DB Pension Schemes

July 2016
Should Trustees buy-in or buy-out of DB pension schemes to reduce the risk of deficit?

Cardano's Steve Berkovi looks at Trustees’ options for DB pension schemes. Can buy-in or buy-out help to reduce deficit in the challenging DB UK pension scheme market?

The defined benefit (DB) UK pension scheme market continues to bring challenges to the Trustee table. In recent years, DB pension schemes have been hit by a combination of ever decreasing interest rates and ever increasing regulation.

Trustees are also contending with the impact of increases to longevity, as well as navigating through the range of complex investment options and investment strategies available.

So what next? Schemes are getting more mature. Attention and focus seems to be turning to the de-risking journey, but is the de-risking end game all about seeking buy-out or are there other paths to consider?

To buy-out or buy-in, that is the question

Many Trustees will consider their goal to be buying out pension liabilities with an insurance company, but the reality is that this remains an expensive option.

With interest rates at record lows and rising longevity expectations, many have seen their liabilities and funding ratios deteriorate to levels where affordability seems further and further away.

Even the buy-in approach, while less costly, is not very efficient. It involves insuring only a portion of liabilities, normally for those already drawing a pension from the scheme, but remains beyond the reach of many.

So if we are at a crossroads, what other paths could we follow?

1.    Call time on interest rate and inflation risks

Regardless of the size of the deficit, the impact of interest rates and inflation remain a big risk for many.

Despite the record low levels of rates, we are entering a world where more Trustees are becoming impatient with the interest rate stalemate. Many are thinking of biting the bullet and increasing levels of liability hedging. The reality is that liability hedging can bring significant de-risking benefits to DB pension schemes, similar to those associated with buy-out and buy-ins.

2.    Introduce longevity hedging

It is also likely that longevity hedging, which transfers the risk that members should live longer than expected, will become an increasingly popular option.

The increased availability of more cost efficient products coming to market, especially for smaller DB pension schemes, will support this move over the coming years.

Longevity swaps are expected to see increased uptake, given that this relatively new financial instrument is one of the most capital efficient means to remove this risk.

3.    Rethink the investment risks

For those managing their DB pension scheme to maturity, the equity roulette table will look less attractive. As Trustees look towards less volatile and more income producing strategies.

It is likely that alternative investments able to deliver attractive returns, whilst providing a good match for liabilities or reducing exposure to risk, will become increasingly popular.

Credit strategies like corporate bonds, high yield, bank loans and asset backed securities, together with certain property strategies, will likely be in demand. Given their more attractive risk/return characteristics compared to traditional UK gilts. By getting the balance right you can also help contribute to the de-risking journey.

Choosing the right path

The de-risking agenda is certainly giving trustees lots to consider when it comes to DB pension schemes. The reality is that de-risking can be achieved in a variety of ways.

Trustees will be spending more and more time thinking about the different paths, figuring out what works for them and crucially thinking about which options are the most cost effective.

Find out more about DB pension schemes

If you would like more information on de-risking strategies for DB pension schemes, please get in touch with us. Or take a look at our services page to find out how we help pension fund investors achieve a stable funding ratio.