Introduction:
Paternoster is a regulated insurance company that takes on the risks associated with companies’ final salary/defined benefit pension schemes and assumes the responsibility for paying their pensioners into the future.
Paternoster was set up in 2005 by Mark Wood who was previously Chief Executive of Prudential (UK and Europe). We are based in London and Mumbai and have over 100 employees.
Key takeaway points:
It was ranked in the Financial Times 50 Best Workplaces in the UK.
It has a 15% share of the bulk annuity market in the United Kingdom.
Awarded for the design of an FSA approved National Average Earnings Index (NAEI) hedge in 2007.
Important Personnel:
Mark Wood - Deputy Chairman
V. Balamurugan - Chief Executive Officer (India)
CONCEPTS:
In the UK, defined benefit pension schemes were traditionally set up by employers who wanted to ensure that their employees were able to earn a pension that would allow them to retire with enough income to maintain their standard of living. Employers set these schemes up voluntarily and created pensions trusts to hold the assets against the promises made.
Nowadays many employers and trustees are looking to insurers such as Paternoster to take over some or all of the liabilities associated with their pension schemes. This can take the format of a buy-in/buy-out or longevity hedge.
A bulk annuity policy (buy-in)
A bulk annuity policy insures the pension scheme in part or in its entirety. Some or all of the pension scheme assets transfer to the insurer, who then provides an amount to the trustees on agreed dates equal to the value of the pension payments due. In other words, the insurer is responsible for giving the trustees the income they need to pay the pensions. Depending on whether trustees also select the insurer to carry out their scheme administration means that scheme members will either continue to receive communications and/or payments from their current scheme administrators or direct from the insurer. Once the contract between the insurer and the trustees has been agreed the scheme members’ benefits will stay the same, including for deferred members, the options available to them (e.g. early retirement or transfer out of the scheme).
Individual annuity policies (buy-out)
The issuance of individual policies directly to scheme members usually takes place towards the end of the process of winding up a pension scheme. Once individual policies have been issued the scheme members’ pension benefits are insured directly with an insurer, members are no longer a member of the original scheme and the liabilities no longer reside on the sponsoring employers’ balance sheet. Where the member receiving the policy is a deferred scheme member then their policy entitles them to a ‘deferred annuity’. This means that they will receive an income directly from the insurer when they retire. The amount that they will get will be based on their pension benefit entitlement at the date they left their company pension scheme. Pensioners with an individual policy are entitled to an annuity.
Longevity hedge
A defined benefit pension scheme is exposed to a number of risks which are ultimately borne by the sponsoring employer. These risks include investment, 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 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.
The hedge offers the ability to convert the policy to bulk annuity policy at a later date.
Advantages for scheme members
There are several advantages of transferring to an insurer for scheme members:
- they are no longer dependant on the ability (or otherwise) of the company to fund the liabilities (i.e. pay their pensions)
- the insurer will understand pension risks better and therefore be able to manage the pension promises more efficiently and effectively
- the promise to pay pensions is supported by prudent reserving, solvency capital, a conservative investment strategy and a regulatory framework overseen by the Financial Services Authority.
A pension scheme with a corporate sponsor has no such protections or oversights.
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