Will Hale discusses how enhanced annuities can be a good solution for small schemes looking to de-risk

Smaller pension schemes may often feel trapped by the lack of availability of de-risking options. The Purple Book indicates that schemes of fewer than 1,000 members have assets worth £83 billion, whereas those of over 1,000 have assets worth over £754 billion. Unsurprisingly, therefore, much more effort goes into monitoring and managing the longevity calculations of larger schemes than those of their smaller peers.

However, the size of the issue is far from inconsequential. In the UK there are 6,897 DB schemes. 2,468 have less than 100 members; 3,132 have between 100 and 1,000; and only 313 have more than 5,000. So, the majority of the assets may sit in larger schemes, but smaller schemes have the ‘need’.

Employers with smaller schemes often have a greater need because they can face a more challenging business environment. For many, survival of the business ranks higher than that of schemes defaulting. However, whilst de-risking strategies are well established for larger companies, for smaller firms*, their options are fewer and more costly.

The buyout option is attractive –but may be daunting as the scheme/employer has to meet the full buyout cost of the annuities. The buy-in option involves purchase of a bulk annuity policy, which means the scheme then owns an asset which matches their income stream but they must still retain responsibility for paying benefits.

For smaller schemes, there is possibly one viable solution more traditionally associated with individual DC pensions: enhanced annuities – or individual member buyout/ins. The primary benefit to a smaller DB scheme is cost savings, which can be realised for up to half of retired members on a typical scheme, depending on its socio-demographic profile.

However, introducing enhanced annuities into any of the above options could reduce the cost as they make allowance for those with serious medical conditions or adverse lifestyle factors, such as obesity and smoking. Using these details enables pensioner liabilities to be insured on an individual rather than a bulk basis, with lifestyle and health information being used to secure the most competitive terms from annuity providers. It may even allow access to buy-in for schemes that cannot afford standard policies.

In essence, gaining the lifestyle and medical information about members improves the understanding of longevity, which means a more accurate forecast of longevity risk can be made and, where the associated risk is found to be lower than average, results in cheaper costs.

Even so, establishing the health status of retired members can be a challenge. Some are wary of the potential for invasive and complex underwriting. However, our research has shown that there is a way to deal with that – by cutting the process to a minimum and using just a one page questionnaire with yes or no answers. Typically, using this shortened approach, we receive back around 80–90 per cent of these questionnaires – and results can indicate that over 50 per cent of a scheme’s pensioner population qualify for enhanced.

Enhanced de-risking is particularly suited to schemes in industries associated with health problems or shortened life expectancy – manufacturing, construction, brewing, printing, etc. Where retired members form a disproportionate percentage of the overall liabilities, schemes can also achieve substantial savings if those members qualify for enhanced.

One of the traditional arguments against individual underwriting has been the invasive nature of the health quesions. However, from both an actuarial and an underwriting perspective, based on our data, accumulated over more than 17 years experience of the enhanced annuity market, we believe that sufficient information can be gathered from ten simple questions.

Written by Will Hale, director of corporate partnerships at Partnership

*The following schemes in particular should look at the potential benefits of individually underwriting members:
• those with fewer than 300 members
• those unable to afford a full buy-in or buyout, but wish to remove their risks
• those with a small number of members who carry a disproportionate liability
• those whose socio-economic profile may differ from average assumptions
• PPF cases that are overfunded on a s143 basis

Share Story: