The £1.5tn asset pool of the UK's 5,000+ increasingly well-funded corporate defined benefit (DB) schemes, is attracting considerable attention from a variety of interested stakeholders.
Notable amongst these are bulk annuity providers, for whom a now widely anticipated buy-in and buyout bonanza lies in prospect. However, against the backdrop of widespread regulatory-driven and buyout‑targeted investment de-risking, an alternative and almost diametrically opposed direction of travel for UK corporate DB has been proposed by consultants LCP and WTW — each of which seeks to benefit multiple stakeholders. This edition of Pensions Watch considers the key facets of these proposals and asks whether they could realistically reverse a deeply entrenched de‑risking mindset and the notion of a swift transition to buyout being the only end game in town.
A swift transition to buyout has seemingly become the only end game in town…
On 22 September 2022, then Chancellor, Kwasi Kwarteng unveiled the biggest tax give away since the "Barber Boom" of 1972. Targeting a growth plan akin to Chancellor Anthony Barber's "dash for growth", the gilt market was immediately spooked by the unfunded and uncosted nature of these gargantuan tax cuts, culminating in unprecedented fixed income market turmoil, as gilt yields recorded their biggest ever one day move and soared to 14-year highs. However, despite the consequent significant losses incurred by Defined Benefit (DB) scheme liability driven investment (LDI) portfolios, what immediately became apparent was that DB funding levels had, in the main, improved to such an extent1 that buyout had, almost overnight, become a viable proposition for many — at least for those in an appropriate state of preparedness.
In fact, over the weeks and months that followed, a swift transition to buyout began to be framed as the only end game in town, despite the obvious capacity constraints of bulk annuity providers and the general lack of readiness of many well-funded DB schemes to progress to buyout in the short to medium term. Indeed, although accepting that for most, if not all, schemes, buyout is the natural ultimate end game,2 such is the momentum that has been building around more immediate buyouts, it's recently been suggested that, by end-2026 up to £300bn of DB assets and liabilities could transfer to insurers, while by 2029 more than half of UK corporate DB assets could be in the hands of insurers.3
…yet further reinforcing the regulatory-driven move to de-risking
Prior to this dramatic improvement in scheme funding ratios, which have since been bolstered by an equally dramatic tightening of monetary policy to suppress persistent price inflation, most of the UK's 5,000+, mainly closed, corporate DB schemes were assuming investment risk and chasing returns, commensurate with their funding position and the strength of their sponsor's covenant, in order to plug the longstanding gap between the value of their assets and projected liabilities. However, that's not to say they all were. Indeed, well-funded schemes, although in the minority, were, in moving to a low dependence funding and investment strategy, derisking into lower risk and returning assets. In fact, some had been doing so for years. That said, with buyout some way off for most, buyout and run off, or DIY buyout, were fairly evenly matched as the formally targeted end game of UK corporate DB.
However, with more widespread improvement in funding has come even more widespread investment de-risking, compounded by an increasing number of schemes liquidating their, buyout unfriendly, illiquid assets in preparation for meeting insurers', increasingly discerning, entry requirements for the buying out of member benefits.4 Ironically, while these insurers, principally as a consequence of regulation, tend to invest predominantly in bonds and other relatively low risk/low-return bond-like assets, illiquid assets do feature quite prominently in their portfolios.5
Read previous Pensions Watch articles by clicking on the links below
Pensions Watch 1, Pensions Watch 2, Pensions Watch 3, Pensions Watch 4, Pensions Watch 5, Pensions Watch 6, Pensions Watch 7, Pensions Watch 8, Pensions Watch 9, Pensions Watch 10, Pensions Watch 11, Pensions Watch 12, Pensions Watch 13, Pensions Watch 14, Pensions Watch 15, Pensions Watch 16, Pensions Watch 17, Pensions Watch 18, Pensions Watch 19, Pensions Watch 20, Pensions Watch 21, Pensions Watch 22, Pensions Watch 23, Pensions Watch 24, Pensions Watch 25
References
1This fortuitous result stemmed from a significantly higher discount rate, courtesy of higher yields, being applied to the valuation of DB scheme liabilities, which significantly reduced their value.
2After all, buyout, with all of the protections afforded to scheme members, not least the strict solvency regulations applied to insurers by the Prudential Regulatory Authority (PRA), means that member security is all but guaranteed, albeit at a cost. Consequently, it's increasingly become perceived as the end game gold standard.
3See: How is the insurance regulator responding to the rapid growth in the bulk annuity market? Charlie Finch. LCP. 31 July 2023.
The future of UK pensions: delayed and confused. Helen Thomas. Financial Times. 12 July 2023.
4It's been suggested that around one in five corporate DB schemes are fully funded on the high bar of the buyout basis. However, that's not to say all of these fully funded schemes are ready to go to buyout. Buyout readiness requires alignment of trustee and sponsor, good quality member data, clarity over the benefits to be insured, preparation of a benefit specification document, an appropriate asset allocation and clear asset transition plans.
5With bulk annuity providers looking set to benefit from less stringent Solvency II reserving and ALM requirements, over the next 12-18 months, these insurers may yet widen the range and extent of illiquid assets in which they invest. However, these relaxations and the PRA's nascent concerns about insurers' ambitions to expand market capacity to meet accelerating demand, may yet challenge buyout's gold standard nomenclature.
This post is funded by Columbia Threadneedle Investments
