Consultants expect high growth in UK pension risk transfers to continue after last year’s record figures
- Consultants and insurers estimate £30bn-40bn worth of UK pension risk transfer deals a year for the next few years
- The North American market is also expected to see more activity in the near future
- As demand soars, insurers are becoming more innovative with their transactions
Last year marked a record year for the UK’s pension risk transfer (PRT) market, with an estimated £50bn (€59bn) worth of transactions completed, including buy-ins, buyouts, and longevity swaps.
The total was almost double that of the previous year, according to Mercer, which compiled the figures, and there were several innovative approaches to buy-ins and buyouts as demand from pension funds and competition among insurers reached new highs.
Communications company Telent conducted the biggest single deal of the year, agreeing a full buy-in of its GEC 1972 Pension Plan with Rothesay Life worth £4.7bn. The agreement will subsequently be converted into a buyout, with individual annuities issued to the scheme’s approximately 39,000 members, making it the biggest buyout in the UK to date.
Publicised transactions ranged in size from 3i’s £95m deal with Legal & General (L&G) to the £4.7bn Telent buy-in, although consultants say a number of smaller transactions were also completed, including some sub-£10m arrangements.
Some consultants have introduced streamlined processes for small schemes seeking a buy-in or buyout, simplifying the process for trustees and reducing the amount of time insurers have to spend analysing deals.
Larger schemes have been de-risking in tranches, selecting different insurers for various buy-ins as a way of obtaining the best price and diversifying insurance risk. Marks & Spencer and National Grid both took this approach in 2019.
Other innovations included Dresdner Kleinwort’s £1.2bn deal with Pension Insurance Corporation (PIC) that involved the conversion of a £300m hybrid defined benefit (DB)/defined contribution (DC) scheme. See the case study for more detail.
Looking to 2020
The records set in 2019 have led some consultants to issue bold forecasts for what the next year – and decade – might bring.
LCP expects demand from schemes combined with healthy insurance company capacity to drive £30bn-40bn worth of deals a year from 2020. Mercer has estimated that the total for the next decade could be quadruple that of the previous decade’s £135bn, which would require an average of more than £50bn a year.
This growth, Mercer says, will be fuelled by factors such as the ongoing maturing of the DB sector driving down prices as well as more reinsurers entering the UK market, adding capacity to pension insurers seeking to offload longevity risk.
“The next few years are looking bright for those schemes wishing to insure their members’ retirement income,” says David Ellis, partner at Mercer. “As the UK’s defined benefit schemes mature, the length of insurance contracts reduces, making them more predictable and cheaper to buy. Despite the increased demand, there is still capacity in the market for well-prepared schemes.”
Jay Shah, head of origination at PIC, says there are several constraints on the pension risk transfer sector that insurers and schemes need to negotiate. These include the scarcity of illiquid assets suitable for backing pension liabilities at a scale that is attractive to a fast-growing insurance balance sheet. PIC’s assets under management have grown from £16.6bn at the end of 2015 to £39.6bn as of 30 June 2019.
In addition, the capacity of the reinsurance market will play an important role in insurers’ ability to take on risk, as it dictates whether or not they can offload longevity risk.
Shah also highlights capital-raising and talent-sourcing as issues that must be addressed if insurers are to continue to take back buy-ins and buyouts at the rate the industry expects. Both PIC and fellow specialist pension insurer Rothesay Life issued bonds last year to help fund new transactions, while Shah says PIC has made a number of hires in the past year to support its growth.
“There are some constraints to the market, but the market has proven resilient as we saw last year, and my expectation is that it will continue at the high level we saw last year into the future,” he says.
David Blake, professor of finance and director of the Pensions Institute at Cass Business School in London, says that, while there is no shortage of insurance companies to back deals, one potential stumbling block could be a lack of trained lawyers to advise on transactions.
“Increasing standardisation should help with that,” he adds.
Netherlands case study: Chemours
While most discussions of pension risk transfer centre on the UK or North America, the Netherlands has had some limited action in the insurance sector.
Last July, Dutch chemicals company Chemours announced that it had agreed to transfer €820m worth of assets and liabilities from its pension fund, Stichting Pensioenfonds Chemours, to insurance company Nationale-Nederlanden (NN). Effective from October 2019, NN has taken on responsibility for paying the pensions of retired or deferred members.
