Frankie Borrell from Legal & General reflects on a record breaking year for the pension buy-in and buyout market and asks if the significant increase in market activity is here to stay.
The bulk annuity market has hit dizzying new heights in 2018. A perfect storm of pent up demand from trustees and significant appetite on the part of insurers has led to around £20bn of members' benefits being secured with UK insurers. This is a vast step up from the £10-13bn secured each year since 2014 and an indication that the market is - after much promise in recent years - truly now taking off.
While this is great news for trustees, their members, corporate sponsors and insurers, £20bn remains a drop in the ocean of the £2trn of defined benefit pension (DB) liabilities in the UK. So should we expect another £20bn of member's pension promises to be secured in 2019 or can we go even further?
There is every suggestion that trustees' interest in bulk annuities will gain further momentum in the coming years: after all, for most, they are seen as the 'sleep well at night' endgame solution to pursue.
The key change over the last year is one of affordability. Asset outperformance, employer deficit contributions and liability management, alongside a tail-off in longevity improvements, have all played a part in delivering much healthier pension scheme funding levels. The PPF recently reported that the funding level of UK DB pension schemes had increased to 97.7% at the end of August 2018 - the best funded these pension schemes have been in seven years.
It's these improved funding levels - along with particularly attractive pricing from insurers - that has driven a step change in appetite from trustees and their corporate sponsors. Many have recalibrated their de-risking strategies, including those that believed their first or next bulk annuity was years away. Indeed many sponsors, who have grown weary of volatile funding levels, see the current market as a cheque-writing sweet spot not to be missed.
So the demand side is expected to be as strong as ever as we head into 2019. In fact, a number of pension schemes who came to market in late 2018 have deferred their transaction to the first half of 2019, in light of insurer supply side constraints.
So why couldn't insurers absorb all of the demand in late 2018?
The four principal factors that affect insurer supply are capital, reinsurance, people power and assets. The first two of these aren't seen as a constraint for the foreseeable future. Insurers have access to the capital they need to support this growing market for many years ahead, and there is plenty of global reinsurer demand for taking on longevity risk.
Producing a bulk annuity quotation is very labour intensive for insurers, with huge effort invested in detailed modelling and price optimisation. The good news is that insurers anticipated the increased quote volumes as pension schemes' funding levels improved. In recent years, large teams have been established and insurers have invested in making their quote processes increasingly efficient.
However, due to the sheer number of quotes being requested, it does mean insurers have had to become more selective around the competitive processes that they participate in. That said, trustees and their advisers that identify their preferred short list of insurers, engage early, set price targets and ensure they are transaction ready, are continuing to attract strong interest from their preferred insurers.
The real challenge faced by insurers in a £20bn plus market is one of assets. In order to meet this level of demand, insurers must find the right investment opportunities for the premium they're paid by trustees, which will deliver a high enough return to support the pricing expected by pension schemes while meeting the strict regulatory rules in place around assets they can use.
Insurers are increasingly deploying the premium they receive into new asset classes, such as infrastructure, housing and urban regeneration. These perfect 'slow money' opportunities offer a great fit for the long-term nature of the pension promises they take on through buy-ins and buyouts. This really is a good news story for our industry: using these substantial holdings to invest in the UK's future prosperity.
However, the right slow money assets are few and far between. To continue to support buy-in and buyout pricing levels observed in 2018 and even higher market volumes, insurers will need to continue to work hard to find the right assets.
An efficient and growing market
The bulk annuity market has come a long way in the past decade: it's grown into an exciting and vibrant market place. As the market reaches £20bn for the first time in 2018, it's an opportunity to celebrate the many success stories to be proud of.
But there is a huge amount left to do. As funding levels improve in the next ten years - with many de-risking plans reaching maturity - our industry is committed to ensuring we'll be ready to deliver for many more trustees and their members in the years ahead.
Frankie Borrell is director, pension risk transfer, Legal & General