Risk settlement is a polite phrase for “capitulation”. The schemes who have capitulated to insurance company buy-outs/ buy-in’s are small. This chart shows just how biased the market to small DB plans.
The big schemes make the big news because they are so important to the story that the market is collapsing. But the truth is that the small schemes, which super-trusts were supposed to swallow up, have gone entirely to Purchased Bulk Annuities. Only four schemes have gone to a super trust (Clara) and there are no reports whatsoever of capital backed DB plans .
Aon reports that there is no sign of the sell out by small schemes to insurers. We will see if the Pension Bill with a reported section formalising Super Trusts will put a rock in the road. I suspect this unlikely, new BPA providers are arriving in a hurry , keen to pick over the carcass of our small schemes and 8 years after announcing super trusts, the DWP has done precious little to put them on an even footing with the insurers. Indeed Clara has set its out as a step to the certainty of annuity.
Longevity swaps for schemes who don’t make buy-out.
For schemes either bold enough to reject or too weak to sell to “buy-out”, Aon are suggesting longevity swaps to tie down liabilities using reinsurers.
Credit spreads narrow
As the advantage to insurers of holding bonds over Government debt (gilts) narrows, small schemes are being told to stay in gilts as gilts are now digestible by those who eat them.
There is considerable detail on the correlation between gilt and bulk annuity prices in the Aon report but for many smaller schemes the future with insurers looks to be linked to gilts, most especially the price of sale.
The loss of a source of growth
Smaller DB pension schemes (less than £100m) look abandoned by Government. The Aon report is nothing if not pessimistic for roll-on in this part of the market.
There are small schemes who club together but it will take a good business plan from Trustees to sponsors to keep schemes alive.
While bigger schemes with the muscle to survive will do so – and profit from surpluses, small and weak DB schemes have little hope at present. It is a shame that superfunds, capital backing and the capacity of the PPF cannot be put to work.We are losing an important part of the economy and many pensioners are losing any benefit from investment that may come out of the forthcoming Pension Act.
This position highlighted by Aon indicates a complete misunderstanding of the financing of smaller companies.
If we assume smaller DB pension schemes are associated with smaller companies, these are the companies that have the most to gain from running on their DB pension schemes. Running on the pension scheme gives the smaller company the opportunity to reduce its future employment costs, minimise cash outflows, and provide a potential source of crisis capital. All critical issue for the smaller company.
For too long smaller companies with DB pension schemes have been frightened into “risk transfer” transactions by the obscene over-valuation of their pension scheme liabilities mandating bloated and unjustified deficit recovery contributions and PPF levy payments and hitting their cash flow and Balance Sheets based on an entirely worst case and contingent liability figure. The penny is now beginning to drop and the companies who still have their DB scheme have survived this environment over 20 years and are still around. If the pension scheme is able to afford the risk transfer premium, almost by definition, it must be in surplus for a run-on scenario.
The risk transfer salesmen and advisors have in the past and are still asking them to make irrevocable investment decisions to sell income generating assets to match their liabilities at the transaction date worst case estimated cost. The recent examples of NatWest Bank and WH Smith, although apparently mandated by corporate restructuring transactions and obscured by questionable application of accounting asset ceiling caps, have indicated how large those losses can be in relation to the pension scheme assets prior to the start of the risk transfer path.
I am aware of many companies who had started down the buy-in and buy-out path but how have now paused the process and are seriously considering how to reverse the process to benefit from run-on. Even some who believe that they can benefit from the productive investment of the assets in their pension scheme to further reduce future employment costs, minimise cash outflows, and provide a potential source of crisis capital through the re-opening of DB accrual!