In addition, these members were promised a one-off indexation payment on 1 January 2020 to compensate for past periods when the scheme was unable to pay inflation-linked uplifts. In the future, the roughly 3,000 members covered by the transaction will receive a guaranteed annual indexation payment.
Active members of the Chemours fund were transferred to the Centraal Beheer general pension fund (APF) at the start of 2020 where they will continue to accrue benefits.
Frans van Dorsten, chairman of Stichting Pensioenfonds Chemours, said in July that the scheme’s board had “conducted extensive research” on how “future-proof” the pension fund was. Transferring members to an insurer or an APF was a direct action to improve the likelihood of members receiving full indexation, he said.
The Chemours transaction was unusual by Dutch standards. Normally, a buy-in or buyout will cover the entire population of a pension fund – the Chemours deal with NN was just the second time specific tranches of a scheme’s membership had been transferred, according to a spokesperson for the insurer.
Tight regulation from regulator De Nederlandsche Bank makes it difficult to split transactions as members of the same pension scheme are not allowed to be treated differently.
For Chemours, this meant the scheme’s board had to ensure that the deferred and retired members transferring to
NN were not going to be treated better or worse than the active members transferring to the Centraal Beheer APF.
The NN spokesperson told IPE: “This is a more complex way of calculating economically equivalent rights for different groups, including the level of guarantees relating to the accrued entitlements.
This is, in general, a circumstance to deal with, and will become easier to cope with when more experience is gained in this market…
“Now that more experience is available with partial buy-ins or buyouts, it is expected that more pension funds will work towards transferring deferred and/or retired entitlements to insurance companies.”
There is good news for smaller DB schemes too, according to LCP. It estimates that there will be about 10 transactions covering a total of £15bn in 2020, which would leave more capacity for deals in the £250m to £1bn range.
Iain Pearce, a consulting actuary at Hymans Robertson, says the next big step for insurers and reinsurers will be to take on more non-pensioner business.
“The vast majority of bulk annuity business has been for pensioners who receive their benefits already,” he says. “Most schemes take the view that those are cheaper to insure.… but we are seeing schemes generally becoming better funded and well hedged. They may have already insured a lot of their pensioners and are able to insure their non-pensioners as well, or a proportion.”
Pearce says insurance companies are actively working on their propositions to write non-pensioner business, including investing in administration capabilities and reserving capital. This, in turn, is encouraging reinsurers to assess whether they can offer non-pensioner longevity reinsurance.
David Blake expects data science to be applied to more areas of the pension risk transfer market. He points to L&G’s introduction of a blockchain-powered risk-transfer platform last year, designed to streamline the reinsurance aspect of the process.
Launching the service – dubbed ‘estua-re’ – in June 2019, Thomas Olunloyo, CEO of L&G Reinsurance said blockchain was “uniquely suited to the long-term nature of annuities business as it allows data and transactions to be signed, recorded and maintained in a permanent and secure nature over the lifetime of these contracts, which can span over 50 years”.
Blake explains that this “will introduce greater transparency, since all parties will have access to the latest version of the ledger database of scheme member information”.
The Cass professor also calls for the introduction of reinsurance ‘sidecars’ to allow investors such as sovereign wealth funds to share in the risks and returns of pension reinsurance. In addition, he favours longevity bonds to “help kick-start a liquid market and set the risk-free term structure for mortality rates as it has done in the fixed-interest and index-linked bond markets”.
PIC’s head of origination structuring Uzma Nazir says insurers will have to get used to renegotiating longevity swaps when taking on DB schemes with legacy insurance contracts.
“The next few years are looking bright for schemes wishing to insure their members’ retirement income” - David Ellis
Schemes with longevity hedges already in place have begun asking insurers such as PIC to take on the longevity swap and convert it into a buy-in. The Scottish Hydro-Electric Pension Scheme completed such a deal in November 2019, insuring £750m worth of liabilities, and Nazir says PIC has more in the pipeline.
“Normally when we do a buy-in, we get our own longevity swap,” Nazir says. “These transactions come with a longevity swap that the trustees negotiated. On paper, it sounds ideal because that’s what we’re looking for anyway, [but] there are a lot more parties involved in the discussions, which adds to the complexity of things.”
Pension schemes have different requirements to insurers regarding reporting and calculations, Nazir says. This means insurers may have to renegotiate the terms of the longevity swap when converting it to a buy-in.
“Trustees having a clause in a longevity swap contract to say that this might happen in the future, and how it might happen, is quite helpful,” she says.
