Trustees Prefer Sponsor Loans and Secondary Market Sales for Bulk Purchase Annuity Transactions

In recent months, defined benefit (DB) trustees in the UK have increasingly favored sponsor loans and secondary market sales as primary strategies for managing illiquid assets within Bulk Purchase Annuity (BPA) transactions. This shift reflects a broader de-risking trend, driven by significant improvements in DB scheme funding levels and the need for effective liquidity management.

Background: Improving Funding Levels and De-risking

DB schemes have experienced substantial improvements in their funding levels, largely due to higher interest rates. This has enabled many schemes to accelerate their de-risking plans, bringing the challenge of managing illiquid assets to the forefront. Illiquid assets, which often include infrastructure, private credit, and property investments, are not typically well-suited for insurers' annuity portfolios due to regulatory constraints. Therefore, schemes must explore alternative strategies to manage these assets effectively[2][4].

Popular Strategies: Sponsor Loans and Secondary Market Sales

Sponsor Loans

• Popularity: Sponsor loans are currently the most favored option among DB trustees, with almost two-thirds (64%) considering them for managing illiquid assets[1][3].
• Benefits: Key advantages include reduced or eliminated need for deferred premium solutions, avoiding the complexity of new service providers, and potentially quicker setup times compared to other options[2][3]. This approach also allows for continued management of illiquid asset holdings without the need for immediate sale or in-specie transfer, which can avoid crystallizing value losses[2][3].
• Considerations: However, sponsor loans require the company to have the capacity and appetite for such loans. Additionally, the scheme may still pay interest on the loan, and the company takes on market risk if distributions from illiquid assets are insufficient to cover the loan[5].

Secondary Market Sales

• Popularity: Over half (55%) of DB trustees are considering secondary market sales for managing illiquids[1][3].
• Benefits: This option provides greater certainty in paying premiums, eliminates interest costs, and reduces currency risks. Secondary market sales can unlock value, particularly for infrastructure, private credit, and property assets[2][3].
• Challenges: Despite its benefits, the process involves a material discount to the current asset value and requires the appointment of a broker, adding complexity and cost[5].

Other Considered Options

• Deferred Premiums: Nearly half (45%) of trustees are exploring deferred premiums as a liquidity solution. This approach allows for delayed payment of the premium portion related to illiquids, giving time for assets to roll off naturally[3][5].

• Pros: Relatively straightforward, avoids taking a 'haircut' on asset value, and removes market risk.

• Cons: No guarantee of sufficient cash at the end of the deferment period; potential need for sponsor contribution; interest costs on deferred premium[5].

• Bank Loans and In-Specie Transfers: Less popular alternatives include bank loans and passing assets to insurers in-specie. These options are less favored due to their complexity and potential delays[3].

The Role of Insurers and the Future of BPA Transactions

Insurers continue to play a vital role in supporting de-risking strategies for DB schemes. However, their regulatory constraints limit their ability to take on illiquid assets directly. As a result, external strategies like sponsor loans and secondary market sales have gained prominence[4].

As the DB scheme landscape evolves, trustees are increasingly coming to the market with pre-arranged solutions for their illiquid holdings. Early planning, collaboration with insurers, and a thorough assessment of assets are crucial in navigating these complex transactions effectively[2][3].

Conclusion

The favoring of sponsor loans and secondary market sales by DB trustees underscores the importance of proactive management of illiquid assets within BPA transactions. As trustees continue to explore diverse liquidity solutions, these strategies offer cost-effective and efficient pathways to achieve de-risking objectives in a rapidly changing financial environment.

Key Points for Trustees to Consider

• Early Engagement: Start conversations with insurers and advisors well ahead of planned transactions to ensure smooth execution.
• Asset Assessment: Conduct detailed assessments of illiquid assets to determine their suitability for different management strategies.
• Options Evaluation: Consider all available options (sponsor loans, secondary market sales, deferred premiums) based on scheme-specific needs and risks.
• Regulatory Compliance: Be aware of regulatory constraints affecting insurers and plan accordingly to ensure compliance.

By adopting a comprehensive approach to managing illiquids, DB trustees can balance liquidity management and risk reduction in a cost-effective manner, positioning their schemes strongly for future de-risking endeavors.