Dairy Crest: importance of investment risk management in buy-in strategies

Dairy Crest have announced today that the company’s pension fund has purchased a second bulk annuity, which insures the balance of liabilities for pensions in payment. Mercer was the investment consultant for the deal.
 
Kevin McLaughlin, a principal in Mercer’s financial strategy group, commented:

“Getting the deal right involved a lot of detailed work on the Fund’s investment strategy. As a buy-in deal involves a transfer of a large amount of assets, it can have knock-on impacts for the overall investment strategy.
 
“While the buy-in policy removes a lot of interest rate, inflation and mortality uncertainty associated with the pensioner liabilities, Mercer worked with the Trustee to put in place an appropriate investment strategy for the non-insured deferred liabilities. Of primary concern was to ensure that sufficient long-term inflation cover was in place.”
 
Commenting on the wider issues associated with pension buy-ins, he added:

“Purchasing a bulk annuity is a significant investment for any scheme, involving the transfer of substantial amounts of assets. Since many insurance companies now request schemes to pay across bonds and inflation-protected investments as part of the buy-in premium, another layer of complexity has been added to the process.
 
“Schemes can end up removing pensioner mortality risk but leaving themselves exposed to other risks such as future inflation and interest rate changes. For example, many funds are holding long dated inflation-linked bonds which provide protection for the longer-term deferred member liabilities. This protection is lost if the assets are transferred.
 
“Companies in a pre or post pensions buy-in stage should therefore handle their investment strategy with care, particularly in the area of managing inflation risk.”
 
Commenting on other recent industry activity, he said:

“Although we’ve seen some activity in the buy-in market in the last six months, a number of deals are being put on hold, mainly because companies have failed to align their asset strategy with a targeted buy-in objective. Late appreciation of the implications of the asset transfer has caused a number of trustees to delay pulling the trigger on a buy-in.
 
“The schemes that have been successful in completing a pensioner buy-in deal in recent months have recognised the investment strategy issues and made appropriate asset allocation changes in the lead up to implementing a pensioner buy-in.”

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