UK pension schemes should examine reshaping their benefit structures before entering into a standard bulk annuity to avoid unaffordable inflation-hedging fees, Aon Hewitt has said.
The consultants said that, when entering into a standard bulk annuity contract, a scheme automatically enters into a hedge on its inflation-linked pension increases. This makes a bulk annuity unaffordable for many trustees and companies.
'The cost of hedging pension increases could be at least 5% greater than might currently be allowed for in the scheme's funding valuation or in the company's accounts,' Aon's principal consultant John Baines said.
'And if a scheme's benefits are linked to the Consumer Prices Index, the difference could be a staggering 15%. The main reasons behind these cost differences are the price of inflation floors in the swaps markets, along with the lack of CPI linked investments.'
However, the consultants claimed trustees are now looking at ways to minimise this cost.
'Offering members the option to convert inflation-linked pension rises into a higher initial pension with fixed increases is a well-established method of managing pension cost and risk,' added Ben Roe, head of the firm's liability management team.
'Now, trustees and sponsors are increasingly considering whether this change can be made across the whole membership for some of their pension increases - and on terms that do not penalise members - while still making settlement more achievable.'
Roe went on: 'It is, of course, vital that members are genuinely provided with fair value for their benefits, but if this is achieved, the sponsor and trustees have far greater certainty over the outcome compared with giving each individual member the option to consider a change to their pension.
'For some schemes, the financial implications of this could be the difference between being able to secure members' benefits through a buy-in, or not.'
