New insurance deals in the UK buyout market will grow to around £60bn per year over the next decade – tenfold the value over the previous decade – according to Adam Gillespie, partner at XPS Pensions Group.
Gillespie was a panel member at last week’s online conference on the Future of DB Investment held by the Society of Pension Professionals (SPP), following the publication of its Vision 2030 report for defined benefit (DB) pension schemes.
The report outlined the dynamics defining DB investment strategy over the next decade, the challenges facing trustees, and how they might rethink the endgame target ahead of them.
It pointed out that schemes today are in much stronger funding positions and invested in lower-risk portfolios, compared with 10 years ago.
The SPP also expects schemes to focus on resilience, against rising interest rates, defaults and longevity.
“Last year’s Gilt crisis highlighted the fragility of the Gilts market, particularly the very concentrated index-linked market – we estimate 90% of index-linked gilts are held by pension schemes,” said Emily Tann, solution designer at Insight Investment.
“We now see schemes holding much higher collateral buffers, so they are able to support a higher rise in interest rates. There is therefore less systemic risk now of rising interest rates causing that same negative feedback loop as last year,” she said.
But Tann warned that pension schemes should still remain prudent with their collateral buffers, because of a very different supply and demand picture in the Gilt market.
“On the demand side, pension scheme hedging is largely done, so large buyers of gilts no longer exist in the future,” she said. “And the Bank of England has switched from being a buyer to a seller of gilts.” Meanwhile on the supply side, UK government borrowing is expected to increase.
“That combination of higher supply and lower demand will clearly put upward pressure on yields,” Tann warned.
The report also highlighted another key theme, the shift towards contractual cashflows in portfolios, particularly from high-quality corporate bonds and asset-backed securities.
However, a remaining challenge is that because of last year’s Gilts crisis, many schemes still have a high allocation to illiquids – over one-third of portfolios, for around one in four schemes, according to a survey of some SPP members.
The panel also considered the risks and benefits of different end-game options, given the recent improvement in scheme funding levels.
Trustees were advised they need to consider the protection available in a run-off compared with a buyout scenario, although the SPP has estimated that even if sponsors became insolvent, 90% of pension assets would not transfer to the Pension Protection Fund (PPF), because schemes would be worse off under the reduced benefits it offers.
There would also be systemic risks with a mass transfer of pension assets to the buyout market. These include the concentration risk, with just a handful of insurers active in the market, and current proposals to adjust Solvency II in the UK, likely to further reduce the capital which insurers are required to hold against liabilities.
The Financial Services Compensation Scheme (FSCS), which would support insurers in a crisis scenario, is untested and not fully funded, said Tann. So a future government could find it difficult to bail out pensioners through financial support to the FSCS.
Meanwhile Hugo Laing, partner at Eversheds Sutherland, said the so-called “capacity crunch” meant there were questions as to whether insurers could manage buyout volumes. However, funded reinsurance allowed them to carry out more transactions, and the regulator was monitoring its use.