UK – Investment management group Foreign & Colonial (F&C) has launched a service aimed at providing insurers with a method of neutralising the impact of interest rate movements on the cost of guaranteed annuity options.

F&C says the service, which advises insurers on the use derivatives to manage the interest rate risk of guarantees, will partly address the issue of unknown annuity liabilities that occurred in the high profile case of Equitable Life.
Equitable closed its doors to new business in December last year faced with a so-called ‘black hole’ of liabilities estimated at £1.5bn.

Derek McLean, product development director for F&C, comments: “Many UK insurance companies are in the position of having sold a number of pension products that contain guaranteed annuity options, but not having an effective hedge against interest rate movements.”

The group says the size of liability can be split into two elements; the final size of each policyholder’s pension fund and the level of interest rates at the time they retire.
“ If an insurance company uses this service it will all but eliminate the interest rate risk element: a key step to resolving the problem,” says F&C.

Stephen Dolbear, director and head of derivatives with F&C, adds: “We believe that the approach of purchasing strips of Over-The-Counter interest rate option contracts, which is currently commonplace, may turn out to be too crude a method for dealing with what is essentially a very complex problem and one filled with uncertainty.”