Guest Editorial
Pensions seminar: Buy-out or cop-out? Pensions (2009) 14, 79–80. doi:10.1057/pm.2009.9 In November 2008, Cass Business School held a breakfast seminar jointly with Palgrave Macmillan, publishers of Pensions: An International Journal. The event was very successful, attracting an audience of professionals and academics from the pensions field, and it has led to this special issue of the journal on the pensions buy-out market. The purpose of this Editorial is to establish some initial thoughts on this market and to set the scene for the contributed papers. Until recently, most of the bulk annuity business transacted by UK insurance companies was what could be described as ‘full buy-out’. Much of this business has related to the wind-up of small defined benefit pension schemes, which were forced down this route because of the insolvency of the sponsoring employer. For most pension schemes, the full buy-out rate was too expensive and the market capacity was rather limited for this to be a viable risk management option. Buy-out has become a topical issue in recent months; DB schemes that would not have thought about the option a year or two back are now quietly reflecting on whether it might solve a problem for them or for their plan sponsors. There is no shortage of inventive providers from the usual market makers such as Legal and General and the Prudential, who have been active for over 20 years in the bulk annuity business, to the new contenders such as Paternoster, Lucida, Synesis, Brighton Rock and the Pensions Insurance Corporation. This development had led to a wider range of solutions being offered in the market. At one end of the spectrum is the traditional, full buy-out. But the spectrum is now being populated with choices, which are offering varying degrees of partial transfer of risk to an insurance company.
Among the questions for trustees and sponsoring employers to ask are the following: — Do these different types of risk transfer offer ‘value for money’? — What are the alternatives to risk transfer to an insurance company? Other stakeholders may be interested in the answers to other questions and I will come to these shortly. Buy-out is like reinsurance – it is about the transfer of risk and it should enable the transferring organisation better to control its risk levels. One of the main risks is the longevity risk. We are fully aware of how significant this is – a rule of thumb used by many practitioners is that a 1 per cent increase is the mortality improvement factor adds 8 per cent to the pension liability. Is longevity really risk or is it uncertainty? In a lecture at Cass Business School in 2007, Adair Turner (one of our visiting professors) reminded us of the distinction first proposed by Frank Knight in 1921. — Risk is quantifiable. — Uncertainty is unquantifiable. Turner then argued cogently that statements about trends in future life expectancy and future mortality rates are judgements about uncertainty rather than risk. If we accept this argument, then how does a pension buy-out work if it is dealing potentially with quantifying something that is unquantifiable? In insurance, generally, one of the arguments for reinsurance is that the reinsurer is able to construct a more homogenous pool of risks that can be priced and managed more effectively.
© 2009 Palgrave Macmillan 1478-5315 Pensions Vol. 14, 2, 79–80 www.palgrave-journals.com/pm/
Guest Editorial
Does that argument apply here to a pension buy-out? Longevity risk is systemic – it is not clear that pooling will help unless we are combining groups with likely offsetting trajectories over time for example, across national boundaries, as with the United Kingdom and Russia. Perhaps the increased interest in the pension buy-out is just a question of better models: — for measuring the base mortality and assessing adverse selection — for modelling and identifying the sector trends Or is the interaction of these factors important? I note, from the preliminary responses to the Board for Actuarial Standards Discussion Paper on Actuarial Mortality Assumptions, that most respondents thought that there is no objective basis for differentiating the future mortality
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changes likely to be experienced by a particular small group of lives from those likely to be experienced by the population as a whole. Perhaps the increased interest in the pension buy-out is a question of regulatory arbitrage – finding an opportunity to switch to a lighter regime. The Financial Services Authority seems to be requiring capital reserving to be on the basis of 99½ per cent percentages – that is, demonstrating the ability to withstand a 1 in 200-year event. This is a stricter requirement than that proposed by The Pensions Regulator. So how does buy-out work? That is a question that the speakers at our seminar discussed and our contributing authors to this issue also address.
© 2009 Palgrave Macmillan 1478-5315 Pensions Vol. 14, 2, 79–80
Steven Haberman Cass Business School London, UK
