A framework has been put in place to permit the use of sovereign annuities by pension schemes. Click here for a previous article on sovereign annuities.  The main advantage of this new initiative is that defined benefit (DB) schemes can avail of a credit in their funding standard calculations to the extent that their liabilities are matched with sovereign annuities.  Furthermore, sovereign annuities are expected to be cheaper than other pension products and will therefore be a cost efficient way for trustees to meet their obligations to pensioners.  Consequently, trustees will undoubtedly come under pressure from sponsoring employers to avail of the sovereign annuity option.  However, as payments from sovereign annuities are linked directly to the proceeds of bonds issued by Ireland or any other EU Member State, there is a credit risk associated with such products. 

Trustees have two options when purchasing sovereign annuities:

• Buy-in option – sovereign annuities are purchased in the name of scheme
• Buy-out option – sovereign annuities are purchased in the name of the member

On-going schemes

In the case of on-going schemes, trustees may be reluctant to purchase sovereign annuities in the name of pensioners given that this will involve transferring the credit risk to those pensioners.  In such instances, trustees may be more likely to purchase sovereign annuities in the name of the scheme but may seek some form of additional security (for example, employers may offer contingent assets as security for funding obligations) before they might be prepared to proceed with a buy-in option.  While schemes may avail of a “credit” in their funding standard calculations for annuities purchased under the buy-in option, trustees must first take advice, pass a resolution and notify scheme members of their intentions.

Schemes in wind-up

Where a scheme is in wind-up, trustees may consider the buy-out option to be an equitable way to proceed with the winding-up process as the current statutory wind-up rules applicable to DB schemes provide that first priority be given to pensioners. In addition, because it is expected that sovereign annuities will be cheaper than conventional annuities, they will allow trustees of underfunded schemes to achieve more equality in the distribution of assets. 

It is anticipated that “blended” type annuity products will emerge whereby, for example, a conventional annuity is used to secure the core pension and a sovereign annuity is used to fund promised pension increases.  Such products are likely to be more appealing to trustees than pure sovereign annuities.

Trustees will face difficult decisions in trying to balance benefit entitlements with pension security and the most appropriate solution will very much depend on the circumstances of the particular scheme.  In reaching their decision, trustees will need to carefully evaluate their different options and be mindful of their fiduciary duties to all scheme members.

Contributed by Mary Greaney, Lorna Osborne and Michael Wolfe.