The market for UK defined benefit pension schemes to transfer their liabilities to insurers is set to climb sharply, analysis by consultancy LCP has found.
It said the significant boost to funding levels should be viewed as a “silver lining” amid a series of short-term challenges, with collective scheme liabilities dropping by almost £1tn in a year.
LCP’s research shows that the average DB scheme has seen a 15 per cent improvement in funding over the past year relative to the cost of transferring to an insurer, also known as the ‘buyout cost’.
It comes as separate research by Charles Stanley found a significant year-on-year shift from DB trustees towards targeting buyout via an insurer for pension funds, with fewer targeting self-sufficiency.
Buyout is currently a cheaper, more viable, route to endgame than it has been for years
Bob Campion, Charles Stanley Fiduciary Management
Funding boost
According to LCP’s research, around one in five of the UK’s approximately 5,000 DB schemes are now estimated to be fully funded against the buyout cost.
The average projected period to reach full funding on buyout has reduced by more than five years as schemes have made a “huge leap forward” over the past year, LCP said.
The total aggregate buyout cost has tumbled from £2.3bn to £1.4bn over the year to September 30 2022 – a value that equates to nearly half of the UK’s annual GDP.
LCP said there could be more than £200bn of liabilities transferred to insurers over the next three years, but warned that the insurance market faces the challenge of dealing with an “unprecedented wave of demand from schemes”.
Data from the insurers indicates current annual capacity of £45bn. In comparison, an average of £30bn has been transferred in each of the past two years.
LCP is warning that with projected demand of up to £60bn next year, a potential “capacity gap” could open up in 2023, leading to operational constraints.
The main driver in the acceleration in funding has been the rapid rise in long-term yields, which insurers use to determine the buyout cost.
Meanwhile, DB schemes were eyeing up buyout via insurers prior to the mini Budget-induced acceleration in yields, Charles Stanley research has found.
The survey of 70 professional DB trustees appointed on schemes with a total asset of more than £60bn, in July this year, found that 34 per cent of schemes were targeting buyout, up from 19 per cent the previous year.
But three-quarters of professional trustees are yet to set a long-term funding target at all, making no progress from last year, representing a potential disconnect between long-term planning and future expectations.
Self-sufficiency is now a less popular option for trustees, with 39 per cent saying it is a likely target, down from 51 per cent last year.
Twenty-seven per cent say superfund consolidation is their long-term funding target – a finding in line with last year’s result (26 per cent).
Post-economic upheaval planning
LCP partner Charlie Finch said the recent weeks of economic upheaval has led to a staggering change in the financial position of pension schemes.
“We expect this to trigger an unprecedented wave of transactions between defined benefit schemes and insurers as UK plc seeks to shed their legacy pension liabilities,” he said, but momentum is likely to run into “market capacity buffers”.
“The industry simply does not have the operational bandwidth to process the potential number of schemes moving to insurers. Once schemes have navigated the recent market turmoil, they should reassess their strategy.
“Many schemes had planned for a journey lasting five years or more to reach buyout and will now be finding that recent events have significantly truncated that timeline,” he added.
But Charles Stanley found that more than half of trustees are anticipating being able to set their long-term funding targets within the next 12 months.
Meanwhile, the regulatory landscape has steered trustees into a “wait-and-see-approach”, Charles Stanley said, with trustees waiting for the regulator to issue concrete proposals to bolster long-term planning arrangements.
Looking at when trustees believe they will achieve their funding targets, 73 per cent expect this to happen in up to 10 years. This rises to 88 per cent of those who have formally set their funding targets.
Half of trustees believe they will realistically achieve their funding targets in five to 10 years, whereas a quarter believe they will realistically achieve targets in 10 to 15 years.
Charles Stanley Fiduciary Management senior portfolio manager Bob Campion said: “The past few weeks have thrown a huge amount of uncertainty at pension scheme trustees, with dramatic volatility in the gilt market having a seismic impact on scheme funding.
“This follows a record year for buyout deals in 2021 and a massive drop in buyout prices due to rising gilt yields in the run-up to summer 2022,” he said.
Campion added that it is no wonder that some trustees had “already moved their goalposts” towards buyout.
He continued: “Now, with many schemes benefiting from recent events, I’m sure more are planning to do so.
“Buyout is currently a cheaper, more viable, route to endgame than it has been for years, and the gradual emergence of superfunds will keep the pressure on insurers to keep their prices affordable.
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“For any pension fund that anticipates buying out within a reasonable timeframe, we would encourage the trustee to consider adopting buyout as the target for their investment strategy,” he said.
Despite volatile markets throughout 2022, 71 per cent of trustees say they are confident their scheme will achieve its long-term funding target objective. Of those, 21 per cent are very confident and 50 per cent are somewhat confident.
The entirety of those with a set funding target are confident that they will achieve that objective.
