This blog contains a technical examination of the risks trustees take when transferring assets and liabilities to an insurance company.

It has two sections, a response from Keating and Clacher to the question and a presentation given by Paul Brine of Dalriada Trustees that builds on these arguments.

The call for evidence by the work and pensions committee included a question on buy-out.

This was Con Keating and Iain Clacher’s response:

2. Is there sufficient capacity in the buy-out market to meet demand from DB schemes? If not, what are the alternatives?

No. Full scheme buyout has been the exception rather than the rule. In the past decade, a total of just £63 billion of buyout transactions have been completed.

There are serious constraints on the human resources side in insurance which will limit expansion of the sector. Given the profitability of this business to the insurance sector, it is to be expected that insurers will increase their capacity to undertake more buyouts over the coming years.

However, the scale of this expansion would require a near doubling of the asset size of the insurance market and would suggest that this should be expected to take at least a decade. It also raises an important issue.

Rapid increases in written premiums are associated with higher rates of failure of insurance companies, a trade-off that is well-known and often used by analysts as a cautionary tell-tale.

There are two important further issues with the use of insurance buy-out.

The first is that the liabilities may be novated, that is ceded to some other insurance company, a process which would usually be motivated by the desire to recognise profits. There are no formal constraints as to the creditworthiness of the purchaser of the pension liability portfolio.

This differs from the use of reinsurance, where the ceding insurer is the beneficiary of the cover.

We are also concerned with the use of the ‘matching adjustment’ in insurance accounting. This, in essence, is the recognition of future profits from a book of business as profits and capital resources today. It has been described elsewhere as fictive capital.

It is in fact debatable whether transfer to an insurance company improves the security of a funded pension scheme, notwithstanding its greater cost. Clearly it is case and fact specific.

Since submitting that we have seen a powerpoint from Paul Brine of Dalriada which raises many further questions over bulk annuitisation and member security.

This is the presentation Keating and Clacher mention

If you find this presentation hard to read, you can download it to fit your screen from here

The slides are laid out here – thank you Con Keating, Iain Clacher and Paul Brine.