Taha Lokhandwala explores how recent changes announced in the UK Budget will affect the bulk annuity market in future
Last year turned out to be a record-breaker for the UK bulk annuity market, as pension schemes flooded in and insurers wrote more than £7bn (€8.5bn) in buy-in and buyout deals.
The market boomed for a variety of reasons, mainly due to buy-side players. Pension schemes with significant Gilt holdings could have executed a pensioner buy-in at little cost, as pricing remained more favourable than Gilt valuations throughout most of the year, according to consultancy LCP. Increased funding levels fuel the buyout market, with both expected to continue.
As demand from pension funds grows – and the number of suppliers remains stagnant, or dwindles, as has been the case in recent years – basic economics shows that pricing for schemes would increase.
However, after the UK government removes the need for defined contribution pots to be annuitised, providers in the £12bn a year individual annuity market will need to look elsewhere to satisfy longevity budgets, with the bulk business an easy solution.
This was shown after IPE reported that LV=, currently not active in the bulk space, is looking to enter the market, and Aviva, which previously retreated to writing smaller deals, is set to ramp up its writing capacity.
Commentators suggest further new entrants will grace the market over this year and next, but the question remains – how will the market be formed in the future?
Demand vs supply
Consultants advising in the area are less convinced about an over-supply of bulk annuity quotes driving down prices for schemes, although for a variety of reasons.
Matthew Demwell, a partner in Mercer’s financial strategy group, believes not only that recent developments will have little impact on prices but also that the notion insurers will step into the market is overstated.
“There might be some price impact at the margins, but [it will not be] significant,” he says. “There is always pent-up demand from pension schemes and companies looking to shift risk. Supply increases can very quickly get mopped up from demand, which may have been holding back before.
“There are forces going in different directions here – there might be some marginal improvement in pricing, but do not hold your breath for a massive supply-driven price drop.”
Dominic Grimley, principal consultant at Aon Hewitt, goes one step further in suggesting the demand from the market, and the potential growth in this, will offset any increase in supply.
“Schemes invest similarly,” Grimley says, “so, last year, Gilt yields rose, easing liabilities, and funding levels rose by over 10%. But this tends to be the same effect on lots of scheme at the same time.
“It has helped but not moved schemes to 90-100% buyout funding. But if they improve further, a lot of schemes simultaneously could think now is the time.”
However, James Mullins, a partner at UK consultancy Hymans Robertson, says market forces remain in the buyers’ hands.
He suggests that, despite demand from schemes being on the increase, the market, even in its current state, has enough competitive appetite.
“The extra supply will benefit schemes for the time being,” he argues. “The balance is still in schemes’ favour.”
However, any increase in the long-term interest rate, and thus scheme funding, will tip the balance into excess demand, he says.
Unpredictability is a key factor in the market, with demand on supply affected by differing metrics, and no one can be quite sure how pricing will level. This raises the possibility of volatility, with the moving value of assets used in risk transfers – namely fixed income – yet to be accounted for.
The issue of capacity within the market does not necessarily stem from writing ability but rather surrounding market factors that make up this complicated industry. Capacity increase in insurers writing bulk annuities is anticipated. But issues remain with re-insurance, corporate bonds and human resource. This could lead to providers being more selective, and discriminatory overpricing for smaller, less prepared schemes.
General insurers often look to re-insure longevity risk from annuities to balance internal budgets. While the capacity in the UK to write these deals increases, the global re-insurance market remains stagnant.
Schemes in the UK and US account for well over £4trn in liabilities, but the market simply isn’t deep enough to handle this.
Mullins says the key here is the US market, where risk transfers are less developed. UK schemes should not be concerned with capacity, unless their North American counterparts pick up the pace.
“The North American market is developing quite rapidly and would use up capacity if attention were diverted towards there,” Mullins says. “This is a conceivable impact but still not a short-term issue.”
However, Aon Hewitt’s Grimley suggests the bigger capacity issue would be underlying investments. A popular way for insurers to profit from bulk annuity deals is to take scheme Gilt holdings and swap them into higher-yielding corporate bonds, making depth in this market fundamental to pricing and writing capacity.
“I don’t how many corporate bonds are still being issued – a lot are owned by insurance companies already,” Grimley says.
“Insurers are looking at infrastructure and property, but the question is whether there are enough of these assets available to both support the current pricing and not be too risky to meddle with solvency margins. If funding positions hold up, the first question will be sourcing assets over how many writers there are.”
The latter factor is the physical human capacity of providers to manage the level of demand. As schemes come to market, deals require a high level of analysis and pricing strategy, regardless of size.
Commentators suggest existing providers, namely Rothesay Life and L&G, are looking to increase staffing levels. However, should a sudden rush take place, providers can easily become more selective in the business they write, thus capping demand.
Impacts on the bulk market will differ in tenure. However, there is no doubt the latest changes from the UK government, and a growing desire to shift risk away to insurers, will see the market fundamentally change, however long into the future.