Striking back over pension pain

With insurers, staff and employers all standing to benefit, consultants predict the market will grow exponentially.

THERE'S not much employees can take for granted in these troubled economic times, and a decent company pension to retire on is increasingly becoming something only the lucky few can look forward to with any certainty.

Final salary, or defined benefit (DB), company pension schemes – where staff know exactly how much they will retire on – were for years taken for granted. Not any more.

Rather than being a sideshow, pensions are now taking the main stage and are increasingly becoming the reason behind disgruntled workers threatening strike action or mergers and acquisitions falling through when the size of the takeover target's scheme liabilities emerges.

In April, workers at Ineos, which runs the Grangemouth oil refinery, threatened to walk out in a dispute over their final salary scheme, leading to panic-buying of fuel across the country. Even the non-unionised insurance giant Standard Life faced a serious backlash when it proposed closing its highly valued final salary scheme last year.

But for some companies, the scale of their pension liabilities could make them go bust, or at least force job cuts.

For that reason, businesses of all sizes are looking to reduce risk by shifting their pension liabilities onto a third party, usually an insurer. This has led to a boom in the pensions buyout market and the emergence of specialist insurers such as Paternoster.

Last week marked the biggest buyout deal of the year, with FTSE 100 UK telecoms group Cable & Wireless striking a record-breaking deal to offload £1bn of its pension liabilities to Prudential. C&W's DB pension fund trustees bought a bulk annuity policy from Pru under which the life insurer will cover the retirement benefits of 5,000 former staff.

Analysts are saying that C&W's move last Wednesday may be paving the way for the break-up of the group, as pension fund trustees could have tried to put a stop to any restructuring that would have put entitlements at risk. Pru benefits from the arrangement because the C&W annuity policy will generate £100m a year in premiums. Meanwhile, C&W's retired employees will be secure in the knowledge that their future payments will be met.

The deal tops the £700m agreement reached in February for Rothesay Life, part of Goldman Sachs, to buy the assets and liabilities of Rank Group's scheme and takes the buyout market to a new level.

The market has existed for around 10 years, but until recently it was seen as an option of last resort for firms facing insolvency. Buyouts are now becoming an attractive strategic option for finance directors of large firms who want to shed pension risk relating to investment, inflation and longevity, which are difficult to control and expensive to hedge.

Going down the buyout route is also losing the stigma that was attached to it from the days when it was only considered by firms that were going bust, according to consultants.

John Broome Saunders, actuarial director at BDO Stoy Hayward Investment Management, said: "Historically, some companies were a bit embarrassed to admit to wanting to initiate a buyout. There might have been an element of residual paternalism and a reluctance to pass some responsibility for employees onto a third party. This is less the case now, with household names such as C&W going for this option."

Based on the fact that insurers, employers and staff all stand to benefit from pension buyouts, consultants are predicting the market will grow exponentially.

Research by actuaries Lane Clark & Peacock predicted that the buyout market will exceed £10bn of business this year, a three-fold increase on 2007, but still less than 1% of the potential market offered by private sector DB schemes.

It's also being seen as significant that C&W chose Pru, a traditional life insurer, for the deal, rather than one of the specialist firms such as Paternoster, which has a 50% share of the buyout market. Pru only had a 2% share at the start of the year, Aegon had 3%, Norwich Union had 3% and Legal & General had 40%, according to Lane Clark & Peacock.

Such well-known life insurers, which may be suffering in other parts of their business because of the credit crunch, are now moving back into the pension buyout market which they regarded as uneconomical for a time.

Tony Read, marketing manager with Aegon Trustees Solutions, said it is close to launching a suite of products to manage liabilities for DB schemes worth up to £100m, including an actuarial "road map", and has brought in an asset liability modelling service.

This service will complement the buyout arrangement it offers companies with schemes worth more than £100m through a tie-up with UBS investment bank.

Read said: "The buyout market has changed and it's no longer only for insolvent employers. Buyouts are a proposition for any DB schemes under pressure. There are now a lot of different ways of de-risking. For example, a lot of investment banks are introducing phased DB schemes and are looking to work with life companies, like ourselves."

Following on from the C&W deal, Pru said it has another two or three possible buyouts in the pipeline, of about £2bn to £3bn in size.

Although Steven Haasz, managing director of Prudential Corporate Solutions, said there is no guarantee buyouts of this size will go through this year, he is convinced transactions of around £500m will go ahead. He believes household names are able to compete with the likes of Paternoster because companies make buyout decisions based on more than price alone.

"Companies want the comfort of knowing the insurer will be around for the life of the scheme. During the credit crunch in particular, there has been a flight to quality, and price is not the critical issue," Haasz said.

With about £800bn of liabilities locked up in DB schemes there is enough room for more competition as it would be impossible for monoline insurers, such as Paternoster and Rothesay, to take on the responsibility for this amount of buyout business alone.

Martin Hunter, consultant with Punter Southall Transaction Services, said that Paternoster, for example, initially raised around £500m and has completed about £2.4bn of buyout business.

"It is becoming close to using up all its available capital and will have to get another £500m from investors soon," he said.

One of the factors that could hold back the potential of the buyout market is the capacity of insurers to handle the business. They will need massive reserves to write this scale of annuity business, and financial restrictions may act as a brake on the growth of the market, according to Broome Saunders.

And not all life insurers are keen to get their slice of the buyout market. Scottish Widows said it is a "challenging" market which is difficult to enter and is not an area of consideration.

The "mortality risks" that come with taking on a company's millions or billions of pounds of DB liabilities are not something Standard Life is willing to venture into either, for the time being at least.

John Lawson, head of pensions policy at Standard Life, said: "DB schemes in the UK have close to £9bn in assets, so we'll monitor the market closely, but as an individual insurer we're not very interested in taking on that mortality risk."

He explained that if the average age of a member of a DB scheme is 40 or 45, any insurer taking on those liabilities will not be able to predict the effect of current rapid advances in medical science, for example through genetic research and nanotechnology. They will therefore have no idea of the life expectancy of scheme members and how much their retirement will cost to fund.

While the buyout market is certain to continue moving into the mainstream, it may not take off to quite the level some commentators have predicted.