Getting the Best of Both Worlds
Being able to insure a pension scheme's liabilities and transfer all of the related risks to a third party is a desirable situation for companies and trustees alike. However, it is often thought to be an unrealistic aspiration, especially in the current economic climate where asset values are depressed relative to their previous highs.
You may therefore be surprised that last year alone more than £7.5bn of pension liabilities were insured. A significant proportion of this was by schemes which were not fully funded.
The continued activity in the insurance market is due in large part to innovations and new approaches. These allow a scheme to benefit from insuring part of its liabilities without reducing future expected returns
For many schemes it really is possible to get the best of both worlds.
Development of the insurance market
Historically, the cost of insuring liabilities has been high relative to the cost of funding them on an ongoing basis. This was because most schemes invested significantly in growth assets, such as equities, which were generally assumed to generate higher returns than those offered by insurance companies. Consequently, it has tended to be only very small schemes, or those whose sponsor ceased trading, which have insured their liabilities.
More recently, there has been a greater appreciation of the risks associated with defined benefit pension schemes and a trend has developed for better funded schemes to insure part or all of their liabilities.
Over the last 12 months, the insurance market has continued to develop strongly and there are now a variety of alternative approaches, and some quite sophisticated solutions. These allow insurance products to be combined with continued exposure to investment markets (such exposure is often seen as have a crucial role to play in removing funding deficits).
A market in longevity products (which have a value linked to future life expectancies) is also developing. These products can be used as part of a liability matching investment strategy to provide many of the benefits of insurance, but at a potentially lower cost. Although it is early days for the market, the first deals have now been completed and we expect that more to follow. Where the circumstances are right, companies and schemes may well be able to benefit from early mover advantage.
Contact
Patrick McCoy
Partner
KPMG LLP (UK)
Head of Investment Advisory
020 7311 2393 | patrick.mccoy@kpmg.co.uk
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