Will Hale explains the attraction of enhanced de-risking in the light of growing activity
Not everything in life is as it seems. The first glance at an idea in theory can often look far more attractive than it turns out to be in practice. Equally, not everything is as bad as it may at first seem.
The principle of enhanced annuities is well established in the retail pensions market and 50 per cent of those shopping around for their own annuity now obtain a better deal through individual underwriting. The level of the increase received can be very high. These facts mean that the retail market has been moving for some time towards a state in which, eventually, everyone will receive an individually underwritten annuity.
It can, therefore, appear automatically obvious that a DB scheme securing benefits for a group of individuals under the scheme rules should obtain a better deal in respect of those with health or lifestyle conditions and thus reduce the cost to the scheme. There are, however, a number of issues that mean this is not always the case. It is important to understand the context for enhanced de-risking to improve identification of schemes for which an enhanced approach will be beneficial and the process of dealing with these schemes.
Firstly, it is important to realise that standard annuities reflect average life expectancy and variance across a pool of healthy and unhealthy lives. In the retail market, enhanced annuities capture the reduced life expectancy of those with health and lifestyle conditions, changing the experience of the remaining segment of the population. The ultimate consequence of this is that rates offered to those without health and lifestyle conditions will reduce.
For large DB schemes the picture can be less clear. The experience of those in poor health may be offset in the scheme by those in good health and, in general, the larger the scheme the more likely it is that the experience will reflect that of the retired population as a whole and that standard pricing will produce the lowest cost to secure benefits. Additionally for larger schemes it is easier for traditional bulk providers to adjust pricing to reflect industry, occupation and location without incurring a significant administration burden. Scheme specific mortality is also more likely to be available with larger schemes.
The smaller the scheme, however, the less likely the profile of pensioners will reflect the profile of the retired population or the industry in which the employer operates, scheme specific mortality is less likely to be available and thus any variances or anomalies can be exploited for the benefit of the scheme when securing benefits. There are two situations in which this usually manifests itself:
1. Schemes with a higher proportion of pensioners qualifying with relatively (although not especially) high levels of enhancement than is seen in the population as a whole,
2. Schemes in which a small number of pensioners represent a high proportion of the liabilities and have conditions that qualify them for enhancements even though the overall membership experience is close to the average for the population.
With a substantial and growing level of activity in this area, Partnership’s experience demonstrates there are sufficient schemes for which at least one of these two considerations applies. By small schemes, we are talking about those with up to 400 pensioners in an exercise – although it is worth pointing out that the second category could very well include many larger schemes as well.
With six transactions completed in the market and more exercises in progress, our experience with gathering medical information has been particularly encouraging as member engagement with the exercises has been high: the simplified questionnaire has worked very well with half of the schemes for which binding quotes have been provided, having a response rate of 100 per cent. On only two occasions has the response rate been below 70 per cent and never below 60 per cent.
In addition to this, the approach to the collection of GP reports has helped increase the effectiveness of buy-in exercises as further investigation, where deemed appropriate, has discovered undisclosed medical conditions resulting in sometimes significant further reductions in cost. There have also been some useful improvements in scheme data with medical questionnaires serving to correct data on marital status of individual members, for example.
For the right schemes, enhanced de-risking exercises have indeed proved as attractive as they first appeared, sometimes surprisingly so.
Written by Will Hale, director of corporate partnerships at Partnership