Outside the UK
The UK is not the only market opening up to more risk transfer business. L&G completed its first transaction in Canada in April 2019, following the formation of a strategic partnership with Brookfield Annuity Company. The two companies supported a CAD200m (€138m) buy-in with an unnamed pension scheme, with L&G as the reinsurer.
The North American market is central to L&G’s international pension risk transfer strategy, according to a company statement announcing the Canadian deal. As of April 2019 the group had written £2.5bn of international pension insurance deals.
Prudential Financial – the US insurance giant that has reinsured dozens of large UK transactions – affirmed its market leading position in its home market with a $1.8bn (€1.6bn) buyout of the Lockheed Martin pension scheme.
UK case study: Dresdner Kleinwort
Transferring defined benefit (DB) liabilities and assets to an insurer is an accepted norm for the UK pension sector. In April 2019, however, one scheme managed to extend this to include its defined contribution (DC) fund.
The Dresdner Kleinwort Pension Plan – part of Commerzbank – agreed a £1.2bn (€1.4bn) full buy-in with Pension Insurance Corporation (PIC), split across three transactions.
The first was a relatively straightforward £900m buy-in of the plan’s DB section. The second and third involved its £300m DC section and allowed members of the hybrid scheme the option to transfer their DC savings out or convert them into a DB equivalent, ready for transfer to PIC.
While this sounds straightforward on the surface, as Uzma Nazir, head of origination structuring at PIC, explains, there were several parts to the transaction that required PIC to be flexible.
When the Dresdner Kleinwort scheme came to market, the trustees brought in an independent financial adviser to help members decide whether to opt for a DB conversion – and go to PIC – or transfer to an alternative DC scheme. However, this process was not complete when PIC was chosen as the insurance provider. This posed a problem for PIC when deciding how to price the deal.
“When we talked about pricing, we had to take a view on how much of that DC section was actually going to come across to us,” Nazir says. “That’s important because the nature of the liabilities and the duration of pension scheme affects the assets that we would be looking to invest in. That, in turn, affects the underlying price that we would give to the scheme.”
In addition, the DC section had a DB underpin, meaning that each member had an individual DC pot that would be topped up by the company if it underperformed the minimum DB level. This meant that PIC had to take the unusual step of calculating premiums on a per-member basis.
“We had to do individual premium calculations per member, compare it to how much DC pension that person had, and then look at whether there was extra money that we needed from the scheme or the company to come across for that member if they chose to stay with us,” Nazir explains. “Usually we don’t do individual calculations.”
These complications meant PIC and the Dresdner Kleinwort scheme signed two agreements covering the DC section, one to cover those who had already made their decision about converting to DB, and another to cover those who had yet to decide. The latter became effective in mid-2019 once all members’ decisions had been confirmed.
David Curtis, chairman of the plan’s trustee board, said at the time: “This transaction required a high level of creative thinking by our advisers, LCP, in designing a structure combining the member choice programme with the insurance transaction.”
He praised PIC’s flexibility, “especially in relation to the insurance of the [DC] section, which is an unusual transaction and, I believe, a great result for the membership”.
PIC publicised five large transactions in 2019, according to IPE research, insuring almost £6.8bn worth of liabilities. This included a £3.4bn buy-in deal with British American Tobacco, which at the time was the largest ever to include both pensioner and deferred members.
In Europe, Italian financial services group Generali announced plans to enter the de-risking market at the end of 2018, setting up a cross-border pension fund, although it has yet to complete any transactions.
Meanwhile, the Dutch pension insurance market has shown signs of growth in recent years – although it is still a fraction of the size of the UK’s. Chemicals company Chemours became the latest to seek an insurance-based solution to its de-risking plan (see case study) last year, while the €581m pension fund for publishing company VNU is exploring options for an insurance buyout.
Nationale Nederlanden (NN), the insurance company behind the Chemours transaction, says that pension funds and sponsoring employers “are looking for future-proof solutions and a reduction of risk”, according to a spokesperson. “We expect that the market for buy-ins and buyouts will increase in the coming years, with more and more focus on carve-outs from specifically deferred and/or retired participants.”
The consensus among industry experts is that the volume of pension risk transfer activity has undergone a step change in the past two years, with far more activity expected in the years ahead.
With this comes challenges for all actors to maintain the insurance and reinsurance sectors’ capability to take on these volumes. Demand also looks set to bring about new technological developments and innovative approaches to further secure the future benefits of millions of DB scheme members.