More room for growth
Written by Pádraig Floyd
September 2013
Buyout volumes were disappointing in 2012, but does this mean there is no longer growth in the market? Pádraig Floyd reports
Buyout is not a sexy subject, but it gets the straightest-laced of the pensions fraternity hot under the collar. It is the endgame – the dénouement or money shot – plan sponsors, trustees and their advisers have been working towards for years.
For some, the buyout market has been dragging its heels of late. It’s fair to say the financial crisis and subsequent economic environment have made it difficult to write business as schemes have found it a little rich for their blood. But many thought 2012 would be a big year for writing business, so when it failed to come to fruition, there was some disappointment.
Down but not out
Although the UK buyout market is down on previous years – around £4.5 billion compared to £5 billion in both 2010 and 2011 – this doesn’t show a massive contraction and indicates where the market was, says Buck Consultants senior consulting actuary (de-risking) Tony Winterburn. “Buyout tends to be dominated by the bigger deals, of which there are smaller numbers. Nothing happens for a while and, a bit like buses, they tend to come along together.”
Business has been reasonably steady this year, and is believed to be shaping up to be the biggest since 2008. “It’s moving in the right sort of direction,” says Winterburn, “but like any market, it’s driven by affordability.”
The chances of 2013 beating recent records are good, as more than £3 billion of buyout has been written already, according to figures from LCP. Almost half of this is accounted for by the record-breaking EMI deal worth £1.5 billion.
The front runner is Pension Insurance Corporation (PIC), which is responsible for writing almost £2.3 billion of buyout and buy-in business, including the EMI deal and a £160 million buy-in by the First Quench Pension Fund, giving it a market share of 70 per cent to date.
Legal & General is currently in second place, with first half figures of £565 million, while Rothesay Life has written £190 million in respect of the pensioner buy-in by Smith & Nephew’s plans in May.
Business has picked up for a number of reasons. “There has been a general improvement in asset values and funding position over past two years, making buyout more appealing, or for those with large amounts of gilts, pensioner buy-ins,” says Winterburn.
This improvement in funding positions is reflected in the UK’s Pension Protection Fund’s 7800 Index. This showed the aggregate deficit for the 6,300 schemes it monitors was down to £116 billion, the lowest in two years, while the funding ratio was up from 89.1 per cent to 90.7 per cent.
The index also recorded 1,748 schemes – one in four – in surplus of an ongoing basis.
This is leading to a change in culture. Schemes are now going to insurers and asking not only for quotes, but the conditions under which they would transact. If the price is too high, they will park the process, but it means a lot of the heavy digging has already been done.
“It means the scheme can go back when the timing is right and the contracts that have been awarded can be drawn up,” says Winterburn.
Buyout back on the agenda
Buyout may seem nothing but a pipe dream for many schemes, but that belies the reality, says JLT director, head of buyouts Martyn Phillips.
JLT has completed around 15 deals in 2013, half of which have been full scheme buyouts, which Phillips admits is a high proportion. This is often driven by an overseas parent with a relatively small scheme – between £5 million and £15 million – that is worried about carrying that liability on its balance sheet. With its home market perhaps leaving recession behind, it may seek funding in the near future and doesn’t want this hanging over it.
“Since the financial crisis, many employers have been stockpiling cash and not spending their capital,” says Phillips. “They are therefore looking to use this reduce or remove those liabilities. As a result, quite a number are coming forward to transact.”
And it isn’t only overseas schemes, says Phillips, who is working with a UK scheme with several billion pounds of liabilities as buyout has now become a distinct possibility. Phillips is also being kept busy with demand for longevity deals, but PIC’s co-head of origination Jay Shah warns against getting carried away by the numbers associated with these contracts.
“There is a more subtle story around longevity swaps,” says Shah. “On face value, these deals are huge – BAE’s £3 billion deal for instance – but it isn’t a sensible way of presenting that business, for while the liability may be £3 billion, the size of the deal is considerably less.”
There are very good reasons for using longevity swaps, says Shah, but they are only going to be appropriate for large, sophisticated schemes that have no intention of running off for up to 50 years. As a result, it is no surprise these deals are large, though expectations of more and larger deals have yet to filter through.
Overseas interest
Another market developing slowly is that of Europe in a wider context.
It is underdeveloped, largely because defined benefit schemes are confined to certain jurisdictions, particularly the Netherlands and Scandinavia.
They don’t always face the same issues, with lower equity exposure and assets better matched with bond-like instruments. “There is also less of a practice of discretionary increases in benefits,” says Shah, “so it’s not the same position as UK schemes find themselves in.
“However, we do have inbound enquiries, so there is interest, with schemes watching the UK market and the Irish market, which is a lot closer to the UK model.”
The fact that L&G has broken into the Irish market with reinsurance of Irish annuity books bodes well for growth in European deals, adds Shah.
That demand works both ways too, says Phillips, as the insurance companies may see the opportunity to diversify both their longevity and investments across their general book. Though a fraction of the UK’s potential £1.5 trillion, it could still amount to several hundred million pounds in liabilities that requires coverage.
Breaking into this market requires scale and there are concerns about the number of players in the market just in the UK. With Rothesay Life and MetLife believed to be up for sale, this has constricted the market and despite the rigorous protections placed around sold insurance books, there is nervousness about doing deals with an entity that may not exist much longer. This, in turn, may have an impact on price.
“It’s a fine balance for healthy competition in the marketplace and the natural policing of prices could be affected,” says Phillips. “Prices could go up in response to supply and demand, but then we won’t see deals unless they are done at a sensible price.”
The whole market in his hands
The issue of price is always a sensitive one, but one innovation may prove a game changer, particularly for some small schemes.
One way of guaranteeing you only pay for what you’re going to use is to have an underwritten process. The drawback with this is, unless you want to write to all your members with forms for each of the different providers, you are forced to commit to one, limiting the choice of quotes.
But JLT is confident it can now run a whole of market search among the insurance companies quoting at the lower level – Aviva, Just Retirement, L&G and Partnership. It has developed a common form that is in pilot and Phillips believes this could have a considerable impact on many smaller schemes looking to buy out.
“The ability to hold a whole of market exercise will break the cycle of loading somewhere in the pricing due to uncertainty about the members.”
Though some small schemes will pay less, he concedes those with a healthy population will pay more, but argues the system will be fairer.
“And just as with car and house insurance, each insurer likes different risks, so schemes will likely receive different rates for different impairments, giving them better options for their members,” he adds.
The pilot is already underway and JLT is looking at schemes with liabilities as high as £30-£40 million. And with several thousand small DB schemes in the market, buyout may no longer be an unobtainable dream, particularly for small employers.
Pádraig Floyd is a freelance journalist
