Buy-side Awards 2016
Within eight working days of the UK's June 23 referendum decision to leave the European Union (‘Brexit'), ICI's pension fund had carried out a £750 million ($934.3 million) buy-in, the ninth for the fund up to that point.
UK 10-year bond yields fell 44 basis points in two days after the referendum, which makes it seem an unlikely time for a pension scheme to do such a deal. Discounting liabilities at the lower rate should bloat any deficit. But in ICI's case, the opposite was true.
The fund's asset-liability matching means it is nearly fully protected against interest rate movements. But after the vote, widening credit spreads – which drive pricing for insurer counterparties, in this case Legal & General (L&G) – cheapened the buy-in by about £10 million.
The transaction closed on July 6. Ordinarily, such a deal would take about six weeks to complete.
"We were positioned for either outcome from the referendum. We made the right choice because we made a £400 million asset gain on the day that more than tracked the rise in our liabilities," says Heath Mottram, chief executive of the ICI fund, although he declines to provide further details of the fund's Brexit hedges.
At the same time, ICI was "conscious an opportunity could arise" to complete a buy-in after the vote, depending on how markets reacted, he says. It had asked its insurer counterparties to be ready to offer pricing for a deal.
The ability to make a decision so quickly owed much to ICI's de-risking dashboard, created in collaboration with consultancy Lane Clark & Peacock using their LCP Visualise platform.
The dashboard allows the fund to track daily changes in the profile of its longevity risk alongside key investment risks and to access up-to-the-minute hard pricing from a panel of insurers – L&G, Prudential and Scottish Widows – each of which feeds in regular prices based on specific information about ICI's liabilities.
"[The LCP Visualise dashboard] gives us a competitive advantage with the insurers we are facing off to [as counterparties]," says Mottram. "We know the appetite of the insurers to do a transaction, and we can grab that opportunity before others get to it."
L&G and Prudential PLC have been part of the panel since 2014. In June 2016, ICI added Scottish Widows, which Mottram says helps increase "competitive tension" among the three.
We were positioned for either outcome from the [UK] referendum. We made the right choice because we made a £400 million asset gain on the day that more than tracked the rise in our liabilities
Heath Mottram, ICI
"We have transactable pricing," Mottram says. "Normally, you have to put forward your members' data and set out the specific terms on which you want to transact. Then you wait about six weeks for the insurers to run it through their systems and come back to you with a real number."
ICI receives updated pricing at least quarterly, but also on request – as was the case running up to the referendum.
Even so, to execute a £750 million deal in eight days was possible only because of existing "umbrella" buy-in contracts with panel insurers. These contracts – put in place with L&G and Prudential on a £3.75 billion deal 15 months earlier – allow the parties to extend the contractual terms and security arrangements of the prior trade to new buy-ins.
Mottram says he is surprised himself at what ICI has achieved, having completed buy-ins that now cover about £10 billion in liabilities in two-and-a-half years. The fund has only about £2 billion of liabilities remaining where longevity risk is unhedged, mainly associated with non-pension liabilities.
The fund is now 11 transactions into its journey to reduce risk, having started 15 years ago as one of the pioneers of liability-driven investing.
Back in 2013, the fund was already largely hedged against rates and inflation movements, and only moderately exposed to equity and credit. From about the middle of 2013, it started to grapple with longevity risk - carving its liabilities into tranches with homogenous risk characteristics with a view to insuring them one by one through pension buy-ins with insurers.
In 2014, ICI carried out the biggest ever such deal with L&G and Prudential in the UK. From the start, this was done with documentation in place to execute transactions quickly and easily with the same insurers in future.
"You catch us at a point of reflection," Mottram says. The fund has about a billion pounds of assets "seeking some degree of return over gilts", and must now set out a strategic path for the years ahead. The de-risking process would have been "impossible without the arrangements and monitoring platform we put in place, which were an absolute necessity", he says.
The week on Risk.net, May 12-18, 2018Receive this by email