This summer's market turbulence took many UK pension funds by surprise, pushing them to look even more closely at their de-risking strategy. But while pension buyout deal prices have remained fairly stable, the cost of such deals has increased significantly due to falls in bond yields.
Only a few years ago, de-risking strategies including buy-ins, buyouts and swaps, were still largely unexplored by pension funds. Nonetheless, the 2008 financial turmoil came as a tidal wave, warning pension schemes that necessary measures will have to be implemented to reduce their liabilities.
As a result, since then, pension funds in the UK have increasingly used de-risking options, including buyout deals. The Pension Buyouts 2011 report published by the consultancy firm LCP in June, revealed that nearly £30bn (€34.2bn) of business has been written by 10 different insurance companies over the past five years, including at least 40 transactions over £100m.
The buy-in market remains highly attractive, as deals are more affordable for pensioners, typically costing 0-5% above the funding reserve and 15% above the company accounting reserve, according to LCP.
Although, some pension funds could have thought that the market turbulence experienced this summer would affect buyout prices, the fact that bond yields - which primarily drive the price of buyouts - dropped, means that bulk annuity prices have only been affected slightly.
Mercer notes that, unlike in 2008 when several risks emerged in the corporate bond sector making insurers nervous and resulting in rising bulk annuity prices, the current market remains relatively stable. However, the stability in prices cannot hide the cost of such transactions.
"The recent events are a great demonstration that risk happens," David Ellis, head of longevity risk management at Mercer, says. "They have made trustees and board members from pension schemes want to enter into buyout deals but these events have also left fewer of these decision makers able to do so due to the increasing cost."
While the price of buyout products is relatively stable, the value of many schemes' assets has dropped due to their large equity holdings.
As a result, the gap between the price and the real cost has widened over recent months and many pension funds in the UK are no longer willing to take on the cost of buyout deals.
Regarding the likely volume of pension buyout deals in Q4, Ellis stressed that it is still difficult to predict as the market is particularly ‘lumpy'. "In spite of the fact that many pension schemes are judging the cost of buyout transactions too high, several UK companies are currently looking at closing their pension schemes to future accrual and have reasons to do buyout deals", he adds. "As a matter of fact, the increasing costs are unlikely to stop them using this type of de-risking option."
As a result, even though UK pension schemes have clearly driven the global buyout market in recent years, as they were under pressure to de-risk, most of them are now re-evaluating the real cost of such transactions, and are also reviewing their decision to enter into a de-risking transfer deal.