With appetite for ‘run on’ and other alternative endgame solutions on the rise, will there be a knock-on effect on the bulk annuity market? Jon Yarker reports.
Earlier this year, an XPS report found that there was a “marked shift” in the number of defined benefit (DB) schemes reconsidering their endgame ambitions. This was particularly the case among medium-to-large schemes, with the argument for running on and gradually releasing surplus over time getting more attention.
The Pension Schemes Act includes a “statutory resolution power” for trustees, permitting modifications to scheme rules to allow access to surplus, with a consultation on the specifics now underway.
However, while this is causing more noise around run-on, it’s unclear if this will have a direct impact on schemes’ choices. For smaller pension schemes at least, the choices often remain straightforward and limited.
“The rise in smaller transactions is a result of significantly improved funding levels, as well as more streamlined models from insurers.”
“Surplus release and the potential of run-on is not a driving factor pushing smaller schemes to consider buyout,” says Alexa Mitterhuber, director of pension risk transfer at Standard Life. “Instead, the rise in smaller transactions is a result of significantly improved funding levels, as well as more streamlined models from insurers.”
Last year saw a slight dip in the number of large endgame transactions, which will lead some to draw correlations between greater surplus flexibility and a potential for greater run-on selection. Drawing a direct link between the two is difficult at this point, and David Stewart – partner at LCP – concedes this may be down to a simple weighing up of endgame options.
“Larger transactions are lumpier and will only come to market when buy-in is thought to be affordable and they have completed their preparation,” adds Stewart.
“It’s too early to say with certainty exactly how the government’s planned new flexibilities for ongoing surplus will impact the demand for bulk annuities, but our expectation is a smoothing of nearer-term buy-in demand.”
Insurance: still the gold standard?
In a recent blog post, the Pensions Regulator’s executive director for market oversight Ben Gunnee highlighted that “while insurer buyout may still be the preferred choice for many schemes, it’s not the only option”.
“New endgame models and approaches are making many trustees look again at their long-term objectives and consider whether there is potential to not just pay members their promised benefits, but also safely release surplus for the benefit of members and sponsoring employers,” Gunnee said.
The combination of healthier funding levels and greater surplus flexibility may turn heads, but the overall attractiveness of a buyout is likely to remain the top choice, according to consultants.
“There remains a high level of demand from pension schemes at all parts of the risk transfer market,” says Iain Church, head of core transactions at Hyman Robertson.
“Surplus release may have a marginal influence on insurers seeking other areas of the market to support new transaction volumes. However, this is not a key driver of increased competition on small transactions as there are a number of more meaningful factors.”
A key reason is the fundamental allure of endgame – rather than remaining invested and being at the mercy of markets, schemes are able to lock in member benefits now.
“The primary driver for trustees continues to be securing members’ benefits for the long term,” points out Jamie Cole, head of bulk annuity origination at Aviva. “Member security remains central to trustee decision‑making.”
The impact of size
Pension scheme size is also a critical factor. This brings a new context to the likelihood of running on becoming a more popular route, simply because this may be out of reach for the majority of schemes.
“Larger schemes are pausing to consider their options, whereas smaller schemes generally have fewer feasible options to begin with and, in our experience, buyout continues to be their preferred derisking approach,” explains Phil Kelly, associate partner and senior risk transfer consultant, First Actuarial.
The larger schemes may be able to mull their options but, with their smaller peers less fortunate, this is likely to mean sustained endgame activity.
Tom Ashworth, senior director of pension risk transfer at WTW, explains that buyers with fewer options is good news for insurers, and will likely keep acting as a tailwind to bulk annuity transactions.
“We can’t forget that insurers are commercial organisations,” says Ashworth. “They all have stretching new business targets to meet and investors to appease. Therefore, in years with less activity at the larger end, it’s not surprising to see more insurers compete for small-to-medium size transactions to deliver their targets.”
“Run-on is helping to create some of the most favourable buyout conditions small schemes have seen in years.”
Alastair Meeks, a client director at professional trustee firm Zedra, agrees. “While run-on may not be a realistic endgame option for most smaller schemes, it is helping to create some of the most favourable buyout conditions they have seen in years,” he says, pointing out that this could be seen as a “safe harbour” for small schemes with weaker covenants.
Run-on may be becoming a more viable option for some schemes, and its inclusion as an option will add to the choices facing some trustees. This cohort is likely to remain a minority due to size restrictions, meaning insurance transactions will likely remain a priority for schemes to access while they can.
