Focus on pensions: Bulk annuity market stirs up

As employers seem evermore ready to lighten their balance sheets of heavy final salary liabilities, rescuers assemble in the defined benefit buyout market, says Vicki Taylor

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The dominance of the bulk annuity market by providers Legal & General and Prudential looks set to be challenged by new entrants.

Some investment banks and private equity houses are looking at buying out defined benefit schemes.

Changes in the market have initially been welcomed but employers and trustees should carefully consider their options.

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The buyout market for defined benefit (DB) pension schemes is evolving, potentially introducing a greater choice for employers over how they unburden their balance sheet of a final salary scheme. Historically, employers which wanted to offload pension liabilities had to buy a bulk annuity with one of two main providers to ensure scheme members received their pension. Andrew Dawson, deputy managing director at Gissings Consultancy Services, explains: “The buyout marketplace until recently has been a straight choice between Legal & General and Prudential.”

However, new entrants to the market are emerging. Life insurance company, Paternoster, headed up by Mark Wood, the former chief executive of Prudential, is currently being set up to enter the bulk annuities arena later this year once it has gained approval from the Financial Services Authority.

While companies such as Aegon and Norwich Union are also considering making a similar move. Furthermore, a new way of transferring the risk from a DB pension scheme also seems to be emerging involving third parties with plenty of capital, such as investment banks and private equity houses. Stewart Ritchie, director of pensions development at Scottish Equitable, says: “The most interesting development is the appearance of a third way. This is to involve a third party [which] would be another entity with lots of capital. “The finance director gets the liability off [their] balance sheet for less than buying out with a life office.

What is in it for the third party is that it believes it can invest the pension scheme’s assets in equities and outperform the price it paid for it.” James Pinnock, an associate at Hewitt Associates, agrees that this option is likely to be cheaper than a conventional buyout. “[Third parties] will presumably pitch the price lower than a buyout with Legal & General or Prudential because otherwise companies would just take the traditional route. It also depends how many [new entrants] come into the market as competition will help drive prices down.”

However, Dawson warns that this new way does not come without risks attached “One of the beauties of having an annuity bought out with an insurance company is that they are very highly regulated. You’d have to be pretty convinced that the alternative company had a really good credit rating, good security and a good business plan – all of which are quite tough to judge,” he explains. Interested businesses will want to know where to find these third parties to strike a deal with.

However, in Pinnock’s view, it is likely that the deals will end up being driven by the buyout vehicle themselves. “They will cherry-pick the best opportunities presented. At least initially, they will need to be careful that the size of the scheme is not too large. It may be around the £50m mark where we see the action starting,” he says.

A Pensions Regulator spokesman believes this may be a way for employers to address pension liabilities. “However, it is for the trustees to make this decision in conjunction with employers after carefully considering their options and taking professional advice where necessary.”