The impact of Solvency II on bulk annuity pricing will be limited, but schemes with generous options could see hefty increases, finds Jack Jones
After many false starts, Solvency II finally comes in on 1 January. As this date approaches much of the uncertainty around the impact of the regulation on the pricing of bulk annuities has disappeared. The overall effect will be muted: the cost of insuring pensions in payment will be broadly unaffected, while covering deferred members will get a little more expensive.
But some schemes could see the cost of insuring deferred members increase sharply. For those with member options like early retirement or commutation factors that are particularly generous or are fixed, buyouts could become prohibitively expensive unless trustees take action.
Any deals that complete before the New Year will benefit from transitional arrangements that exempt insurers from the incoming rules. So, although early fears that Solvency II could significantly jack up prices appear to have been overblown, there is likely to be a clutch of deals before 31 December.
Those schemes that do not get over the line by year end will have to factor Solvency II into their thinking. According to a report from LCP, the regulations will push up the price of insuring non-pensioner members by about 3% on average. This reflects the fact that insurers will have to hold more capital than before because of the extra uncertainty around promises made to younger members.
But Hymans Robertson head of risk transfer solutions James Mullins believes several factors will push pricing in the opposite direction. "It's true that, all else being equal, Solvency II will increase pricing a bit," he says.
"But other developments will more than offset that: competition is strong with almost double the number of insurers competing in the market compared to a few years ago, spreads of corporate bonds over gilts have increased in recent months and insurers are getting increasingly inventive in terms of the assets they invest in."
This will have slightly less of an impact on non-pensioner pricing, however, where less than half of the insurers in the bulk annuity market are competing.
Rothesay Life head of business development Guy Freeman says: "For buyouts that involve deferred members, an increase in reserving requirements is more likely to have an effect on pricing than for pensions in payment. The impact will become clearer as we move through 2016 and the market for buyouts under the new rules starts to clear."
But one effect is already clear. Schemes with fixed early retirement reductions, or that offer transfer values that are more generous than insurers would give, are likely to find it much more difficult to insure benefits at an attractive price.
LCP partner Charlie Finch says: "While in the past it has been possible to insure both of the above under a buy-in or buyout contract, going forwards it will be disproportionately expensive to do so."
This is because these terms invalidate the insurer from being able to use the ‘matching adjustment'. This allows them to tweak the discount rate used to measure liabilities if it holds assets with cash flows that match its obligations. The unpredictability introduced by fixed member options means insurers would need to reserve up to 20% more capital against its liabilities, according to Freeman.
"In reviewing factors, trustees will need to ask their advisers about the impact on buyout costs," he says. "Factors that are generous or even just fixed in the scheme rules may now trigger much higher buy-out costs. Schemes that are planning to buyout should check their factors before coming to market."
This is something trustees will have to consider when reviewing factors used in transfer values. Freeman says this is particularly pressing for schemes that have completely de-risked investments and could be using gilts +0 to calculate transfer values. Gilts +50 would cause problems for some insurers, while anything less generous than this is unlikely to cause difficulties.
Changing the rules
Freeman says this issue caused one potential client to shelve a bulk annuity deal while it reduced its transfer values. The scheme had to carry out a communication exercise and offer members a window to transfer out under the more generous existing terms before going back to the market.
A potentially trickier problem faces schemes that have generous member options like early retirement reductions written into their scheme rules. Trustees in this position will have to make Section 67 changes to scheme rules, which require the scheme actuary to certify members will be no worse off. This means schemes may have to offer an uplift, but this could be offset by the improved pricing.
Finch says these issues are a challenge for trustees. "While we can see why the authorities in Europe may wish to restrict insurers from making promises that introduce risks that are difficult to manage, there are some practical consequences of Solvency II that will be a challenge for trustees to address if they wish to insure deferred members," he says.
Aviva Life & Pensions has concluded an £875m buy-in with its own staff pension scheme, following on from a similar transaction last year.
Just Group has completed a £74m pensioner buy-in with the UK pension scheme of a US-listed engineering business.
The Smiths Industries Pension Scheme has secured a £146m buy-in with Canada Life in its fourth bulk annuity and its sponsor’s tenth overall.
The Prudential Staff Pension Scheme has entered into a £3.7bn longevity swap with Pacific Life Re, insuring the longevity risk of over 20,000 pensioners.
The Baker Hughes (UK) Pension Plan has secured approximately £100m of liabilities through a buy-in with Just Group.