High stakes and headaches in pension scheme market

Is help at hand for fed-up finance directors fretting over the inexorable increases in the cost of final-salary pensions? Up to eight companies are close to launching what could be an attractive service for organisations struggling with huge pension liabilities - they'll simply take the problem off their hands.

It is already possible to dispose of pension scheme liabilities. Two insurers, Legal & General and Prudential, offer bulk annuities - in return for an upfront payment from the sponsoring employer, the insurers guarantee to pay the pensions of scheme members - both current and future pensioners.

However, there are two serious catches. First, employers generally have to wind up their pension schemes to dispose of their liabilities to an insurer, which is likely to be hugely controversial.

Second, with only two insurers in the market, there is little competition. Large schemes may find it impossible to buy a bulk annuity at all, while smaller schemes pay high prices.

Enter two groups of companies aiming to break the bulk annuity closed shop - and to expand the range of products on offer.

The first group consists of insurers such as Aegon, Aviva and Canada Life, as well as the Bermuda-based reinsurer XL Capital, which are all considering offering bulk annuities.

In the second pack are entrepreneurs plotting their route into the pension scheme market. They include the former Prudential UK chief executive Mark Wood and his former colleague Isabel Hudson, who are heading separate private equity-backed vehicles. The private-equity group Duke Street Capital, headed by its founder Edmund Truell, is also interested, as is Hugh Osmond, who has previously set up Sun Capital to buy up closed life funds.

With limited existing capacity, any market entrant should pick up work without having to undercut L&G and Prudential, but a new player may have several key advantages.

David Fraser, a partner in the management consultancy LEK, said: "Analysis of mortality risk is now better than it has been; it may also be possible to better manage the assets used to underwrite liabilities."

Also, the market for closed pension schemes represents only a small chunk of the total liabilities for all final-salary plans.

Some of the new businesses may consider buying up only part of the liabilities of schemes, while the rest of the fund remains ongoing. The idea could be attractive to companies keen to offload some pension liabilities without winding up their schemes.

"The first stage would be to buy the liability of deferred pensioners," Mr Fraser said. "Vehicles offering this sort of business may be spun out once bulk annuity work becomes more established."

Mark Wood's new venture is one operation considering this option, a spokeswoman said. "We are looking at every aspect of the buyout business,"she said. "It is possible pension scheme trustees will be able to sell off just one type of liability."

Such deals are a way off, however. Regulators would need to be satisfied that pension benefits were safe. That would probably mean underwriting pension promises in the financial markets with complicated derivatives transactions.

Even if such instruments could be structured, quantifying the value of benefits promises, when deferred pensioners could be 40 years off retirement, would be difficult. In bulk annuity deals, insurers at least have a chunk of existing pensioners, where costs are easier to estimate, to compensate them for the added risk of scheme members still to retire.

For this reason, the more pressing challenge for most groups will be to first get clearance for a standard bulk annuity product. A spokeswoman for the Financial Services Authority, the chief City regulator, said: "Anyone who wants to sell bulk annuities would have to fulfil our capital adequacy requirements and many of our life insurance rules."

In practice, that means having sufficient assets at any given moment to meet all future pension scheme liabilities, a hugely expensive requirement, especially for companies not set up as insurers.

However, Stephen Yeo, of the actuarial consultant Watson Wyatt, believes it may be possible to get round this problem. He said: "If you avoid taking on a pension scheme's liabilities in the form of an annuity, it may be possible not to register as an insurance company, but to get approved by the Pensions Regulator instead."

There has already been one such deal, according to Yeo. When Marconi sold much of its business to Ericsson for £1.2bn last month, the Pensions Regulator agreed to allow Telent, the tiny business remaining after the sale, to take on the whole of the former business's pension liabilities.

Although the watchdog ruled £600m of Ericsson's money had to be used to support this pension fund, this was much less than the company would have had to pay for a bulk annuity to secure scheme members' benefits. "Had the scheme been sold to an insurer, Marconi shareholders would have got nothing, rather than half the purchase price," Yeo said. Instead, the scheme's liabilities were in effect transferred to new owners.

One member of a private-equity consortium looking at the market said this model could be attractive. "There are going to be two routes to success," he said. "Either get your insurance accreditation in your back pocket, or seek approval for deals on an ongoing basis from the Pensions Regulator."

However, the latter option is far from perfect. It would slow down the rate at which deals could be done - and the Regulator is not yet certain about its attitude to such business. "If there is a contract between a provider and individual members, that would be an insurance agreement in our view," a spokeswoman said.

It is this type of headache that has given Legal & General and Prudential such a free run until now. But such is the prize at stake, some - if not all - of the companies jockeying for position will bring products to market.

Even the standard bulk annuity market was worth more than £3bn last year. Total final-salary pension scheme liabilities could be as high as £400bn.

The runners and riders

* AEGON

A spokeswoman for the Dutch insurer Aegon said a bulk annuity product, "is a natural extension of our business". But Aegon may be handicapped by inexperience - its UK business, Scottish Equitable, began offering open market annuities on an individual basis only last year.

* AVIVA

The insurer that owns Norwich Union is "researching the bulk annuity market", according to a spokesman, who said it would focus on smaller pension schemes. Aviva could start writing business as soon as "late 2006", he added.

* DUKE STREET CAPITAL

A spokesman for the private-equity group said its founder Edmund Truell was considering his options. Mr Truell would like to be "a significant player in the market" - Duke Street will make an announcement on whether it will proceed with a venture over the next few weeks.

* CANADA LIFE

As a leading provider of specialist annuity products for individual pension savers, Canada Life has repeatedly been linked with the bulk annuity market. However, the company remains tight-lipped about its plans.

* ISABEL HUDSON

Ms Hudson, a former senior executive at Prudential, is believed to be seeking investors for her proposed bulk annuities venture, though she has appointed the pension fund specialist Watson Wyatt as an adviser. Ms Hudson has also signed up David Newbigging, former Friends Provident chairman, to chair her company.

* HUGH OSMOND

Mr Osmond has secured insurance company status for his potential venture into bulk annuities but remains unsure about whether he will go ahead with the business amid concerns about the regulatory environment.

* XL CAPITAL

Bob Douglas, the chief executive officer of the life insurance division of the Bermuda-based reinsurer XL, said the company had bought up several blocks of pension annuities in payment. He added: "The company is not involved in the potential market for pension-fund buyouts."

* MARK WOOD

Mr Wood, a former head of Prudential's UK operations, expects to publish formal details of his plans within the next four weeks. A spokeswoman said: "We are looking at the buyout market - total or partial buyouts of pension scheme liabilities."