David Prosser: How to park the pension liabilities
Tuesday 02 February 2010
Outlook Closing the company pension scheme is not the only option for employers worried about the cost of final salary plans, despite what you may have heard in recent months about the end of defined contribution provision being nigh.
Look closely at the explanations given by employers for closing final salary schemes and you'll discover that uncertainty about future costs, rather than concern about today's bill, is their most common motivation. And the good news is that there are ways to reduce that uncertainty.
BMW is the latest in the small but growing number of firms hedging against longevity risk by offloading some of its potential liabilities in the UK to a third party. The detail of the deal has yet to be announced, but BMW may be able to offload as much as £2.5bn worth of risk.
These deals could be crucial for employers with large final salary funds: even the difference between having to close only to new members or to shut up shop altogether.
What's really hit employers for six over the past couple of decades has been the rapid increase in life expectancy of Britons. Companies provided final salary pension benefits on the basis they would have to pay out for a set period, only to discover their assumptions about the duration of this period fell significantly short of reality. Cue a much larger than expected pension bill.
With deals like the one BMW is currently exploring, the risk of making this mistake again in the future is offloaded to a specialist insurer. The employer pays a premium for this protection, safe in the knowledge that if staff live longer than expected, the extra costs falling on the pension scheme as a result will be absorbed by the insurer.
In the short term, longevity risk deals may increase the cost of final salary pension benefits because insurers price some room for error – and some profit – into the premiums they charge. Crucially though this sort of deal reduces the risk of a scheme facing an unexpected bill 10 or 20 years into the future. You might see the contract as a pension industry version of a fixed-rate mortgage. The cost of such loans may be higher for the cheapest variable rate mortgages, but you have certainty about future payments.
Longevity risk is not the only unknown in a pension scheme's finances. Funding requirements will also fluctuate as investment returns rise and fall, and in line with other market movements. However, a deal such as this will substantially reduce volatility in pension scheme finances.
As such, it is to be hoped more companies follow BMW's lead. For employees that value their membership of a final salary scheme (even if it is closed to new joiners) longevity insurance could make all the difference to them keeping it.
- 1 Woman 'suffocates newborn baby in plastic bag and puts it in her desk minutes after giving birth'
- 2 I've been called an abusive and dangerous parent, when all I did was listen to my transgender child
- 3 Company breaks open Apple Watch to discover what it says is 'planned obsolescence'
- 4 Teaching profession headed for crisis as numbers continue to drop and working lives become 'unbearable'
- 5 Chinese student carries disabled friend to school every day for three years
General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband
The sickening truth about food banks that the Tories don't want you to know
Migrant boat disaster: Ukip candidate mocks victims in sickening Twitter post
Nigel Farage wants the BBC to stop making programmes like Doctor Who, Strictly Come Dancing, and Top Gear
Global warming: Scientists say temperatures could rise by 6C by 2100 and call for action ahead of UN meeting in Paris
General Election 2015: Britain would become a 'communist dictatorship' under Ed Miliband and Nicola Sturgeon, claims wife of Michael Gove
iJobs Money & Business
£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...
£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...
£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...
£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...