Pensions - Articles - The role of synthetic credit in pensions endgame journey

 Aon’s 2019 Global Pension Risk Survey showed that many UK pension schemes are now less than 10 years away from buyout and securing their members’ benefits with an insurance company. As a scheme prepares for a buyout, it needs to shift its investment strategy from prioritising growth to ensuring its assets are both in line with insurer buyout pricing and sufficiently liquid to allow for a sale or transition to an insurer. One of the ways a scheme can do this is by having a flexible credit portfolio.

 Lucy Barron, partner at Aon, said: “When an insurer in a buyout transaction quotes a premium, the price will reflect investments the insurer will buy to cover a scheme’s liabilities. Having exposure to credit will help ensure a scheme’s assets move in line with insurer pricing, as all insurers hold investment grade credit albeit in differing amounts. The flexibility to adjust this credit exposure quickly and cheaply will ensure that a close match can be achieved regardless of which insurer is ultimately selected.

 “To protect against market-influenced insurer pricing, pension schemes can benefit from exposure to synthetic credit provided by index credit default swaps. Credit default swaps are standalone contracts that bring a range of benefits by providing investors with liquid, standardised, synthetic exposure to the corporate bonds of a defined set of companies.”

 Lucy Barron continued: “Credit default swaps typically hold their value better than physical credit during a credit sell-off. They can help schemes to track insurer pricing and are liquid due to being easier and cheaper to trade than physical corporate bonds. As schemes approach buyout, they should consider their exposure to credit – and purchasing synthetic credit is a low cost and flexible way to do this.”

 Synthetic credit when approaching buyout