Pension risk transfer, also known as bulk annuities, is the best way of protecting the hard-earned pension benefits of members of defined benefit pension schemes. Here, we examine the market and highlight how insurers such as Pension Insurance Corporation plc (PIC) approach these transactions in an increasingly buoyant market.

The pension risk transfer market has grown rapidly over the last five years, with the market projected to reach £40 billion of new transactions in 2019. This growth has been driven by a number of factors on the liability side.

As defined benefit pension schemes have been closed to new members and / or future accrual, trustees have realised the need for, and benefits of, fully de-risking their liabilities. Many have been on a de-risking journey for up to a decade and are now better prepared than ever to take advantage of attractive opportunities. Those trustees who successfully complete a bulk annuity transaction typically have a clear goal in mind when approaching insurers. They may have been working to a clear long-term de-risking plan and have transacted a series of buy-ins before moving to buyout.

External factors have had a role too, such as the government’s introduction of pension freedoms in April 2015. For the first time, members could choose to opt out of their pension, which resulted in many schemes seeing their liabilities decline, and hence an improvement in their overall funding position. Changes in longevity have had a huge role to play with a decline in forecast average life expectancy increases for British men and women, leading to better funding positions. At the same time, there has been increased demand from the global reinsurance market to take on the risks associated with policyholders living longer than expected. The longevity reinsurance market, which has seen interest and activity from global reinsurers, has helped bulk annuity insurers manage their capital requirements, provide better pricing for trustees and has improved capacity for transactions within the market.

On the asset side, insurers themselves have innovated and adapted as the market has evolved. In particular, insurers have developed their ability to privately source suitable and, more importantly, secure long-term assets to back long-term liabilities. This includes investments in areas like social housing, renewable energy, and the university sector.

These factors have led to a significant increase in transactions coming to market with PIC already quoting on over 80 transactions so far this year in comparison with around 60 in 2016.

The size of deals coming to market has also been increasing, with a significant rise in transactions coming at the larger end of the spectrum. Despite this, there hasn’t been a significant drop-off in quotations on smaller deals, leading to a need to prioritise.

With the increased supply of large transactions in 2019, there have been situations where two transactions come to market at the same time. This leads to a need for insurers to prioritise and consider factors such as staffing, the availability of advisers, assets held by the scheme, capital requirements, ability to secure reinsurance on longevity risks, deal specifics such as the price, target and whether a joint working group has been set up. Similar exercises are carried out when considering two deals of a small size. The case study (see page opposite) illustrates the decision-making process that is typically undertaken by insurers.

CASE STUDY: Two large transactions

In this scenario we compare Scheme A and Scheme B. Scheme A has a transaction size of £1.1 billion and is coming to market to secure a buyout. Scheme A’s assets are split 60% corporate bonds, 35% government bonds and 5% cash. The trustees are looking to transact using the assets of the scheme, which they expect to be funded at 105% of the scheme’s liabilities. Pricing, on a rolling basis, will be locked in to the scheme assets. In addition, the trustees have indicated that there will be three pricing rounds and have set up a joint working group consisting of the advisers, the trustees and the sponsoring company, which will ultimately select the final insurer. The scheme consists of 70% pensioner members and 30% deferred members, which has reinsurance implications.

Scheme B, which wants to transact on a buy-in basis, has assets of £1.3 billion. The assets are 100% government bonds and the pricing target is gilts +40bps, with a gilt-based roll forward mechanism for future pricing. The trustees have planned for two pricing rounds and whilst the US parent company is involved, it is unclear when the final sign off will take place. Scheme B comprises 100% pensioner members.

Comparing the two potential transactions:
• Scheme B benefits from a two round process, whilst Scheme A requires work on assessing the assets and on the surplus
• However, Scheme A provides greater deal certainty given it is fully funded to buyout, and better governance that comes with having a joint working group in place
• Scheme B has a target above gilts which may be stretching; Scheme A has assets that largely move in-line with how PIC’s premium moves and corporate bonds that PIC would be buying, whilst the gilt lock required by Scheme B would lead to exposure against corporate bond movements for a potentially long period of time as the timing of the deal is unclear
• Scheme A has the additional benefit of better mortality experience data on its members and has provided PIC with pricing feedback. This information enables PIC and other insurers to provide reinsurers with improved execution certainty, allowing for more precise quotes on the reinsurance cover for the longevity risk associated with deferred members.

In conclusion, Scheme A represents a more convincing case. The question for insurers like PIC, is whether to put resources such as staffing and capital towards the best price possible, or to hedge against the two. Other considerations such as the level of competition and potential for future transactions would also come into play at this stage.

The importance of open communication between trustees and insurers is pertinent for deals of all sizes. Against the backdrop of record deal volumes insurers are likely to get more selective. Trustees that work closely with advisers and present the best prepared schemes with clear decision-making criteria will stand out to attract the most suitable bids.

Mitul Magudia
Head of Business Development – Pension Insurance Corporation

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