 By Will Hale, Director of Corporate Partnerships, Partnership
In 2012, we saw a growing interest among DB schemes and their advisers to consider de-risking exercises based on individual underwriting. We saw this primarily amongst smaller schemes, where sometimes the concentration of liabilities among just a few members who may have health and/or lifestyle conditions can see the cost of a buy-in/buy-out compare favourably to technical provisions and/or the cost of insuring via a traditional provider.
The Pensions Regulator Purple Book 2012 presents a discouraging outlook for trustees and sponsoring employers with a s179 deficit running at over £200bn in March 2012. Recent research by actuaries at Xafinity Consulting, which measures deficits across the whole of the Purple Book, showed that scheme deficits now total over £550bn as at the start of 2013. As a result, companies, trustees and their advisers are paying much greater attention to not only funding, but also to buy-ins and buy-outs as a way of managing risks.
In my experience, much of the actuarial focus in the UK is given to larger schemes, which while understandable does not necessarily reflect the dynamics of the market, especially when you consider that of the 6,198 DB schemes in the UK, 5,089 have fewer than 1,000 members representing 32% of all scheme membership. And within this, 2,260 have fewer than 100 members.
In February 2013, the Pensions Institute and Cass Business School presented a joint report into the impact of individual member underwriting on the de-risking of DB pension schemes. In summary, the report found that using health and lifestyle information within a buy-in/buy-out exercise could save some schemes approximately 10% when considered against the costs of transacting with a traditional provider. In some cases the savings can be even higher.
In addition, the report highlighted that, while not increasing pension payments, these exercises can benefit members through dramatically improving the scheme’s security due to the additional benefit of the insurance company’s covenant when compared to that of the scheme sponsor.
This report followed Partnership’s announcement of the first medically underwritten bulk purchase of annuities in December 2012, where a small engineering firm was able to achieve a cost benefit of c. 10% when considered against traditional approaches by requesting that scheme members complete a few simple health and lifestyle questions via a single page questionnaire.
There are a large variety of conditions that can be underwritten and the table below highlights the possible enhancements available in a retail environment for a 65 year old man with a £25,000 fund.
The current focus for enhanced bulk buy-ins is on smaller schemes with up to 400 members, representing around 350,000 pensioners with an aggregate of assets under management of about £40bn. These schemes could typically benefit from enhanced de-risking exercises for two main reasons:
1. Liabilities could be skewed towards a small number of dominant members or directors who will benefit from a disproportionate amount of the scheme assets; and/or
2. The social or demographic profile of the members in general could be out of line with that of standard mortality assumptions.
Medical underwriting in a DB context does present challenges around collection of information because, unlike in the individual enhanced annuity market where the member sees a material increase in their pension, in the DB market it is the scheme and/or the employer that is seen to be gaining most benefit as members typically won’t recognise the advantages of additional security. That is, until it’s too late.
The way to deal with that is to cut the process to a minimum. Our research with members has shown that they will return enough personal information for us to deliver material cost saving for the scheme if presented with a short one-page questionnaire requiring just yes or no answers. Current rates of return for this personalised information are typically over 70% although for some schemes we have had 100% of forms completed. Our research shows that more than 50% of people could qualify for an enhancement due to their health and lifestyle conditions, however, for some schemes the qualification rates may be even higher.
Moving forward, I expect many more DB schemes will review the use of enhanced annuities as a way to manage risks as there is little sign that pensions deficits will decrease and trustees will have to consider all available options.
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