Paternoster UK - Defined-Benefit Pension Scheme Risk Transfer

Paternoster UK is an insurance company regulated by the Financial Services Authority, responsible for the provision of retirement benefits to 44,000 members. Our sole focus is the management of longevity, investment and operational risks inherent within defined-benefit pension obligations, and providing assistance and solutions to trustees wishing to transfer risk from their pension schemes.

Risk transfer for defined-benefit pension schemes

Currently Paternoster is working with Abbey Life, the wholly owned subsidiary of Deutsche Bank, to provide risk transfer solutions for defined-benefit pension scheme corporate sponsors and trustees, with a specific focus on the emerging longevity risk transfer market.

Longevity hedges for defined-benefit pension schemes

A defined-benefit pension scheme is exposed to a number of risks, which are ultimately borne by the sponsoring employer. These risks include credit, inflation, interest rates and longevity risk.

Trustees and sponsors have, for a number of years, had solutions available to them to assist in the management of inflation, interest rates and investment risk. Recent developments have seen the introduction of longevity hedges.

A longevity hedge sees the insurer prescribe a set of payments to be made by the pension scheme which represent the expected cash flows to the scheme membership. If, over time, payments to members exceed the prescribed payments then the insurer makes good any difference. If payments are less than as prescribed the scheme pays the insurance company the difference between the actual payment and the prescribed payments, thus providing both the sponsoring employer and the trustees with certainty regarding their future funding requirements.

In layman's terms, if a certain individual in the scheme survives longer than anticipated, the scheme will be protected against the additional cost of providing the unanticipated benefits for that member.

Risks covered by longevity hedges

There are four main risks covered by longevity hedges, and the scale of each is scheme-specific:

• Idiosyncratic risk – also known as concentration risk, this is the impact of a small number of members living longer than expected; this risk is most pronounced in small schemes and for the elderly
• Future improvements risk – this is the risk that life expectancy for the scheme membership improves quicker than expected; although this affects all schemes and all members, it is most pronounced for younger people, as they have a much greater period for improvements to increase
• Base table – this is the risk that members' initial life expectancy has been misestimated
• Married proportion risk – the risk that a greater proportion of the scheme's members have surviving spouses at death than anticipated

Paternoster is able to analyse, assess and price these risks and provide solutions which remove the longevity from the pension scheme.