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The Actuary The magazine of the Institute & Faculty of Actuaries

Affordability driving surge in pensions risk reduction measures

The first half of 2011 will see trustees and sponsors of defined benefit pension funds capitalise on the year long rally in asset markets, if the first quarter is a guide, according to Pension Insurance Corporation (PIC). Many pension funds have been able to narrow their deficits and, as a consequence, it is possible that H1 figures for the pension insurance market will see a strong upswing on the same period last year, the firm says.

Affordability for pension solutions has been a key driver in market activity and, according to PIC’s latest Pension Risk Transfer Index, pensioner-only insurance transactions remain at their most affordable. For whole scheme transactions, pension insurance is at its most affordable since the summer of 2008 - just prior to the collapse of Lehman Brothers.

David Collinson, co-head of business origination, said: "The first quarter of 2011 has been particularly busy, with many trustees andsponsors looking to conclude buyout and buy-in transactions at current pricing levels. In fact we have seen some trustees, who have been considering their de-risking options for some time, move with remarkable speed to transact on favourable terms.

"Given the favourable funding levels, it is not surprising that across the market we see an increase in the number of processes that have been launched. There is also the longer-term perspective for pension funds with regulatory headwinds threatening, including talk of Solvency II being applied to them."

The improvement in affordability continues an upward trend seen since August last year, underpinned to a large extent by a rise in gilt yields, the firm says. However, PIC warns that this seemingly smooth upwards trend belies serious market volatility caused by political instability across the Middle East, another looming Eurozone debt crisis and the recent earthquake and tsunami in Japan.

Another concern for pension fund should be the outlook for inflation, the firm said: "Unhedged inflation, where RPI remains just below 5%, can cost pension funds millions of pounds, as the trustees have to increase members’ pensions. In fact inflation at this level could add 30% at present values to the gross liabilities of a pension fund. However, should it rise above 5% - where pension fund increases are generally capped - the trustees start to see their liabilities erode, although pensioners suffer as their pension increases do not match the rate of inflation."