A rock in a rough sea: How the pension risk transfer market set records in 2020

It would have been easy to think that in a year where longevity risk was heightened significantly, and in which market volatility made investment and funding decisions much more difficult, that a bulk annuity market reliant on both these factors aligning to offer good pricing would be somewhat hindered.

Yet despite some transaction processes being suspended in the wake of the first lockdown in Q2, market volumes and activity stayed fairly uniform throughout the rest of the year. 

And while some schemes held back their moves, others saw themselves get much closer to their buyout positions than maybe they had anticipated.

As such, hot on the heels of a bumper 2019 came yet another record year for risk transfer, with PP analysis finding that the total number of buy-ins, buyouts and longevity swaps hit around £55.6bn in 2020. In the year prior, this was recorded at about £51.9bn. 

Indeed, Mercer risk transfer partner Ben Stone comments: "Even with all the headwinds that could have potentially come across, 2020 saw fairly consistent market volumes through the year. It was buoyed by the attractive pricing that came through during the springtime when market dislocations happened, but we obviously had the normal Q4 business as well."

Even when excluding the £24.3bn of longevity swaps announced, the £31.3bn of buy-ins and buyouts make for the market's second best ever year, only beaten by the super volumes recorded in 2019, a year dominated by an abundance of multi-billion-pound mega deals. 

As is well documented, 2019 saw ten bulk annuity deals valued at over £1bn, comprising £28.7bn of market volumes by themselves. During 2020 just five deals were publicly announced as insuring £1bn or more of benefits, amounting to only £6.7bn of total volumes.

And to be even more selective, in 2019 five deals insured more than £3bn of liabilities. In 2020 there were no such publicly confirmed deals.

Ultimately, last year was characterised by smaller transactions, both as a function of insurer capacity and of sponsor appetite.

Aon head of risk settlement Martin Bird comments: "The brutal truth is that small schemes have been a little bit crowded out by all the big stuff, and particularly in 2019, I wouldn't say they didn't get a look in, but all of the big focus was on the mega deals. Obviously, they don't just consume balance sheet capacity, but they're also hugely complicated and take up a lot of resource.

"The small and the medium stuff was acknowledged as needing to be streamlined and efficient, but it's just struggled a little to compete in such a buoyant mega market. Last year, ironically, all that prep work really came home to roost because there was a real appetite to deploy capacity into smaller transactions. The two things just really lined up."

Consultants have been developing solutions to streamline the approach for smaller schemes, building up their preparedness and making a scheme's liabilities and data more attractive to insurers. Now, Bird says, 2020 has been able to provide "proof of concept". 

"Even when the big stuff comes back, the market will have more confidence in the pace at which you can get some of the smaller stuff done. Hopefully it's carved out its own niche. There was just such an opportunity for small schemes that the streamlined stuff got used en masse, in anger. It proved effective."

While there has been no problem with "bums on seats", he continues, insurer resources are easily taken up by the bigger or more complex deals. The streamlined solutions reduce the amount of resources that either side needs to dedicate to completing a deal, particularly useful in a busy market.

Lane Clark & Peacock (LCP) partner Charlie Finch concurs with this assessment, noting the reduction in the average deal size when compared to the bigger 2019. 

"We did see a big increase in the £100m to £200m range. There was about a 50% rise in transaction numbers at that level. Notwithstanding the lack of mega deals, the market still saw a big volume last year. By historic standards, it's significantly bigger than the £24bn in 2018, which itself was twice the level we saw the previous year.

"It's a continuation of a step up in volumes that we saw in 2018 and, although there will always continue to be volatility from year to year, we expect that pattern to continue."

And this is a trend recognised by each of the insurers. 2020 became the time for small schemes to shine and show off their preparatory work.

"Last year saw lots of deals in the ‘hundreds of millions' of pounds range, but these are not at the expense of smaller deals," says Stone. "These are still going through and what we've seen is the efficiencies that are happening on smaller deals, both in terms of executing the transaction and in terms of insurers pricing in an efficient way. That means that effectively those efficiencies have been locked in for this year."

Like Bird, he believes that the proof was in the pudding and the 2020 demonstration will herald a new era of small scheme de-risking, without pushing out some of the bigger and perhaps trickier deals.

"We are bullish," he says. "I'm not saying that 2021 is going to be the year of either the big deals or the small deals; there's room for both."

Price and speed

There were a number of factors which kept the market buoyant last year, not least in which insurer pricing improved amid the market turmoil. As credit spreads widened, affordability improved; some schemes even found their funding situations improve while the market tanked.

As mentioned earlier, at the outset of the pandemic some schemes put their plans on hold; but others accelerated them. This is indicative of schemes increasingly being opportunistic.

