Small schemes looking to derisk should ensure a high standard of data cleansing and carry out a mortality analysis to manage the costs involved, finds Pippa Stephens
New products for small schemes
High-net-worth pooling – schemes pass on the risk of high earners living longer to providers, who in turn pool this longevity risk with high-paid employees from a number of different schemes.
Buy now, pay later – schemes can pay a proportion of the full premium at the outset of the buyout transaction, making further payments at later dates, with interest.
Longevity insurance – providers are increasingly offering a “stripped back” version of the longevity insurance, which is traditionally offered to larger schemes.
Buyout providers have developed a number of products aimed at smaller schemes, which traditionally find it harder to derisk.
Some remove the risk of higher-paid employees having a greater impact on liabilities than other workers, while others allow schemes to defer paying the premium.
But schemes wishing to take advantage of these new options have been called to ensure data is checked and carry out a mortality analysis on their membership.
Taking these procedures would help schemes get a better idea of the costs involved in these derisking exercises.
“Just because schemes are small it doesn’t mean they are simple,” said Akash Rooprai, principal at Mercer.
“For those schemes, any costs will be relatively high because sorting out complexities is never easy,” he said.
Small schemes are often excluded from innovation in the market as they may be underfunded and subsequently struggle with the cost of derisking.
The smaller a scheme is, the greater the cost per member of fixed costs for advice and administration. There may come a point where the future expectation of costs become more than a buyout.
High-net-worth pooling
Research from Legal and General’s (L&G’s) Longevity Science Advisory Panel has shown life expectancy is increasing more rapidly in wealthier socioeconomic groups.
If high-net-worth individuals live to 90, it could create a big hole in the funding of the pension scheme
The average annual rate of mortality improvement is around 3% for under-65s in the most affluent sections of society, compared with less than 2% for the poorest.
Small schemes are especially susceptible to the risks of higher-paid employees living longer as these people often account for a greater share of the scheme’s liabilities.
In one quotation by Prudential, 2% of a scheme’s membership accounted for 15% of its liabilities due to the high level of pay for senior employees.
If these people live longer, they will have a disproportionate impact on the growth of liabilities.
In response, providers are offering high-net-worth pooling products, which are aimed at insuring against the risk of high earners living longer.
“If high-net-worth individuals live to 90, it could create a big hole in the funding of the pension scheme,” said David Evans, director of innovation at Prudential.
Operational risks
Richard Butcher, managing director at Pitmans Trustees, said small schemes could derisk far more effectively by ensuring they have clear records of liabilities.
He stressed the importance of keeping an eye on operational risks such as fraud, theft, misleading or lost data, reputational and regulatory risks.
Such risks were often overlooked by busy trustees but were vital to derisking, Butcher added.
L&G offers longevity insurance for smaller schemes with a pensioner liability of between £50m and £250m.
Tom Ground, head of business development at L&G, said the product was a “stripped back” version of more complicated longevity products.
It is without the heavy amounts of collateral and complicated structuring instruments inherent in products for larger schemes.
It also offers large individual annuities for schemes of up to £50m in size to manage the risk of higher earners.
Clean up data
Other options available to small schemes are ‘buy now, pay later’ innovations, which can help spread the cost while providing certainty at the outset.
Most pension schemes’ data are in pretty decent shape but that’s not the same standard as what you’d have to have to pass over to an insurance company
In these arrangements, schemes can pay 70% of the premium at the outset and spread the remainder over three, five or seven years with interest.
But schemes looking at such options should ensure they clean up their data before seeking quotations.
“Most pension schemes’ data are in pretty decent shape but that’s not the same standard as what you’d have to have to pass over to an insurance company,” said Mercer’s Rooprai.
“It’s a one-off transaction for the insurer. They want the data to be perfect.”
He added: “That takes a fair degree of work. Over time, scheme records do go out of date. A member's marital status from 20 years ago might not be correct now.”
Gaps in data should be rectified and additional data, such as an analysis of deaths over a time period, should be gathered, Rooprai added. This will give schemes a more accurate expectation of mortality.
