Lucida PLC

Professional Pensions Bulk Annuities Panel. Positive Thinking.

Jan 14 2010

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1. How will the risk-reduction marketplace develop during 2010?

From a supply perspective, the risk-reduction marketplace has evolved very rapidly over the last few years.  We have seen new entrants including new insurers, established insurers, reinsurers and investment banks.  We have also seen departures, particularly of non-insured approaches.  There has also been product innovation, such as pension buy-in and partial buy-in, longevity only insurance and longevity swaps.  Overall this has meant an increase in the supply of risk reduction products and providers.

From a demand perspective, the economic roller-coaster of the last two years has definitely put risk reduction on the agenda for pension schemes.  The ongoing improvement in economic conditions since the end of 2008 is likely to have increased the affordability of risk-reduction for pension schemes and hence the likely demand.

Increased supply combined with increased demand should mean that the pension scheme risk reduction marketplace continues to grow and evolve in 2010.     

2. Several longevity swap deals closed at the end of 2009. Will we see more of these sort of deals over the coming year and how can these instruments be used as part of a broader liability-driven investment or “DIY buy-in” strategy?

It is likely that there will be more longevity swap deals done in 2010 now that this ‘new’ approach has been put into use in de-risking pension schemes. During these still challenging times, the lower apparent costs of this approach will be appealing to some firms keen to de-risk their scheme.  By purchasing longevity swaps alongside interest rate and inflation hedging, schemes can follow a “DIY buy-in” strategy.  However such a strategy introduces significant operational risk and management costs and can leave gaps in coverage such as the longevity of dependants, data risk or in the interaction between inflation and longevity.

Schemes may find that the simpler approach of a partial buy-in is more attractive and at an aggregate level, more cost effective. 

A partial buy-in can address all the elements of risk for a given slice of the scheme membership and benefits, potentially giving trustees and the sponsoring employer greater reduction in total risk without incurring the additional complexity and cost of a DIY solution.                

3. How will UK gilt issuance and the potential withdrawal of quantitative easing affect bonds pricing levels and the consequent cost of buyout or risk-reduction for schemes?

Since the market is already aware that the UK will be issuing large volumes of gilts and that quantitative easing may be withdrawn, the impact of these actions should already be factored into asset values and economic conditions.  An unexpected reduction in quantitative easing and/or increase in the supply of gilts would (all other things being equal) increase longer dated interest rates.

If longer dated interest rates increase this would reduce the buyout cost in absolute terms.  However if a pension scheme holds assets that are very negatively correlated to interest rates such as gilts, corporate bonds, and to some extent equities the buyout cost will not necessarily improve much relative to the scheme assets, i.e. the value of the assets will fall as interest rates increase.

4. To what extent is further education needed to make trustees well prepared for risk-reduction or buyout?

Given the rapidly changing nature of the pension landscape and the significant additional burden being placed on pension scheme trustees, it would be surprising if further education on risk reduction and buyout were not required for some trustees.  These are technically challenging subjects and as with most things that are not simple and straightforward, suspicion and inertia can take root. This is dangerous as it can block sensible and timely steps being taken to reduce risks to the advantage of all involved, not least the scheme members.

In addition, many trustees will only go through the process of buy-out or longevity hedging once so they will inevitably be learning as they go through the process.

However help is at hand.  Organisations like the Pensions Regulator and the ABI have produced very helpful education material for trustees and pension scheme advisers and buyout companies are more than happy to provide support to trustees to help guide them through the buy-out / risk reduction process.

 

Andrew Stoker is Chief Actuary at Lucida. He can be contacted on 020 7467 1600 and at Andrew.stoker@lucidaplc.com.