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Impact Investing

IPE special report May 2018

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Derisking: Granular buy-ins

James Mullins expects medically underwritten buy-ins, which typically separate out the liabilities of senior executives, to gain popularity, with market volume set to reach £1.5bn this year

Over the past two years, the market for medically underwritten buy-ins has grown to the extent that they represented over 10% of all bulk annuity transactions that took place during the fourth quarter of 2014.

The transactions differ from traditional deals by taking into account members’ health status, allowing insurers to refine pricing. This is beneficial if the members to be insured have health or lifestyle conditions. It affords insurance companies the best understanding of the risk to be taken on, permitting them to remove unnecessary prudency margins – required when there is greater uncertainty – and so provide the most competitive pricing for pension schemes. 

The process and the product can have a wider appeal than smaller schemes, where the benefits of individual medical information is eroded by the scale of members. In nearly all pension schemes a few pensioners, typically former executives and senior managers, account for a large proportion of the liabilities. 

This represents a concentration of risk for the scheme because there is a disproportionate impact on the scheme’s financial position if this group lives longer than expected. Medically underwritten buy-ins are currently the most cost effective way of removing this risk. Such transactions are referred to as ‘top sliced, medically underwritten buy-ins’.

Traditional buy-in pricing for high-value pensioners reflects the fact that affluent individuals are likely to live longer. By gathering health data it is more likely than not that some health conditions will be evident, which reduces the insurance premium.

The medically underwritten buy-in market will continue to be dominated by ‘top sliced’ transactions. These transactions are popular with larger pension schemes and, given the attractive pricing, the trend will continue. The largest deal in 2014 was a £206m ‘top sliced’ buy-in with Partnership covering the largest individual liabilities in a multi-billion pound scheme.

Cumulative value of medically underwritten buy-ins, 2013-15

From our experience, medically underwritten buy-in pricing remains 5% cheaper than traditional pricing, often close to a pension scheme’s technical provisions reserve. This means a pension scheme can exchange Gilts for a medically underwritten buy-in without any cost implications or need to increase contributions. We expect medically underwritten buy-in pricing to remain competitive during 2015, but to increase into 2016 as pension scheme demand grows further. This means pension schemes have a window of opportunity.

From a standing start in 2013, 50 pension schemes have now completed medically underwritten buy-ins covering £900m of liabilities. Indeed, the popularity has grown to such an extent that they represented over 10% of all bulk annuity transactions during the fourth quarter of 2014. Given this pricing, medically underwritten buy-ins have widespread appeal and conversion rates, from quotation to completion, are high.

Currently, two insurers drive the market. Just Retirement and Partnership, which have recently announced a merger, together have close to 100% of market share by value, while Aviva has completed one deal. Given the rapid growth, other insurers, in particular Legal & General, are increasingly active in this market. We expect to see one other insurance company offer medically underwritten buy-ins before the end of 2015. 

Last year saw the first medically underwritten buyout covering deferred members as well as pensioners and we expect to see further medically underwritten buy-outs. We expect medically underwritten buy-ins to represent around 10% of all buy-ins by value over 2015. 

Insurer pipelines are stronger than ever and we expect to see between £500m and £1bn of medically underwritten buy-in deals to be completed, taking total market volumes to in excess of £1.5bn by the end of the year. Average deal sizes more than tripled from 2013 (£7m) to 2014 (£27m) and we fully expect this to continue.

James Mullins is partner and head of buyout solutions at Hymans Robertson

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