The EU’s hidden cost for Buy-Out/Buy-In de-risking
When it comes to DB scheme de-risking, Oval’s Simon Chrystal says keep an eye on both legislation and costs.

It may be yet another acronym, but the BO/BI (Buy-Out/Buy-In) approach to hedging your DB scheme’s longevity risk offers many practical advantages. With a pension Buy-Out you transfer existing pension plan assets and liabilities to an insurance company – who then assumes responsibility for the plan’s risk. With a pension Buy-In, you exchange the existing assets of the plan for annuities provided by an insurance company who again, assumes your plan’s longevity risk. In both cases liability and risk are outsourced and the longer term costs of administering the pension scheme fall.

Stop, look and listen
At face value, all well and good – but like good driving technique, it’s wise to check your mirror before you signal and manoeuvre. Why? The EU’s Solvency II Directive - coming on 1st November 2012 - means pension insurers and reinsurers will face more stringent capital adequacy requirements, forcing up the cash reserves they must hold. The insurance industry sees Solvency II as a logical extension for insurance-backed pension products and a necessary measure to protect members. The pensions industry argues that Solvency II rules significantly increase costs for scheme sponsors. Such polarisation doesn’t help employers, trustees, their members and their schemes.  Plus there are two stings in the tail: first, employers may face an increase of 15-25% in the cost of the benefit. Second, Solvency II and its implications are still neither widely recognised nor understood and may come as an uncomfortable surprise to many.

Solvency II: today and tomorrow
By 31st October 2012, all insurance firms in the EU will need to be Solvency II-compliant and all BO/BI pension programmes initiated after this date will run under Solvency II regulations. Today, insurers must hold sufficient assets based on a technical provisions basis. Under Solvency II, insurers will have to measure the level of the technical provisions against more secure but lower yielding securities and this is expected to produce a requirement to hold higher reserves.  All of this will feed through in the cost of securing pensions, whether you are a trustee of a defined benefit pension scheme looking to de-risk or a member of a personal pension arrangement looking to convert your capital into income.

Solvency II: the impact
Whichever way you look at it, annuity prices for those yet to retire and for those schemes looking to undertake a buy-out or buy-in are likely to rise – potentially sharply. If you are considering implementing any flavour of BO/BI scheme then check your financial advisors have spotted this wrinkle in the road and have strategies to manage it. If they haven’t, talk to advisers who understand Solvency II and understand BO/BI - plus how both relate to employers and trustees and members:

• Get your member data in good shape
• Model the cost implications for your cash flow
• Understand the end point for your scheme
• Explore other options – because they do exist.

Some BO/BI providers have already dropped out of the market because of issues around capital availability. Others are considered to be adjusting contract pricing in anticipation of the ultimate implementation date. While BO/BI strategies may remain valid for many schemes, there are alternative options when looking to manage longevity, inflation and investment risk. Like many things in life timing is going to be key. The sooner you speak to advisers who understand developing markets and place context on how these changes may affect funding, then the smoother your ultimate path to applying innovative strategies for securing member benefits will be.

That’s why Oval is here to help.

Like to find out more about what Solvency II means for the long-term management of your DB scheme? Contact Simon Chrystal on 07771 611224 or email: simon.chrystal@theovalgroup.com.