Captive insurance for defined benefit pensions 

Captive insurance: a new path for pension buy-ins

Captive insurers are used by many large companies to deliver significant value for a wide range of purposes, and are now beginning to be applied to defined benefit pension buy-ins. Mercer is at the forefront of the market and working with our sister company Marsh, the world’s largest captive manager, offer a one-stop-solution to cut through the complexity and deliver significant advantages for sponsors.

What is captive insurance?

Many of the world’s largest companies have set up in-house captive insurers to reduce the expense of insuring their risks externally. Now the concept is beginning to be used for “buying in” defined-benefit (DB) pensions, with considerable benefits for companies, trustees and beneficiaries alike. As company profits come under pressure, so the appeal of DB captive insurers is growing.

The primary purpose of a conventional captive insurer is to reduce the total costs of a company’s risks. Typically, companies use them to insure a wide range of risks. For instance, they might be used to insure a company’s fleet of vehicles or its buildings. As a result, there are about 7,000 captive insurers worldwide1, and are used by around 90% of S&P 500 companies.

When it comes to DB pensions, captive insurance does not have to be complex. Mercer has established an off-the-shelf captive insurance solution, which allows companies to access the substantial value a captive can generate without the capital and administrative hurdles typically required for an individual company/captive setup.

What type of companies should consider a captive insurance solution for their DB pension schemes?

Broadly speaking, companies/schemes with the following characteristics:

  • A company with a medium/large pension scheme (>£400m) that has sufficient scale to make accessing Mercer’s captive insurer solution economic.
  • A company with a DB scheme that is close to fully funded on a buy-in basis.
  • A company with a credit rating near investment grade (say BB or higher).

It may be particularly beneficial where Trustees are looking to secure benefits with an insurer, but the company is resistant due to either unfavourable accounting treatment or because they don’t want to pass significant profit to a third party insurer under a conventional buy-in.

1Captive International, AM Best.

Why captive insurance may be a better path for buy-ins

Economic headwinds are putting companies under pressure to protect their profitability and generate value. At the same time, pension scheme funding levels are increasing to historically high levels and trapping ever greater amounts of value. There’s a greater logic than ever for deploying captive insurance to allow companies to access this value, which fundamentally they funded in the first place.

Just as many companies face fresh headwinds, so there’s a need for new ideas. Captive insurance is a tried and tested concept that can be applied to pensions, with the following advantages:

For the company

  • Setting up a captive insurer results in the company retaining the economic value in the Scheme. By contrast, a traditional insurance buy-in would transfer the value to a third party (insurer) which will earn profits from the inherent economic value passed across.
  • Significant potential profits can be accessed from adopting a captive approach over a period of 10-15 years, typically starting in year 1.
  • A high expected return on capital, often far exceeding 15% per annum, with accompanying accounting benefits.
  • The company takes control over how the assets are invested.
  • Does not prevent a full buyout in the future if desired.

For trustees

  • Trustees get a buy-in policy, from a UK-regulated insurer.
  • The policy is covered by the Financial Services Compensation Scheme, as with a normal buy-in.
  • It may be easier for trustees to gain the company’s agreement to a buy-in, due to better economic and/or accounting impacts vs a full buyout.

These advantages need to be considered against the risk that remains with the Company from using a captive (by contrast, a traditional insurance buy-in removes the risk). However, these are the same risks that the Company has managed for many years, and the reward for continuing to do so is high, as outlined above.

Why Mercer?

Mercer is a first mover in the establishment of captive insurers for DB pension buy-ins. At the time of writing, four DB pension captive insurers have been established in the UK and we have been involved in all of them, taking a range of roles. Mercer has leveraged this experience to create an innovative implemented solution to bring to the wider market.

There are three reasons for selecting Mercer to establish your implemented DB pension captive insurer:

  • Simple governance. We have a ready-to-go solution removing complexity and allowing rapid implementation.
  • One-stop-solution. As part of the wider Marsh McLennan group, we can manage all aspects of the captive leveraging the skills and expertise in across Marsh McLennan to be a truly holistic offering.
  • Our solution is designed to allow the company to unlock the value in its DB pension scheme though careful management of the assets.

For more information on our captive insurance solution or to find out if this is suitable for you scheme please contact us.

The key point is that trustees get the buy-in they have been targeting, and the company captures economic value equivalent to about 20% of the pension scheme, over 10-15 years. To simplify matters, Mercer has a captive insurer governance structure that companies can buy off-the-shelf.
John Gething

Mercer Principal and Actuary

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