The latest hotspot
Written by David Adams
September 2012
David Adams examines where the next ‘big’ European markets could be for the buyout and buy-in industry
In an ideal world a pension scheme would be a source of pride to a sponsoring employer and a comfort to members. Unfortunately, many schemes are often referred to in rather more disparaging terms: as a ‘millstone’ dragging a company’s profits downwards, for example. Pension costs now swallow about 10 per cent of earnings for European multinational companies, while deficits account for 4.8 per cent of market capitalisation, up from 2.9 per cent in 2007/2008, according to research published by Mercer in July.
Of course, this matters more for some companies than for others, depending on the nature of the scheme and the local legislation to which it is subject. The Mercer research found that German companies had the highest levels of deficit relative to market capitalisation, at 11.7 per cent, well ahead of companies based in France (7.7 per cent), the UK, (3.1 per cent), the Netherlands (2.1 per cent) and Switzerland (1.8 per cent). Yet German companies do not seem desperate to offload pension liabilities.
In the UK, by contrast, legislative, regulatory, economic and financial circumstances have encouraged de-risking. Could de-risking through buyouts (where the insurer takes the liability away from the scheme sponsor) or buy-ins (where the employer insures benefits for a group of scheme members, with the insurance policy held by the trustees as an asset of the scheme) become popular elsewhere in Europe? A buyout could be a reasonable option for a smaller pension scheme in the Netherlands, with assets below €100 million and a funding target of about 125 per cent of liabilities, for example. It’s also easy to imagine Ireland, where many pension schemes are organised along similar lines to those in the UK and beset by similar problems, seeing more de-risking in future.
But buyouts can be expensive, because of the gap between the value of a scheme’s assets and the premium demanded by an insurer. Some UK schemes have opted for other de-risking measures instead (or until buyout becomes affordable), including liability driven investment (LDI) investment strategies, or hedging strategies to counter inflation or interest rate risks. Some have opted for buy-ins, or purchased longevity swaps.
The drive to de-risk has stimulated the development of various service offerings. For example, Rothesay Life provides bulk purchase annuity deals and longevity swaps as well as buyout. In December 2011 it managed one of the most significant deals seen so far, a £1.3 billion longevity insurance contract with the Airways Pension Scheme, one of British Airways’ two DB schemes.
There remains uncertainty around the extent to which reinsurers will support longevity risks, but capital markets could be used to back longevity swap deals, as was the case in a €12 billion longevity swap deal involving Deutsche Bank and the pension scheme of Dutch insurer Aegon, signed in February 2012.
PensionsFirst Capital has another model. It helps schemes with liabilities of £500 million or more to transfer liabilities to its new insurance vehicle, Long Acre Life. Corporates take a stake in the insurer as part of the transaction, so creating a mutual solution owned by schemes, sponsors and investors, keeping the profits rather than passing them to an insurer – and reducing buyout cost.
PensionsFirst Capital CEO Hugo James says that in theory the company could complete such a transaction in any European market. In practice it has yet to complete its first; and it seems certain that will happen in the UK.
But the UK buyout market stuttered towards the end of 2011. In part that was because of the wider economic picture, but it was also because buyout is complex and challenging: because of the difficulty of preparing the necessary data and documentation (which can take months); and possibly also because of trustee reluctance to use an insurer-backed solution – as well as the fundamental cost issue. Can it really become more popular in other European countries?
Mercer UK lead of longevity risk management David Ellis thinks if it’s going to happen anywhere, it’s most likely to be in the Netherlands or in Ireland, where several Irish and UK insurers are now looking very seriously at this subject. “It is developing in Ireland, but it is a much smaller market,” he says. “Most transactions will be €10 million at most.”
James isn’t quite so sure, pointing out the specific conditions which apply in Ireland: a large proportion of DB scheme risk is concentrated in a few schemes sponsored by big companies, mainly in the financial sector; the Irish Government’s recent initiatives relating to new sovereign debt products; and the state of the Irish economy in general.
Legal firm Stephenson Harwood partner Fraser Sparks is sceptical about the development of a buyout market in the Netherlands. “Although they have a similar benefits structure [to the UK], benefits tend to be provided by a much smaller number of pensions arrangements,” he notes. “They tend to be bulk employee arrangements, negotiated through various unions. They are big financial institutions in their own right. Why would you switch to an insurance model?”
“The Netherlands is very different,” says Ellis. “My Dutch colleagues would say they’ve been doing buyouts for years, but what they call buyout is actually quite different: arrangements I might call buy-ins, where the annuity is held by the fiduciary as an asset.”
James notes that Dutch pension schemes have been enthusiastic adopters of LDI strategies. “Dutch pension obligations are not the same as in a UK DB scheme, so for them risk hedging is more around keeping the pension schemes open,” he says. “So for large schemes in the short to medium term you’re unlikely to see substantial buyout/buy-in opportunities. But for smaller schemes and legacy schemes I do see continued development.” He points to the fact that Aegon appears to be interested in this part of the market.
Beyond these two markets the chances of buyout becoming popular look slim, because of the nature of pension arrangements and local legislation. Might the development of a buyout market in the US make any difference? In June, Prudential Financial in the US announced a major de-risking transaction with General Motors. GM is buying a group annuity contract for 118,000 retirees in its $33 billion DB scheme, reducing its pension obligations by $26 billion. Ellis believes the US de-risking market will develop more rapidly than any of those in Europe.
Regulatory factors will also be influential on this side of the Atlantic. “We shall see what happens with Solvency II,” says Ellis. “In the UK it remains to be seen what the true impact is. Some insurers have pulled out of the market. Others have factored it into pricing already.”
“If [regulation] places more onerous requirements on pension funds there’s an incentive to move the fund to an insurer,” says pensions risk management specialist Pensions Corporation co-head of origination, David Collinson. He also wonders whether changes to the international accounting standard IAS19, which oblige companies to clarify the impact of pension liabilities on the balance sheet, could encourage employers to offload pension liabilities.
In the long term, for mature schemes based in any European country, some form of de-risking may well become more attractive over time. “In countries like Spain, France and Italy a lot of pension provision still comes from social security,” notes Sparks. “But then you look at the Dutch, the Irish, perhaps the Germans: those are the markets with more pension provision from the private sector. If pension liabilities are perceived to be a drag on corporate profitability they’ll look at offloading them.”
“Whatever it’s called, transferring pension obligations to third parties is surely going to grow,” says Ellis. “Those obligations are increasingly legacy obligations, that don’t relate to the current workforce. Most companies would rather transfer them to someone else. But cost is going to be key.
“I think the UK’s going to be years ahead of the Netherlands and Ireland. The US will probably catch up, because the market’s so big. But the general theme, and in countries further afield, like Japan and Australia, is that there will be an impetus to transfer liabilities.”
Written by David Adams, a freelance journalist
