Sovereign annuities were developed in an attempt to assist employers and trustees to deal with the funding crisis currently being experienced by many defined benefit pension schemes in Ireland. A sovereign annuity is an annuity contract where the annual income payment is linked directly to payments under bonds issued by Ireland or any other EU Member State (also known as “reference bonds”). In contrast to the annuity products currently on offer, agreed payments from a sovereign annuity can be reduced if there is an event of non-performance of the reference bonds. This feature will be of concern to pension scheme trustees given their duties under both pensions legislation and trust law generally.
Sovereign annuities can only be purchased by trustees in respect of a person who is receiving benefits under a scheme or has reached normal pensionable age. Scheme trustees can buy sovereign annuities in one of two ways; a “buy-in” or a “buy-out”. Where there is a buy-in, the annuity is owned by the trust. Purchasing sovereign annuities in this manner will result in an immediate reduction in liabilities however the scheme remains responsible for payments to pensioners and assumes the credit risk. A buy out, in contrast, arises where the annuity is owned by the member. The scheme’s liability to pensioners in respect of whom sovereign annuities are purchased ceases and the risk is transferred to the pensioners.
While employers are likely to encourage trustees to purchase sovereign annuities given their reasonable pricing when held in contrast to traditional annuities, trustees are most likely to favour sovereign annuities where they are dealing with pension plans that are very mature and where the funding necessary to secure traditional annuities is not available.
Sovereign annuities will bring a broader range of risk management tools to the table and look set to play a role in the resolution of funding difficulties for some schemes. Given the obvious risk of benefit reduction associated with these products however, trustees should take appropriate legal and financial advice when considering the use of sovereign annuities and should also be aware of the terms of the sovereign annuity being offered by the particular insurer. On a more practical level, trustees should note that there is currently just one Pensions Board approved sovereign annuity product on the market, meaning the market has not, as yet, had the opportunity to develop.