Analysis: Once a distant dream for employers, full buyout is now becoming a reality for defined benefit sponsors, with up to 15 FTSE 100 companies already in a position to offload their liabilities to insurers.
Most companies had closed their plans to new employees and followed up by closing to existing employees, but stubborn deficits had delayed the final wind-up.
However, a tipping point now looks likely to be reached in the next three years, with up to 15 FTSE 100 companies already in a position to offload their liabilities to insurers.
2019 is likely to see a number of ‘mega deals’, so smaller schemes will have to prepare well and work hard to attract the attention of insurers
Francis Fernandes, Lincoln Pensions
Indeed, over the next decade up to 40 of those blue-chip companies with UK DB pension plans are likely to either reach, or be close to, full buyout, equating to £300bn of pension plan liabilities – just under half of the total UK liabilities for the FTSE 100, according to consultancy LCP.
More trickle than flood
Currently, full buyouts represent a trickle rather than a flood, but they are a nearer and more realistic prospect than pension schemes (of all sizes) realise.
James Mullins, Hymans Robertson partner and head of buyout solutions, explains: “Insurance pricing for full buyouts has reduced quite materially in recent years, and in particular the price of insuring deferred member liabilities. In addition, despite the recent market volatility, funding levels for many pension schemes have improved.”
David Ellis, a partner at Mercer, agrees: “Schemes’ finances will improve over time due to members ageing, sponsor contributions and investment returns, and some members taking options such as transfer values, which settle their liability at a lower cost than buyouts.” 
Yet total full buyouts by FTSE 100 companies amount to less than £5bn, compared with around £800bn of pension liabilities belonging to the index constituents. The most significant examples are Rentokil Initial (£1.5bn buyout in December 2018), Rolls-Royce (£1.1bn buyout in November 2017) and InterContinental Hotels (£440m buyout in August 2013), according to LCP.
That is set to take off in 2019. Total volumes of buy-ins and buyouts are expected to reach £25bn, with more than £10bn being full buyouts (compared with the £6bn of full buyouts confirmed to date for 2018).
However, the exact figures for 2019 will depend heavily on pension funding, and a no-deal Brexit could significantly make inroads into these figures.
GMPs continue to cause headaches
There are other factors in the mix, as Francis Fernandes, senior adviser at Lincoln Pensions, warns: “The GMP [guaranteed minimum pension] equalisation issue could drag on and push a few potential buyout cases into 2020.”
He adds that more schemes in the Pension Protection Fund’s assessment period could find they have enough assets to secure better benefits than the lifeboat provides and, as happened with Nortel’s scheme in 2018, will buy out benefits with an insurer.
One notable exception to the trend towards more buyouts may be that of financial institutions. “Many trustees of DB schemes attached to large, strong financial companies with market caps much larger than their schemes have very strong covenants for the long term and, in such cases, they may prefer to run off the liabilities and not buy out with an insurer,” Fernandes explains.
“You could call these DIY buyouts, with the sponsor covenant and any contingent support fulfilling the equivalent role of insurance capital for a bulk annuity provider.”
Mullins adds: “Buy-ins and buyouts can still make good sense for pension schemes sponsored by banks. However, there are additional considerations to factor in, such as how the insurance transaction will impact the banks’ own capital requirements.”
Smaller schemes compete for attention
For smaller schemes, Fernandes says: “Buyout is the natural endgame as insurers are much better placed to pool and manage the liabilities, so it’s just a question of the companies funding the shortfall, but this will take time.”
He adds: “2019 is likely to see a number of ‘mega deals’, so smaller schemes will have to prepare well and work hard to attract the attention of insurers.”
For many, there is still a considerable distance to travel on the journey to full funding, irrespective of the size of their sponsoring employer, as Karen Heaven, managing director of investment consulting of Redington, points out: “Recent data from the Pensions Regulator showed the majority of schemes are under-funded, even on a technical provisions basis.”
She advises: “Where a scheme is not yet close to full funding, we encourage them to think about what they want their 'endgame' to look like – are they ultimately looking to buy out with an insurer, or is a different approach more suitable?”
