The Paternoster buy-out index suffered hugely in the fourth quarter of 2008 (Q4 2008) as a result of market volatility over the year.

Following news that Paternoster's assets for 2008 hit £2.7bn, the company has found in its report that for schemes which remained heavily exposed to equities, the affordability of buy-out remained unchanged.

Over the year, however, the net cost of buy-out for these schemes increased in expense by 13 per cent. However, some schemes de-risked by holding high-quality gilts and bonds, and saw the affordability of buy-out improve by two per cent over Q4 2008, and by ten per cent over the whole of 2008.

"In October and November we saw a major readjustment in inflation expectations which led to a significant reduction in the cost of defined benefit pension scheme buy-out as the majority of liabilities are inflation linked," commented Mark Wood, chief executive of Paternoster. "Subsequently, very strong performance in the government bond markets drove risk free rates down, causing significant increases in the cost of buy-out towards the end of the year."

Wood added that 2009 has seen a drop in the yield available on AA bonds as a result of downgrades on high-yielding financial stocks.

"Although uncertainty has continued during January, spreads on good quality, particularly non-financial corporate bonds, have narrowed in recent weeks and if this continues this will help to progressively stabilise pricing. For those schemes that have already followed a de-risking strategy, insuring a scheme through buy-out or buy-in will offer additional security to scheme member at an increasingly affordable premium," he concluded.

Meanwhile, Punter Southall's senior consultant, Matthew Furniss, has warned of the dangers of a mismatch between liabilities bought in or out with insurance companies and expectations from trustees and members.

"Buy-outs have been promoted as complete solutions to trustees and companies but this may not necessarily be the case particularly with the prospect of deflation.

"Although deflation in the economy is now a real possibility, pensions paid through defined benefit occupational schemes are normally protected from this. This protection should be replicated in any buy-out or buy-in. However, it is not certain that this has been applied in all cases historically following comments from some insurers."

Furniss recommends that trustees who have already bought-out liabilities should review the terms of buy-out, and where a scheme has would-up, look at bringing a claim in relation to the issue. Those with buy-in will not have any concerns with member claims, but should be prepared to make up any shortfall in pension payments.

"Trustees in the process of buying-out or buying-on should ensure that this issue is addressed with the respective insurers and be aware that all benefits should be explained in as much detail as is necessary. Allowance for the floor may increase premiums payable to the insurers," he added.

- Pensions Age January 2009

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