De-Risking - the options
Pension scheme trustees are often encouraged to consider de-risking by purchasing annuities from insurance companies. However, de-risking in bulk remains unaffordable for the majority of Defined Benefit pension schemes. Therefore in the absence of the ability to carry out a bulk annuity buy out or buy in, Trustees may want to consider the following key risks:
- Sponsor Insolvency – This is arguably the only real risk faced by pension schemes. Provided the sponsoring employer remains in existence, the scheme liabilities should always be met. However it is a reality, especially in today’s economic climate, that many schemes will outlive their sponsors. Trustees should therefore ensure that the employer covenant is regularly reviewed and consider, if necessary by commissioning external experts, carrying out a formal review. In addition, other forms of security might be considered such as contingent assets and guarantees from the employer and negative pledges, for example in respect of dividend payments by the employer.
- High Inflation and Low Interest Rates – Whilst these two risks are outside of the Trustees control, there are mechanisms that could be used to help manage these risks such as bespoke interest and inflation swaps.
- Rising Life Expectancy – longevity risk continues to be a main focus of Trustees. It is estimated that one year of additional life expectancy can add around 3% to the value of pension scheme’s liabilities. The financial markets do offer some options that may help manage these risks such as Longevity Swaps.
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