Insurance companies have historically been less likely to use transition managers than other institutional investors such as pension funds. However, even insurers with significant in-house resources and trading desks can potentially benefit from engaging an external manager. With bulk annuity transactions, insurance companies are taking on pension scheme assets that sit on a company’s balance sheet, explains Alyssa Manning, director of pension risk transfer at Legal & General.

“Many of these pension schemes have different investment strategies to insurance companies,” she says. “When we think about taking in these assets, it is often quite challenging because the scheme is looking to move potentially billions of pounds of assets at one time. We are looking to convert that cash into assets, so we have to charge for transaction costs and transition risk.”

Where the market could be heading – a trend that could create significant opportunities for transition managers – is to let pension schemes take that risk themselves rather than pay a premium to the insurer for transaction risk. This could make buy-ins and buy-outs more affordable, a key limiting factor in the growth of this market.

“There are opportunities for transition managers to act on behalf of a pension scheme, but under the guidance of the insurance company to ensure the asset portfolio that comes in is the most efficient for the liabilities the insurance company is taking from the scheme,” adds Manning.

When an insurance company looks at pricing liabilities it has to make a lot of assumptions around the risks it is carrying in terms of transitioning the asset portfolio. If the pension scheme wants a high level of transparency and control over the process, it is helpful to involve a transition manager.

Manning’s advice to insurance companies is to engage the transition manager early. “Talking to a manager before you set a credit portfolio is useful because they will have a more comprehensive view of the market than an insurer and their feedback around what is achievable is invaluable. The other advantage of early engagement is that once the transition manager is aware of the reasons why the transition is taking place, they can identify opportunities to increase the certainty and/or potentially reduce the cost of the project.”

Sovereign portfolios

The less frequent use of transition managers by insurance companies in the past can be largely explained by the fact that they had larger in-house resources than pension funds and may have used their own trading desk, according to Andrew Williams, a principal in the Mercer Sentinel Group. Their tendency to have less complex, largely local sovereign bond-based portfolios that are relatively easily traded is another contributing factor.

“As portfolios become larger and more complex, there is no reason why insurers would not look to transition managers to help them with a large scale restructuring of their assets,” he says. “Most asset owners have broadly the same requirements for moving assets in a cost-effective manner and we have seen a number of projects where pension funds were undertaking large transactions with insurance companies.”

Although the firm has not been party to what has happened to these assets once they have been received by the insurance company, Williams suggests that it is reasonable to assume that in some of the largest cases there would be a transition of assets to restructure what the insurance company receives.

He adds that even where a client has significant in-house resources, there can be benefits to engaging a transition manager. “Transition management is a specialised function and even though we are talking about insurance companies, pension funds or even asset managers with internal trading and operations teams, transition management covers a wide range of disciplines and is not a function clients would be undertaking on a daily basis.”

In this scenario, the internal team would assume a monitoring role rather than having to engage in the transition process directly, overseeing the work of the manager, interpreting the reports that the manager produces and monitoring what is being proposed in terms of trading strategy.

Investing excess capital

There are many other significant ways in which transition managers can work with insurance companies.

“The core part of their assets is managed internally and does not necessarily turn over very frequently,” explains Chris Adolph, head of transition management at EMEA Russell Investments. “However, when they are issuing policies they will look at the extent to which the value of their assets may be greater than their liabilities and whether they can extract more value from that excess. We see insurance companies having more growth-type assets in smaller, satellite portfolios where they can take more risk.”

Adolph says he has seen insurance companies in the UK and US use transition managers, acknowledging that they are not necessarily experts in managing a broader growth portfolio that includes domestic or global equities.

“They will have people internally with knowledge of how assets are priced and valued and the cost and risk associated with these assets,” he adds. “They have a strong core investment base of people who might be trading on a regular basis managing their own insurance book.”

According to Mario Choueiri, head of transition management at Pavilion, Canadian pension plans will generally have to use the services of a transition manager perhaps once every two or three years. “Historically they have been more buy-and-hold with their managers and will only change if a significant event forces them to do so. However, the insurance companies we deal with have platforms – defined contribution or otherwise – where by virtue of their threshold asset allocation criteria, as soon as the allocation threshold is breached, rebalance is triggered.”

For this reason, Canadian insurance companies are among Pavilion’s more active clients, often engaging the firm several times a year.

Choueiri recognises that regulatory considerations will affect the frequency with which insurers use transition management providers. For example, Canadian insurers that use mutual funds must have a portfolio advisor on the account so that, if the insurer is not registered and has to change manager, they have the complete set of regulatory filings to appoint a manager for the interim period between dismissing their previous manager and appointing the new one.

Insurance companies and mutual funds will have some specific additional considerations. For example, if it is a defined contribution plan or even a regular mutual fund, there will be daily cash activity – unit holders buying or selling units – that will impact the cash situation in the accounts.

This has to be planned out, explains Choueiri. “Obviously, if you are just trading from a transition perspective going from one manager to another that is fine, but if there are significant draws you might run out of cash and suddenly find yourself in a short or overdraft situation.”

In these situations, Pavilion will ask the client to provide details of historical (previous month) cash activity and identify the typical flows. If the client has announced that it will be changing manager, outflows might increase as the trigger date for the switch approaches.

Choueiri says it would be unreasonable for a client to expect their transition manager to be intimately familiar with the regulatory environment and legal requirements for insurance companies in every country. “The company itself should know what it is and isn’t allowed to do,” he concludes. “We can assist based on our previous experience of dealing with various fund clients, but when we are asked legal questions we tell the client that they need to seek legal advice.”