Cardano's Steve Berkovi looks at the options for Trustees when faced with the question: to buy-in or to buy-out?

The defined benefit (DB) pension scheme market continues to bring challenges to the trustee table.

In recent years, schemes have been hit by a combination of ever decreasing interest rates and ever increasing regulation.

Trustees are also contending with the impact of increases to longevity as well as navigating through the range of complex investment options and investment strategies available.

So what next? Schemes are getting more mature and attention and focus does seem to be turning to the de-risking journey, but is the de-risking end game all about seeking buy-out or are there other paths to consider?

Buy-out or buy-in: the obvious answers?

Many trustees will consider their goal to be buying out pension liabilities with an insurance company, but the reality is that this remains an expensive option.

With interest rates at record lows and rising longevity expectations, many have seen their liabilities and funding ratios deteriorate to levels where affordability seems further and further away.

Even the less costly buy-in approach which involves insuring only a portion of liabilities normally for those already drawing a pension from the scheme, remains beyond the reach of many – they are also not very efficient.

So we are at a crossroads?

What other paths could we follow?

1 Call time on interest rate and inflation risks

Regardless of the size of the deficit, the impact of interest rates and inflation remain a big risk for many.

Despite the record low levels of rates, we are entering a world where more trustees are becoming impatient with the interest rate stalemate and are thinking of biting the bullet and increasing levels of liability hedging.

The reality is that liability hedging can bring significant de-risking benefits to schemes, similarly to those associated with buy-out and buy-ins.

2 Introduce longevity hedging

It is also likely that longevity hedging – which transfers the risk that members should live longer than expected – will become increasingly popular option.

The increased availability of more cost efficient products coming to market, especially for smaller schemes, will help support this move over the coming years.

Longevity swaps are expected to see increased uptake given that this relatively new financial instrument is one of the most capital efficient means to remove this risk.

3 Rethink the investment risks

For those managing their schemes to maturity, the equity roulette table will look less attractive as trustees look to less volatile and more income producing strategies.

It is likely that alternative investments able to deliver attractive returns whilst providing a good match for liabilities or reducing exposure to risk will become increasingly popular.

Credit strategies like corporate bonds, high yield, bank loans and asset backed securities together with certain property strategies will likely be in demand given their more attractive risk/return characteristics compared to traditional UK gilts.

By getting the balance right you can also help contribute to the de-risking journey.

Choosing the right path

The de-risking agenda is certainly giving trustees lots to consider and the reality is that de-risking can be achieved in a variety of ways.

Trustees will be spending more and more time thinking about the different paths - figuring out what works for them, and crucially thinking about which options are cost effective enough to consider.

Written by Steve Berkovi, Client Manager, Cardano.