Insurers took on high levels of pension liabilities in 2015, but the introduction of Solvency II’s capital requirements may discourage similar transactions, finds Gill Wadsworth
Having taken on £6bn in pension liabilities throughout the course of 2015, insurers are expected to acquire another £4bn before the end of the year.
According to consultant Aon Hewitt, £10bn in completed de-risking transactions is ‘not unrealistic by Christmas’ making 2015 second only to last year’s record £13bn in total buyout and buy-in deals.
It is possible such predictions will fall short of the mark, since insurers are trying to seal as many deals as possible before the advent of new European regulation in January.
From the start of 2016, European insurers will be beholden to the Solvency II Directive that demands they keep greater reserves of capital to secure any risk held on their books.
As a result, it may become more expensive for insurers to take on pension liabilities, and as such there may be a greater cost for trustees and sponsoring employers next year.
There have been numerous warnings of the impact on pricing”
Francis Fernandes, senior adviser at Lincoln Pensions, says: “There have been numerous warnings of the impact on pricing – perhaps rising by 3-4% for deferred pensioners – from the new Solvency II capital requirements from January. Trustees now appear to have suddenly woken up to the prospect of price increases and are pressing for deals to be closed out before the transitional capital protections expire at the 2015 year-end.”
Yet financial regulation alone cannot explain the amount of deals already transacted this year.
Affordability has been an additional driver, with many schemes able to reap the benefits of having moved to liability-driven investment before gilt yields fell, while at the same time enjoying a healthy, if somewhat volatile, return from equities.
Fernandes says: “Where trustees have been well prepared and where schemes have held matching gilt portfolios to back the liabilities to be insured, the deals have kept on coming.”
The number of deals written by Legal & General and Aviva are evidence of the significant pipeline of bulk annuity business, particularly at the smaller end of the market where both insurers tend to play (see table).
However, there can be no ignoring the impact of large scale deals on bulk annuity volumes completed in the first half of this year. Notably, Rothesay Life signed off on the biggest buy-in this year – the second largest on record – undertaking £1.6bn of the Civil Aviation Pension Authority’s liabilities.
Where trustees have been well prepared… the deals have kept on coming”
Longevity swaps – in which insurers and reinsurers take on the risk of members living longer – also gained momentum in 2015.
Deutsche’s Abbey Life Assurance Company completed a £2bn longevity swap with the Scottish Power Pension Scheme, while the Prudential Retirement Insurance and Annuity Company reinsured £1.85bn of longevity risk in Legal & General’s bulk annuity business.
But it was the medically underwritten deals that really stole the show in 2015, with the sector breaking through the £1bn barrier in the first six months.
Thanks to advances in data collection, medical underwriters are able to secure a more detailed picture of a scheme’s membership, which often means more attractive pricing compares to traditional deals.
Costas Yiasoumi, director of defined benefit solutions at Partnership, says: “Trustees can have confidence in going down [the medically underwritten] route as others have gone through it successfully, and almost all of the actuarial consultants have placed this kind of annuity so they have expertise and confidence.”
Aon Hewitt, which advised on three of the largest medically underwritten transactions this year, said offers came in at 10% cheaper than traditional bulk annuity pricing.
Dominic Grimley, principal consultant at Aon Hewitt, says: “There has been a big increase in demand for medical underwriting over the year and the pricing [for buying out] pensioners is better than anywhere else.”
Consolidation in the medical underwriting market may hit the growth”
However, the two major players in the market – Just Retirement and Partnership – are on the brink of merging, an event some feel may have an impact on deal flows.
Fernandes says: “Consolidation in the medical underwriting market may hit the growth we have seen in this type of deal because of a perceived lack of competition.”
However, Fernandes adds that new arrivals on the bulk annuity scene will likely drive competition and provide additional supply to meet demand.
And demand there will be, but trustees must ensure they have their house in order before any insurer will take them seriously.
Yiasoumi says trustees should complete four key stages in readiness for a bulk annuity deal.
He says: “First are clear objectives: at what price are you willing to transact? Second is know what you want to insure; third is robust governance; and fourth is be ready to transact quickly when the price is right.”
He adds: “If you follow these four points, it will lead to a successful transaction for trustees and insurers.”