Data analysis: The market's shape is changing, as insurers seek new investment opportunities and risk strategies evolve.
The consultant’s view
The chart for June shows the cost of a pensioner buy-in moved broadly in line with the value of the model gilt portfolio.
The relationship between buy-in pricing and gilts has remained stable over the past few months. Although bond markets – historically a key driver of annuity pricing relative to gilts – have been relatively benign over the same period, A and AA corporate bond spreads have narrowed.
Intuitively this should result in less attractive pricing. However, the relative stability in pensioner buy-in pricing relative to gilts demonstrates the success insurers are having in sourcing attractive risk-adjusted yields on their investments.
Clearly, the risk-adjusted yield a bulk annuity provider can source and lock into influences the pricing terms they can offer.
More recently insurers have been widening the range of assets they invest in beyond conventional corporate bonds, to include long-dated asset classes such as property, infrastructure projects and collateralised loans.
As long-term investors, it makes sense that insurers should seek to benefit from their tolerance for illiquidity by investing in such assets, provided they can match the cash flows with those of their policyholders’ liabilities.
We are seeing much of this benefit being passed to pension schemes in the form of attractive bulk annuity pricing.
Consequently, activity in the market has been buoyant throughout the first half of 2014. Many buy-in transactions have involved an exchange of gilts and/or liquid corporate bonds for an annuity policy. In June, the Total UK Pension Plan announced its £1.6bn buy-in with Pensions Insurance Corporation.
We continue to see opportunities for schemes that can prepare themselves to execute transactions quickly.
Myles Pink is a principal in the pension buyout practice at LCP
The provider’s view
The theme of the last few months in these columns has been that while there has been good, even excellent, economic news, something is not quite right with the recovery. Yet no one is quite sure what.
Most recently this feeling of uneasiness has been displayed by investors who have moved back into gilts, despite the annualised growth rate of 3.1 per cent the UK saw in the first quarter, despite the booming stock markets and despite house prices rising at their fastest rate for almost 30 years. This seems to signal that the UK is well and truly back in
Or perhaps their move was made precisely because of this news and their concern that the three underlying puzzles in the UK economy are the flip side of the good news.
Are we in a housing bubble?
Why is there weak productivity growth?
How do we close the trade deficit?
Some commentators use these unanswered questions as evidence that we are building a recovery based on debt and are repeating the mistakes that led to 2008.
Time will tell.
However, it is also worth noting the views of Andy Haldane, the Bank of England’s chief economist, which were made recently during a panel discussion.
In particular he said: “What we’re seeing from the future financial system is not risk being removed or obliterated, we’re seeing risk change shape…I think it will mean, on average, that those fear and greed cycles in financial markets will be somewhat more exaggerated than in the past.”
Trustees and sponsors of defined benefit pension schemes should bear these words in mind when setting risk mitigation and investment strategies for many years to come.
Jay Shah is co-head of business origination at Pension Insurance Corporation
