Increased capacity and a heightened competitive landscape should spell good news for pension schemes looking to de-risk by pushing down prices. As Roger Mattingly, director of PAN Trustees says: “We will see some impact on the market in terms of the price of de-risking if individual annuities providers try to compete for parts of the bulk annuities market. “That could raise capacity in the bulk annuities market considerably and increase competition, which should push prices down as providers try to grab market share.”
However, with demand for de-risking expected to remain strong from schemes, especially once interest rates begin to rise, prices may not end up moving that much, even if capacity in the market was to significantly increase. “Demand could outweigh the changes in additional capacity,” says Jay Shah, co-head of business origination at Pension Insurance Corporation. “Around £1.5trn of scheme liabilities ultimately want to go down the buyout route. Total bulk annuity market volumes in 2013 represented only 0.5% of that.”
Even if providers are less compelled to compete on price, schemes are already finding insurers becoming increasingly flexible in how they structure deals, making them more affordable. One recent innovation has been the ability to secure a buy-in that incorporates a deferred premium facility, effectively allowing schemes to immediately insure liabilities, paying a large proportion of the premium upfront, but allowing them to pay the rest later.
In May, L&G announced it had secured a buy-in deal with RetailLink Management Pension Plan covering £35m of liabilities, which included this deferred premium facility. This allowed the plan to fully insure benefits for the members immediately, but spread payment of a portion (believed to be around £9m) of the premium over a four year period. This was the second time L&G used this structure following its transaction with the Kenwood Pension Scheme in 2013.
This structure, L&G’s head of bulk annuities and longevity insurance, Tom Ground, argues, can help trustees and companies “to achieve de-risking outcomes that they previously thought were out of reach” adding, “we expect this to become a common transaction structure in the future.”
More accommodating
Essentially, this is a way of providing the schemes with low-rate temporary loans to enable them to achieve de-risking that would not otherwise be affordable. Because the scheme uses the balance sheet of the insurer, it can access good loan rates, but the insurer is effectively protected from the credit risk of the scheme and sponsor as a default by either would simply decrease the amount of liabilities covered by the buy-in to the amount already paid in premiums. So if the scheme defaulted after paying only 90% of the premiums, the insurer would adjust the scale of buy-in to cover only 90% of the liabilities.
According to JLT’s Phillips, this more accommodating approach by insurers is a manifestation of the greater competition in the bulk annuities market. “The greater flexibility increases the probability of deals happening. We have also seen insurers becoming more accommodating in the assets they are willing to transfer in specie, rather than forcing a scheme to sell assets and take market risk in order to transfer cash to the insurer.
Contract terms, which have also been very insurer-friendly, are also moving in favour of schemes to some degree. We are able to win more of the battles to get better protections than we could in the past.”
Risk of regret
However, although these innovations bring de-risking into the realms of possibility for more schemes, there is a danger of regret risk for those unwilling to wait for the better pricing that is likely to result from the increased capacity and competition in the market resulting from the Budget.
“It wouldn’t be surprising if prices improved,” Altmann says. “If a scheme used too much of its assets to buy annuities that were expensive, they would be better off waiting until pricing improves, especially where they have a weak covenant. Some buy-ins and buyouts transacted in 2012 and 2013 were very expensive and schemes need to consider the risk of regret in the future.” This is particularly pertinent in the case of buy-ins where better pricing would mean a smaller portion of scheme assets are used, allowing a greater portion to continue generating returns to cover liabilities not included in the buy-in transaction.
Osborne’s Budget is having significant ramifications on the bulk annuities market, making de-risking more affordable by increasing capacity and competition. In turn, this is creating innovative structures from insurers in the space and tipping the balance of power more towards schemes. In time, pricing may also come down, especially if new players were to enter the market and need a compelling competitive advantage.
Even though schemes are under significant pressure to de-risk, the changing bulk annuity landscape could mean better prices and protections for those willing to be patient.
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