"One of the most interesting things last year was all about the surge in pricing that we saw in Q2 and schemes being opportunistic," agrees Finch. "It's something we've been banging on for a long time now about if you want to get the best results from your de-risking strategy, you need to be strategic, intelligent, and nimble."

LCP recommends its clients to carry out de-risking moves over a number of buy-ins, taking an almost insure-as-you-go approach where deferred members are brought into policies when they become pensioners - if you cannot insure them before.

"You can be much more intelligent about a) which liabilities you insure with different insurers, because they'll have different appetites, and b) about timing. There are opportunities that come along from time to time which have exceptional pricing. 

"Last Q2 was an exceptional period; we saw clients get price reductions of 5% to 10% just because of market movements. So if you were 90% funded on a full buyout basis, you could potentially do a buyout with little or no contributions."

When markets were shifting significantly on an almost daily basis, the need to be nimble could not have been more apparent. For some schemes, sponsor covenants were degrading, the possibility of cash injections was drying up, and deficit recovery contributions (DRCs) were being deferred.

Fortunately, for many, the ability to be nimble was actually enhanced by the crisis. There was no need to travel halfway across the country, having agreed a date and location, to make what could be a very quick decision.

Bird agrees with this assessment, noting this was particularly the case as people got more used to the remote working paradigm.

"You'd have a price but you literally had to agree that within a day or two because an insurer would need to go and lock into that and they just couldn't hold it indefinitely," he says. "In the second half of the year, one of the positive by-products of everyone being forced into virtual work and then having to embrace it was the speed at which joint working groups were operating and the ease of decision making. You could wake up one morning and you'd need to convene decision makers, and you could probably have the meeting that afternoon or early evening."

While decisions were maybe not made instantaneously, sometimes they could be made within half an hour, Bird says - and he does not believe this will be rolled back in the post-pandemic era.

"When you're at the sharp end of decision making, the ability to just jump on Zoom at very short notice and make those decisions is really, really effective and it aligned particularly well with the theme of capturing pricing opportunities in periods of volatility."

Repeat business

But while the pace of decision-making was certainly enhanced, what underlined a large portion of last year's deals was an existing relationship. Whether it was through other products utilised by a scheme or a prior insurance contract, repeat business was the flavour of the year.

Schemes that had previously conducted bulk annuity transactions were returning to insurers to take further risk off the table, many aided by holding so-called "umbrella contracts", which allow for the efficient progression of further deals using past information and relationships.

As Finch explains: "A lot of transactions we're doing now are for existing clients, and a lot of them are through umbrella contracts. We've got 15 of those in place. Going forward, a greater proportion of business in the market will be schemes which have already been down this route.

"There is a danger for schemes that if you haven't already got relationships, or got contracts, in place, if volumes do continue to pick up, it's going to get harder to access the market. Putting those structures in place is going to be a big trend over the next few years."

For example, the ICI Pension Fund used an umbrella contract to complete its ninth buy-in with Legal & General (L&G) last August, insuring a further £70m of benefits to bring total insured liabilities to around £5.8bn when including another eight transactions with other insurers.

Similarly the Marks & Spencer Pension Scheme completed its second buy-in with Aviva and third policy with Phoenix, also utilising umbrella contracts in both instances, while Siemens also agreed an umbrella contract with L&G after completing a £530m buy-in in August. 

Premier Pensions chief actuary John Herbert notes that one of his clients conducts an "annual roll-in" of all recent retirees, with each deal valued at between £15m and £20m. "This just puts in the people who have retired in that 12-month window, and that's just an agreed risk management policy. They are repeat buyers, but it is almost an automated process now."

In the volatile year, this made it particularly attractive to insurers, notes Bird. "You're going to have to be super well-prepared to capture these opportunities. These repeat buyers knew the drill. They knew what it looked like to actually get pricing, they knew what it looked like to make decisions and to be able to respond quite rapidly from a governance perspective.

"If you're an insurer and you say ‘I've got some capacity to deploy and I'm quite keen to do a deal this quarter', then someone that has traded before and someone who knows the drill is actually quite an attractive proposition to you."

The mantra of being prepared and getting your ducks in a row has not dissipated, but those who have not entered the market before now have to contend with this additional element in their fight to get attention. 

Budding relationships

Schemes with existing relationships will potentially get what Mercer partner Suthan Rajagopalan calls a "reverse inquiry". As schemes set long-term objectives for the endgame as part of heightened regulatory requirements, insurers and schemes will perhaps come to know each other better.

