Defined benefit schemes in the UK pay a lot more to transfer liabilities to a regulated insurer than schemes in other countries, according to Mercers Global pension buyout index.
This practice, known as a buyout, is the ultimate de-risking exercise that enables sponsoring employers and trustees to be fully discharged of pension scheme liabilities. After an arrangement has been completed no risk remains.
But Mercer's index revealed that the UK was spending 23% more than the equivalent accounting liabilities to insure them. This compares poorly with the other three countries in the index, as schemes in Ireland spend 17.5%, the US pays 8.5% and in Canada it is just 5%.
Mercer said the main reason why the UK was paying so much more to de-risk was because of the mandatory indexation of pension benefits, which automatically links payment increases to inflation.
David Ellis, Mercer's UK bulk pensions' insurance leader, told The Actuary that mandatory payment increases in retirement were much less common in the US, for example.
Ellis explained that the mandatory indexation in the UK had two major impacts. 'Technically speaking it makes the average length that a pension needs to be paid for longer [which increases the length of the liability]. Additionally, there's a risk premium attached [to the cost of] taking on inflation risk in the UK.'
Despite this, UK bulk annuities had a strong 2013 with an estimated 200 transactions.
He added that schemes needed to take into consideration local differences specific to each country 'such as the spread of corporate bonds over and above gilts yields' which would represent some differences between the US and UK at any one point in time and indeed in any other country involved.
Mercer also noted that multinationals considering a buyout need to balance the risks and costs associated with de-risking in one country against other factors and determine if de-risking in another country would be more cost-effective.
A buyout represents only one range of strategies for managing pension risk 'but remains appealing for some,' Mercer stated.
'Timing, preparation and regular monitoring is the real key to mitigating the cost - in current volatile market conditions it is all too easy for a real opportunity to pass by,' the consultants advised.
Mercer's DB risk leader Frank Oldham added: 'As economic conditions and company finances improve, we are seeing interest in buyouts grow across the US, UK, Canada and Ireland.'