evolved over the years and how insurers have dealt with past issues, including changes in third party providers. COVID-19 has been a good test of insurer resilience, if nothing else!

    Cyber risk and ESG

    Two very topical aspects, which scheme members are particularly likely to be interested in, are cyber risk and ESG related issues. In connection with cyber risks, it is unlikely that insurers would share their policies in detail, given this is confidential information and there are obvious risks attached to having the information in the public domain. However, information can, and should, be sought on what protections are in place, how these are monitored and kept up to date, how systems are tested (e.g. simulated attacks), what is their past experience of actual attacks and outcomes from these.

    ESG related topics are evolving even more rapidly, partly driven by regulations and partly by growing concern among the general public of issues such as climate change. Bulk annuity providers have positive stories to tell, for example around investment in infrastructure projects with an environmental bias in fields such as renewable energy.  While the emergence of measurable, comparable metrics in this area is still at an early stage, an assessment can be made of how each insurer has integrated ESG thinking in their investment strategy, their willingness to engage with the wider market and their ability to evidence this in communications with shareholders and policyholders.

    Not just for Christmas

     In summary, there is a lot more to selecting a bulk annuity provider than “just” being able to strike an acceptable price and suitable contractual terms. Securing a bulk annuity is ‘not just for Christmas’; it is the culmination of a process which is likely to involve an extended period of preparation in multiple areas. Understanding the insurance market and the individual companies operating within it should be part of this.

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    • Published byTiziana Perrella

      Tiziana is a lead Trustee based in our Manchester Office. A qualified actuary, she has broad pensions experience, with specific expertise in risk settlement including being lead adviser on over 200 buy-ins and buy-outs in the last 20 years. Prior...

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