'Sovereign annuities too expensive' for pension funds
Published 16/01/2013 | 05:00
PENSION fund trustees have been warned about plunging into sovereign annuities, as they have become too expensive.
Eight out of 10 defined benefit pension schemes are in deficit and sovereign annuities have been hailed as a means to help cut the deficits.
Sovereign annuities are linked to long-dated bonds issued by the National Treasury Management Agency.
They offer higher yields than are available from the German and French bonds which traditionally underpin annuity products.
The annuities are expected to be used to buy pensions for those whose defined benefit scheme is being wound up.
Irish Life said this week it had completed the sales of the first sovereign annuity as part of a €20m deal.
But now pensions expert David Kingston of Acuvest Investment Advisers has warned the new annuities may not be the "wonder investments" pension funds had hoped they would be.
When the idea for the new bonds was first mooted in late 2001 the yield on 10-year bonds was around 8pc.
"This made the annuities very attractive from a yield perspective, although it naturally raised concerns about default among trustees," Mr Kingston said.
But since August the yields on conventional Irish government debt have fallen to well below 5pc. That means the market views Ireland as less of a default risk, but it also means sovereign annuities are less attractive for pension funds.
Trustees are at a disadvantage when buying the new annuities, Mr Kingston said. There was no secondary market in the underlying amortising bonds in sovereign annuities, he added.
And yields may keep falling as the developed world was likely to remain in a low interest rate environment.
"It seems clear that low interest rates are also going to persist for some time," the pensions expert said.
"While this might be necessary to restore some strength to governments and banks, some dangerous side effects are emerging. These include driving up annuity prices and having to pay someone to look after your deposits – bad news for defined benefit pension schemes and money market funds."
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