"The defined benefit (DB) funding regime is in itself going to be encouraging clients to think about what their long-term objective is, but also what it is exactly they're funding for," he says. "There are clients that are actually taking that to the insurance market and saying, ‘Well, look, we're not ready to transact, we don't think we are going to be for a while, but can we partner with you, can we build those relationships with you, with our advisers, to maybe get some cashflow pricing to know where we stand and therefore plan for the much longer term?'"

The scheme, as a result, gets better management information and an understanding for their endgame, while the insurer gets greater insight into a potential pipeline. 

"But then there is the extra bit of value that the client gets the potential for a reverse inquiry. That cashflow pricing might lead the insurer and the trustees to actually think, ‘we're closer than we thought'. The long-term funding regime is going to be a catalyst for this market.

"For schemes who know that buyout will be their destination, there is an alternative route that starts the communication with insurers a lot earlier, such that schemes can find the right contract at the right time, rather than just securing the best contract at a specific time that it goes to market. That could lead to schemes securing members' benefits earlier than anticipated."

Finch says there are a number of "push factors" on schemes to think about the longer term and essentially end up on the de-risking path. As well as the increasing regulatory focus, the past year has demonstrated the potential for black swan events to come in, distract and potentially decimate sponsors, and fundamentally alter the security of members' benefits.

He notes also the introduction of the funding and investment statement in the Pension Schemes Act 2021, which will require trustees and the company to agree the long-term investment strategy - while also being mindful of the potential for criminal investigations and enforcement activity.

Uncertain longevity

One final area of significant growth in the year was in both the adoption and the novation of longevity swaps. This segment of the market saw £24.3bn of longevity risk reinsured across seven deals, marking a record year in what is quite a lumpy market.

"Last year was a bumper year," says Rajagopalan. "There's clearly been a large number of swaps in the making for a number of months and years and quite possibly Covid could have ended any/all of them or stalled them, but the fundamental reasons why each of those trustees were looking at it must have been tested quite closely in 2020. They had the backdrop of the first and second waves and needed to double check that the rationale was still appropriate."

He notes the "white collar" nature of many of the schemes, with financial institutions in particular taking the longevity risk off the table, a trend also noted by Finch, who says it is largely a question about regulatory capital.

"The key drivers for the banks is it goes directly to their regulatory capital if you do a buy-in; a longevity swap doesn't do that in the same way. I fully expect we'll see further financial institutions going down that route, and it will continue to be quite lumpy. There will be a few transactions, but it's quite dependent on the timing."

What has become clearer over the past few years, all agree, is the need to understand how to exit these contracts if schemes want to take broader risks off the table. Many contracts were drawn up in the late 2000s or early 2010s and now are being used to smooth the path to a buy-in.

Aon's Bird says: "We'll see more and more novations coming through. It's a big area of focus for people putting on swaps, which might sound odd but at the point you go into a swap it's important to be very clear about how you come back out of it on the other side."

The oldest swaps were agreed at a time when the schemes maybe did not have enough investment or funding headroom to afford an annuity, he says, but now this is very much recognised as a stepping stone to a future bulk annuity.

"It's weird that you spend as much time negotiating the exit terms of a swap when you're actually purchasing the thing as you do on just the actual pricing of the thing that you buy."

Furthermore, the novation of the swaps is potentially a "feeder for more longevity swaps", says Rajagopalan. "For some insurers, they find that very attractive because you're handing them a hedge they'd normally go and get themselves."

It is not the case that all insurers will like the notion of novating a swap - some prefer there not to be this added complication, but Rajagopalan nevertheless believes this is where the market is heading, even if there would not be preferential treatment.

"The majority and competitive pressure will push more insurers to be able to accept longevity swaps, but I wouldn't necessarily see insurers preferring a scheme with a longevity swap, unless it was very large or very white collar."

Wider product offering

On a similar vein, the 2019 introduction by L&G of its assured payment policy could also provide this smoother route to a bulk annuity. The product, now used by Allied Irish Bank and L&G's own scheme, insures some of the largest risks in a pension scheme, except the longevity risk. 

In a way, it could be considered the completing half to a longevity swap - but this does not mean a scheme has to use both. Ultimately, as Mercer's Stone says, it is "a kind of pre-buy-in". "What it's doing is securing cashflows without longevity, but it gives you a plan to build that up to a buy-in over time in a more secure way than just saying, ‘we're going to run the scheme on our own for five years, and then go to market and do a buy-in later.'"

Finch characterises the product similarly, noting it is "either a buy-in without longevity, or effectively a super liability-driven investment strategy providing an exact match for your cashflows". 

While he believes the product is suitable for the right clients, he does recognise that the innovation could limit the range of options when a scheme goes to full buy-in - but he is optimistic over the longer term. "As it becomes more popular, we might see it develop and become more flexible," he says.

