Unlocking Liquidity: How secondary sales support pension schemes in insurance buy-in/buy-outs

The interplay between insurance buy-in/buy-outs and secondaries

As pension schemes approach BPA transactions, their private market exposures can represent a critical issue. The illiquidity inherent in these assets can hinder a scheme’s ability to pay the required insurance premium if (as is often the case) the insurer is not willing to take the relevant private assets as part of any in-specie portion of the premium. And even if an insurer is willing to take the relevant assets – something that is seen more often, particularly at the larger (£1b+) end of the market – they may only be willing to do so at a material haircut. We have set out below some of the ways in which a secondary transaction might provide a solution.

Optimising portfolio liquidity 

Before entering into a BPA transaction, pension schemes are typically faced with the need to adjust their asset allocations to align with insurer requirements. Bulk annuity insurers, reliant on the use of the "matching adjustment" to support competitive pricing, prefer highly liquid, predictable asset portfolios that are well matched to scheme liabilities. Pension schemes with significant allocations to private equity, infrastructure and other illiquid asset classes may face challenges meeting these preferences. Secondary disposals can provide a way to exit illiquid positions in a timely manner, freeing up the pension scheme to rebalance its investment portfolio into something that is likely to be attractive to a wider range of insurers.

Enhancing valuations for insurance 

In the context of insurance, there can be considerable uncertainty around asset values for illiquid assets. A sale via the secondary market crystalises value and gives certainty about the funding position. 

Navigating price volatility 

The timing of secondary sales is important, particularly in the context of an uncertain market. Collaborating with experienced financial advisors and legal counsel will ensure that transactions are executed efficiently, whilst minimising discounts to net assets value and optimising overall value for the scheme. 

Key considerations

For trustees of pension funds and investment managers, there are a number of legal issues that should be considered: 

Fund information: Once the selling portfolio has been defined, the governing documentation relating to each fund should be collated together with any financial statements, K-1 forms and post-NAV date cashflow notices. These documents are important for tax and non-tax diligence, compliance with warranties in the transaction documents and, in the case of cashflow notices, purchase price adjustments. 

Tax analysis: Secondary transactions require careful consideration after due diligence has been performed in order to avoid unintended tax consequences. A US withholding tax analysis in particular must be undertaken even where the portfolio is located outside of the US. 

Market approach: Secondary market specialist financial advisors and legal counsel should be engaged to identify potential buyers, negotiate terms and execute transactions. Financial advisors can also assist trustees in assessing which illiquid assets should be included in the sale portfolio. Experienced advisors will be able to leverage deep relationships with secondary buyers to guide trustees in identifying the right counterparties and negotiating favourable terms.

Counterparty risk: It should be noted that a secondary sale may involve counterparties whose financial strength and ability to perform its obligations should be scrutinised. Legal counsel will be able to build in certain additional contractual protections in the documentation depending of the covenant strength of the buyer. This will be particularly relevant where the transaction involves deferred consideration. 

Timelines: It is better to engage advisors and counsel sooner rather than later in order to ensure a smooth process and timely execution. Most general partners of funds will only permit transfers to take place at quarter-end dates. Coordinating the timing of the secondary sale with the preparation for a buy-in or buy-out process is critical to achieving a seamless process.

Conclusion

Pension schemes today face a complex investment landscape, balancing the need for de-risking, liquidity and value creation. By leveraging secondary market opportunities in conjunction with insurance buy-ins/buy-outs, trustees can achieve these objectives while ensuring member benefits remain secure. 

Collaborating with experienced legal advisors who understand the nuanced interplay of these strategies is essential to navigating challenges and maximising outcomes for pension schemes. 

Authored by Leanne Moezi, Jonathan Russell, Claire Southern, and Lily Wu.