Buyouts have become more feasible as annuity pricing for non-pensioners has improved, but some experts say many schemes still have a long way to go before being able to afford a buyout or buy-in transaction.
Research conducted by consultancy LCP shows that around 1m people had their defined benefit pension insured through a buy-in or buyout, as insurers started to find their feet following the introduction of Solvency II.
It’s all about essentially trying to remove any last minute surprises
Gavin Markham, Barnett Waddingham
More recently, the Cancer Research UK Pension Scheme completed a £250m pensioner buy-in with Canada Life as part of the scheme’s plan to reduce risk, including an introduction last year to liability-driven investing.
While annuity pricing for pensioner deals improved in the second half of 2016, an increasing number of providers have reached “historically attractive” pricing levels since then, particularly for annuities worth more than £100m, according to Aon Hewitt’s latest bulletin on UK risk settlement. This shows that an increasing number of providers are keen on writing larger transactions..
Insurers accessing long-dated assets
The study found that, since insurers have built confidence in pricing non-pensioners under the new Solvency II regime, they have optimised their asset strategy accordingly.
It said pricing has become less dependent on US and UK credit market conditions as “providers are utilising infrastructure, equity release mortgages, commercial property and secured asset lending to obtain additional yield spreads and to access predictable income streams of particularly long durations”.
Source: LCP Pensions De-Risking 2016
The research also highlighted the importance of choosing the right price lock, which is a mechanism that tracks the movement of the agreed price through to the point of paying the premium. Each price-lock method will result in a different final premium.
John Baines, partner at Aon Hewitt, said: "Non-pensioners have historically been more expensive to insure than pensioner members because non-pensioners are longer-duration liabilities… Members are younger, which means that insurers have to source longer-term assets".
However, “the cost of insuring those benefits has come down fairly materially”, partly due to the fact insurers have been more successful in sourcing these longer-term assets, he said.
He said another reason for this reduced cost is that “the priority for insurers when Solvency II came in was to optimise the pensioner pricing, and to some extent non-pensioner pricing was less of a priority because there are more pensioner deals in the market”.
Challenges remain
James Mullins, head of risk transfer buyout solutions at Hymans Robertson, said he agreed that insurers have started to get access to more long-dated assets, “which has enabled them to give better pricing for buy-ins and buyouts that involve younger members and deferred pensioners”.
However, “the challenge still remains on the pension scheme side” because market conditions are still difficult, so buyout affordability from a pension fund perspective is “still tough for many”, said Mullins.
Cancer Research scheme takes the plunge into LDI
Trustees of Cancer Research UK’s defined benefit pension fund have put in place a new liability-driven investment allocation, minimising funding volatility following the EU referendum.
Consequently, “for some schemes the gap is so big that even a bit of an improvement isn’t enough to make it suddenly within reach”, he said.
But for those already close to a buy-in or buyout due to being very well hedged over the past few years, this improved pricing may well make a transaction possible, he added.
Nevertheless, “there aren’t many pension schemes in that lucky position”, Mullins said.
No last minute surprises
Gavin Markham, partner and head of bulk annuities at Barnett Waddingham, said he agreed that the general position with regard to buyouts was “relatively favourable in terms of pricing”, while there was a “move from insurers into a broader range of assets” to support transactions, including illiquid investments.
Markham pointed out the variation in insurer pricing when schemes get very close to transacting: typically, when an insurer quotes a price at the start of a tender process, it “isn’t guaranteed” and “will move depending on market conditions”, he said.
“It’s possible for you to agree how that pricing might move based on a fixed group of assets” and that allows you, in a certain period of time, "to more align your investment strategy with that price lock, and therefore your assets are not moving out of line with where insurer assets are moving,” he explained.
“It’s all about essentially trying to remove any last minute surprises.”
