After much talk over the past 2 or 3 years, at last sovereign annuities have become a reality… nearly. This week, I was one of the speakers at the launch of the first sovereign annuity approved by the Pensions Board. Getting to this point is a major milestone in the long journey towards being able to use sovereign annuities. We are not quite there yet though.
One of the speakers at the launch was Anthony Linehan of the National Treasury Management Agency (NTMA). The view in the industry is that sovereign annuities are most likely to be backed by Irish sovereign bonds. Mr Linehan gave a very interesting presentation on the bonds which the State will issue to back sovereign annuities and the process for issuing and pricing those bonds.
It seems that the State will issue what are being called ‘amortising bonds’. These are bonds which will pay out equal annual payments which are made up of a coupon payment and part of the principal which would usually be repaid at the expiry of the bond. They are ideally suited to sovereign annuities.
The reason why sovereign annuities are not quite a reality is that none of these amortising bonds have been issued yet. It seems that the NTMA has been waiting for yields on Irish sovereign bonds to come down to around the 6% level which is the level acceptable to the State in the short term. Now that yields are at this level, the NTMA is waiting for demand for the first tranche of these bonds to reach €100 million before it will issue these bonds. How will this critical mass be reached? One way is that one or two large schemes will decide to use sovereign annuities creating the necessary demand. Another way is that a number of smaller schemes will let insurers know of their interest and when that interest reaches the critical threshold insurers will ask the NTMA to issue the first bonds. So we are nearly but not quite there.
My talk at the launch covered the situations in which trustees might seek to use sovereign annuities. These are:
- Buying out pensioner liabilities to downsize an ongoing scheme;
- Buying-in sovereign annuities to hold as scheme investments to benefit from the reduced funding standard pensioner liability calculation; and
- On wind-up.
My view is that most of the initial demand for these annuities will come from scheme sponsors who will try to persuade trustees to make use of sovereign annuities as part of defined benefit scheme restructuring. Trustees will naturally be suspicious of sovereign annuities given that they are a brand new product and they lessen the security of benefits for pensioners where benefits are bought out. I believe that this suspicion will subside over time.
Should trustees be looking seriously at sovereign annuities yet? I think that they should if only to understand the full range of options for managing a scheme’s liabilities or securing liabilities on a winding-up. That said, given that it isn’t yet possible to buy a sovereign annuity, looking into these annuities is something that trustees could put on the long finger, at least for the moment.