Published by Pete Smith on
Large funding deficits and low yields have meant that, for many trustees, annuities haven’t been considered a suitable asset over the last decade. However, that picture is changing slowly. Today, competitive pricing in the bulk annuity market, together with improved funding positions and more mature schemes, means that annuities should be considered.
For many pension schemes, the reported buy-out deficit is significant and seems an unachievable target. However, there are a number of reasons why this may not reflect the real cost of buying out in the long term. For example, as members retire the cost of buy-out will come down considerably, as pensioner members are typically cheaper to insure.
In addition to the above, liability management exercises – such as transfer value exercises or pension increase exchanges, can be used to reduce the buy-out shortfall.
Therefore, we would encourage trustees and employers to consider how the ‘headline’ buy-out deficit is to be dealt with rather than just dismiss it out of hand. It’s not all employer contributions.
Whether or not your scheme is working towards buy-out, annuities can be viable investment options.
However, there may be good reasons why a buy-in does not make sense for your scheme at the moment. In particular:
Finally, if buy-in is right for your scheme, you may want to take some action to protect against significant increases in the price of the annuities. In the past, some schemes have attempted to do this by aiming to mirror the investments held by insurers in the scheme’s investment portfolio.
Our view is that, rather than trying to mirror the insurer’s portfolio, the important thing is to gain exposure to the key drivers of changes in insurer’s prices: interest rates, inflation and credit spreads. This can be done through liquid derivatives and assets that are easily converted to cash when needed.
In summary, we suggest that trustees: