Trustees of defined benefit (DB) pension schemes could secure savings of 10% or more when they de-risk their pensioner sections, thanks to the introduction of health and lifestyle underwriting techniques in the bulk purchase annuity (BPA) market. The first major report on this innovation, published today by the Pensions Institute, coincides with news of the first ‘enhanced’ buy-ins to be completed in a market estimated to be worth up to £380bn.

Individual underwriting could slash the cost of a buy-in relative to conventional approaches to pricing, while the entry of specialist enhanced insurers will shake up competition in the de-risking market, the report says. Importantly, as the report’s analysis of the first completed deals demonstrates, individual underwriting makes possible de-risking transactions that previously had been unaffordable, taking schemes closer to a fully funded position and to a final buy-out, at a time when they are suffering from increasing liabilities due to economic conditions. Members also benefit from these transactions, which can make schemes more secure and reduce the risk of transfer to the Pension Protection Fund (PPF).

However, the report warns that in any complex market, such as DB de-risking, increased choice can lead to increased complexity. Regulators and stakeholders in the market will be keen to evaluate the different approaches to collecting health and lifestyle information from members, and also the pricing implications when individual underwriting shows the members of a scheme are likely to live longer than average assumptions would indicate. Another consideration is that the selection of an insurer that is able to address a scheme’s specific member profile requires considerable expertise and this might not be readily available to smaller schemes in particular. The report recommends that stakeholders and regulators work together to establish a clear regulatory framework and a code of practice to ensure the market reaches its full potential and develops in an orderly manner. The recommendations include a call for:

Consistent regulation of the BPA market on the part of the Financial Services Authority (FSA) and the Pensions Regulator (tPR). The FSA and tPR memorandum of understanding on pensions issues is woefully out of date and does not address de-risking.

  • Consistent and reliable data for the de-risking market as a whole and the development of consistent data in the enhanced buy-in market. To achieve the latter objective would require enhanced insurers to share their qualitative and quantitative experience.
  • Insurers to develop flexibility in the way they can collect data on members’ health, so that schemes can benefit from whole-of-market bidding processes and avoid having to pre-select the insurer with the most appropriate methodology, as seems to be the case at present.
  • Insurers and reinsurers to work with schemes and their advisers to develop a comprehensive disclosure process, so that all material medical underwriting facts are made available during the bidding process. This would eliminate anti-selection concerns on the part of conventional underwriters.
  • Trustees to seek expert advice about the impact of the insurer’s covenant on the scheme’s financial position. They should also ensure that their trustee liability insurance extends to cover their liability in relation to de-risking exercises, including enhanced buy-ins.
  • Stakeholders and regulators to produce clear guidance for trustees, sponsors and their advisers to ensure best practice is extended to the smaller schemes, which constitutes the market initially identified by medical underwriters as suitable for enhanced buy-ins.

A healthier way to de-risk: The introduction of medical underwriting to the defined benefit de-risking market’, is published today by the Pensions Institute at Cass Business School. The report authors are Dr Debbie Harrison, Senior Visiting Fellow of the Pensions Institute, and David Blake, Director of the Pensions Institute and Professor of Pensions Economics at Cass Business School. The report was sponsored by Partnership Assurance and JLT Pension Capital Strategies.

My Little Pension

My Little Pension

Dr Debbie Harrison, Senior Visiting Fellow at The Pensions Institute said: “This is a major development in the de-risking market. Trustees and scheme sponsors depend on securing affordable buy-ins in order to reach their ultimate goal, which is to transfer all liabilities to insurance companies. The introduction of medically-underwritten buy-ins will help them to reach this goal more quickly – a development that should be be welcomed by stakeholders and regulators alike.”

Will Hale, Director of Corporate Partnerships at Partnership commented: “Sophisticated underwriting techniques, which have made a significant impact in the individual annuity market by increasing retirement incomes for people with health or lifestyle conditions, can now provide a more cost-effective way for certain DB schemes to insure their liabilities.

“We believe the proposal for industry and regulators to establish a code of practice is a welcome and significant initiative. This provides a clear framework for how schemes and their advisers consider the benefits of individual underwriting when evaluating the most effective way to insure liabilities.”

Martyn Phillips Director and Head of Buyouts at JLT Pension Capital Strategies commented: “Buy-ins are already a common tool for trustees looking to de-risk their DB schemes. In the same way that enhanced annuities have changed the decumulation landscape for DC pensioners through the Open Market Option, the enhanced buy-in offers DB trustees a more cost effective way to derisk. With an ever increasing pressure on costs driven by widening scheme deficits, it is important that trustees are aware of, and explore all available options.”

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