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PwC suggested a “worst case scenario” of the cost of a buyout, where the insurance company takes on all liabilities of a defined benefit (DB) pension scheme, rising by 10% in 2016. However, pensions director and buyout adviser, Jerome Melcer, said this was a rough estimate based on a combination of stringent capital requirements by the UK’s Prudential Regulation Authority, unfavourable discount rates, and a high average liability duration.
The issue stems from revised capital requirements under Solvency II coming into effect from 2016, meaning all business written in 2015 would be cheaper for insurers, with regulations allowing for a transitional period of 16 years for old liabilities to be covered under the new regime.
While insurance companies can perfectly match pensioner liabilities in DB schemes, this is not possible for deferred and younger members where the liability is impossible to determine. This results in the insurance company needing to hold more capital for such liabilities.
Insurers are currently negotiating with the PRA as to exactly how much capital should be required for each type of liability, based on their own capital and investment structures, with final determinations expected next month. The resulting system would see different capital requirements imposed on each insurer for the same liabilities based on how these are matched by investments.
Melcer said the 10% was slightly “finger in the air” but that business written in 2016 would certainly be more costly to pension schemes than 2015. “There will be a range of outcomes depending on the insurer so the extent of cost increases will vary among providers,” he said. “The 10% is based on the insurance companies not adapting to the new environment.”
While buyout pricing could rise, insurance buy-ins, where the scheme exchanges assets for an insurance contract, will not as they are easily matched under Solvency II.
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