Guest Viewpoint: Debbie Harrison & Dr David Black - Cass Business School
We predict that a revolution will take place in the UK life company sector over the next five years in terms of its involvement in private-sector pension provision. By 2020, between five and seven organisations, including life insurers, will be in the ‘premier league’ of auto-enrolment (AE) pension scheme providers. They will control 90% of total assets under management (AUM), which are expected to almost double from £280bn at present to £550bn in 2020. Several well-known life companies will no longer exist in their present form, or at all. Some will be bought by more competitive life companies; others will be sold-off piecemeal as a series of books of business.
Since the turn of the century, both the defined benefit (DB) and the defined contribution (DC) markets have changed beyond recognition. In DB, the change is due to the widespread closure of schemes (about 87% by number of schemes) and the trend towards the transfer of these liabilities from the employers’ corporate balance sheets to the balance sheets of bulk purchase annuity (BPA) insurers. This market is relevant to life companies, in their capacity as providers of BPAs and also as third-party asset managers to DB schemes. However, the market in third-party asset management services to private-sector DB schemes has a finite future. As the demand for asset management services shrinks, it will not be compensated for by a corresponding increase in the demand for BPA buy-outs.
In DC, the change is due to the development of modern mass-market AE workplace schemes. With the exception of a small number of large single-employer trust-based schemes, mass-market workplace schemes began in the late 1980s and early 1990s. Today, the market is dominated by large-scale multi-trust, multi-employer schemes (known as master trusts).
Taken as a whole, the changes in the DC market call into question the fundamental purpose of the traditional UK life company. The largest and, arguably, the most visibly successful life companies are restructuring to compete with a diverse range of challenger-providers. Several of these challenger-providers have already demonstrated the merits of alternative business models in the master-trust auto-enrolment market and have gained a significant market share at the expense of traditional life companies. As these challenger-providers move into the decumulation market – in which the historic distinction between ‘retail’ and ‘workplace’ increasingly will be recognised as an anachronism – life companies will find themselves beset on all sides.
At this watershed in the history of UK life companies, clarity of understanding of market conditions, together with a vision of the future, are essential.
Massive consolidation in the auto-enrolment scheme provider market is inevitable and needs to be well-managed by the industry and the regulators to avoid market instability.
Policy and regulatory reforms have broken the near-monopoly of life companies in the DC market for accumulation and decumulation, facilitating the entrance and growth of powerful competitors in the master trust market.
Lack of clear and consistent data on the DC market undermines regulation and independent evaluation of areas of success and failure. It also creates the potential for regulatory arbitrage, for example, where certain contract-based schemes, which are regulated by the Financial Conduct Authority (FCA), in effect have been replicated as master-trusts, under the light-touch entry requirements and ongoing regulation of the Pensions Regulator (TPR).
We also predict a surge in sales of legacy back books, as life companies struggle with increasing capital requirements under Solvency II, which comes into force this month, and reducing member charges. Life companies with back books may face a second investigation – this time in relation to retail policies – where up to £50bn (€70.8bn) AUM may be held in policies with high charges and restrictive terms and conditions relative to modern products.
The definition of ‘back-book’ is out of date. It now includes private-sector closed DB schemes and bulk purchase annuities. The aggregate AUM of DB scheme ‘back books’ is almost three times the value of the legacy DC pension and long-term savings back-book market, at about £1.2trn versus £420bn, respectively.
Finally, the market suffers from a skill shortage. The heyday of the with-profits policy – from the mid-1970s to the mid-2000s – is long over, even though its legacy lingers on. The market holds little or no attraction for younger actuaries, resulting in a skill shortage for life companies that manage these back books.
The report calls for an open debate about the DC provider’s business model of the future, which we believe will be based on specialist distributors that rely on a combination of joint ventures and outsourcing arrangements to deliver excellence across all the component parts of DC pension schemes and plans – for new business and back books alike. We propose that the debate centres around two sets of questions.
Questions the life company sector needs to address in relation to developing new business lines:
• In the light of the potential for significant consolidation in the life company market between 2016 and 2020, should the UK financial regulators (FCA and TPR) develop, agree and publish a clear regulatory position with the government on how this will be supervised?
• What are the alternative sustainable lines of business for mid-tier life companies that cannot make a profit out of auto-enrolment?
• What are the opportunities for life companies in the market for non-pension workplace-based savings schemes that give employers the control they need over the retirement management of key staff? What structure might these schemes adopt, for example, in relation to trust law and the use of a life company wrapper?
Questions the life company sector needs to address in relation to the management of existing and new types of back books:
• Should treating customers fairly (TCF) apply across the board in relation to charges, terms and conditions, that is, to retail policyholders and not just to members of workplace schemes?
• Should the government and regulators consider introducing a ‘de minimis’ for cash returns for small legacy policies? If so, should this include a metric for measuring ‘TCF drift’, and also a facility to return policy values to customers without requiring their permission, where they do not respond to an initial communication?
• What is the evidence that consolidators could achieve better economies of scale and better deployment of skills by managing both retail and institutional (BPA) back books?
• What is the best way for the actuarial profession, the FCA and PRA to address the with-profits skill shortage?
The paper, The Meaning of Life, is available at www.pensions-institute.org/reports/MeaningOfLife.pdf. The views expressed in this report are those of the authors and not the Pensions Institute, which takes no policy positions