Legislation was introduced earlier this year to allow scheme trustees to use sovereign annuities to meet their obligations to scheme pensioners.
Under a conventional annuity policy, the insurer guarantees to provide an income payment for the life of the annuitant. The insurer must keep paying the annuity regardless of the investment performance of the underlying assets. The insurer therefore assumes all the risk that the capital sum paid for the annuity and its investment return will cover future pension payments. Insurers in turn are subject to a strict regulatory regime and typically price annuities using AAA bond yields.
Under a sovereign annuity, the payment of the annuity is linked directly to the proceeds of Euro denominated bonds such as Irish or other EU Government bonds. The payment of the annuity may be adjusted by the annuity provider should there be a default or restructuring of the bonds used to match the annuity. As sovereign annuities are likely to prove to be less expensive than other pension products due to the reduced level of risk for the provider, the purchase of these annuities should make additional assets available to secure the benefits of active and deferred scheme members.
With respect to risk, if trustees buy sovereign annuities and continue to pay pensions from the scheme, this will have the effect of reducing their pensioner liabilities under the Funding Standard although the trustees will take the credit risk and continue to be responsible for payments to pensioners. However, where sovereign annuities are purchased in the name of the pensioners, the pensioners will take the credit risk as the payments will be made directly to the pensioner by the insurance company and there will be no further link to the scheme. Any potential risk can therefore be passed from the scheme to pensioners. A potential downside to using sovereign annuities in this way is that pensioners could be exposed to losses in their pension payments in the event that there is a default with respect to the underlying asset on which their annuity is based.
The Pensions Board will certify sovereign annuity products and the Pensions Board recently published its certification conditions. The certification process will ensure that the annuity products for pensioners are allowable for pension purposes under the Pensions Act. The guidelines for providers have been published on the Pensions Board website.
It will be a matter for the trustees of a scheme to decide, having taken appropriate legal, actuarial and/or financial advice, whether or not to purchase sovereign annuities. It should be noted that the Pensions Board has no role in assessing the creditworthiness of the denominated bonds underlying sovereign annuities or in relation to the terms on which insurers make sovereign annuities available in the marketplace.
Although the Pensions Act does provide scheme trustees with some protection in the event of a claim where “it appears to the court that he or she acted honestly and reasonably” in deciding to purchase sovereign annuities, trustees will face difficult decisions in relation to the purchase of sovereign annuities in respect of pensioners. In making a decision, trustees will have to consider a number of factors relevant to their particular scheme including the funding level, the balance between pensioner and active/deferred member liabilities and the quality of the employer covenant. It is essential that trustees are aware of the risks that the pensioners will face before they make a decision to purchase sovereign annuities. Ultimately, as with all decisions, trustees will need to ensure that any decision they make is in the best interests of members.
Contributed by Michael Wolfe.