Bird agrees that innovation is increasing the range of options available to schemes. "Innovation is rife and I'm pretty sure we will continue to see a lot of innovation in this market as people ask, ‘what can we do to get a greater amount of certainty around volatility if we can't afford the mainstream solutions?'"

Where the take-up of these products will be in five years' time, Bird is uncertain, but he is sure "there'll be a lot of conversations, and a lot of innovation" in a market where trustees are focused and wanting to move the de-risking conversation on further. 

Alongside L&G's insured self-sufficiency product, fund managers' liability- and cashflow-driven investment ranges, as well as wider market introduction of capital-backed journey plans and DB consolidators, schemes have a veritable selection box of de-risking options.

These are not to replace bulk annuities policies, but to provide a greater suite of, in some instances, stepping stones to the ultimate ambition of buying out the scheme.

"We don't believe these options mean there is a slowdown in buy-ins and buyouts for pension schemes," says Stone. "What it does mean is that maybe these schemes that are planning to go to market in maybe seven years' time might now be approaching the market in five years' time. For pension schemes, this is a really good opportunity for them to plan their own journey."

There may even be others coming to market soon, says Bird, who says: "We'll see all of these products compete with one another. There's a lot of variations on the similar theme knocking around the market. Some haven't been announced, they're kind of embryonic. 

"Hand on heart, do I think we'll see mass volumes into these in 2021? Probably not. But it's an area of development and sometimes it doesn't take much, one or two deals go through and they get the edges knocked off them in terms of structural changes. All that thinking leads to something that works and then, all of a sudden, it snowballs."

This is exactly what happened with longevity swaps, he argues, and we should not watch for the wider innovations in the market to do the same thing.

Looking ahead

Many now believe 2019 may have essentially been a blip. Irrespective of the upheaval caused by the pandemic, in myriad ways 2020 may have been typical of future market dynamics.

Bird certainly believes 2021 will prove very similar to 2020. "The big theme of 2020 was it was a lot smaller in deal size compared to 2019. Even taking into account the pandemic, 2019 was just an exceptional year. I don't think anyone expected to repeat that in 2020.

"It did kind of do a complete about turn, because it was smaller off the back of a big year, but also smaller just because of the pandemic."

He expects 2021 to see a number of large longevity swaps, supported by a "buoyant annuity market that looks like last year in terms of deal size".

And while, at the time of writing, just £3.3bn of risk transfer - including one £3bn longevity swap with Axa and Hannover Re - has been confirmed across four deals, behind the scenes things are much busier.

Stone says: "There is quite a lot of carryover from last year. We're seeing with some insurers that they were so busy closing deals at the end of 2020, they put back their work on a whole bunch of other things and now they're just flat out catching up. It's going to be a healthy 2021 all in."

Sadly, one particular area of focus for this year and those a little further out will be bulk annuities providing above Pension Protection Fund (PPF) compensation levels, but below full entitlement. 

Last year saw a couple of these, including the Old British Steel and Countryside Farmers schemes, both of whose woes preceded the Covid crisis. Now, a year of on/off lockdowns and closed businesses and the impending unravelling of government support could raise a new onslaught, albeit delayed, of PPF+ deals.

As Bird argues: "With all the pressure on sponsor covenants, we certainly think there's going to be a steady flow of this for the coming years." But it is a slightly different and more complicated market, especially when working out how to structure the policies and value the benefits - while also working with the compensation fund while the scheme is in assessment.

Nevertheless, these types of deals, in addition to normal market dynamics, are set to lead to a continuingly buoyant market for bulk annuities and longevity swaps over the coming years. Ultimately, schemes need, as per usual, to be prepared - even if they think their endgame is not close.

Finch predicts that schemes are on a journey of "five to ten years to reach full buyout", which will inevitably drive a "sudden burst of larger volumes in the late 2020s". 

A multitude of factors will drive more schemes and employers to seek greater certainty from insurer policies: regulatory and governance pressures, sudden improvements in funding levels, and, not least, the longevity uncertainty arising from Covid and its long-term direct and indirect consequences.

All-in-all, LCP predicts between £30bn and £50bn to be the regular annual levels of bulk annuity business, with a number of large schemes approaching full buyout towards the end of the decade. Mercer anticipates around £60bn of transactions across bulk annuities and longevity swaps this year, also, while Aon has predicted bulk annuities of at least £30bn this year.

The key lesson for trustees is, unsurprisingly, to be prepared. The last year has shown how quickly things can change and the need to be ready to act opportunistically. This means readying the data, tidying up records, and building relationships, all while understanding what your end goal is.

Bird says Aon has a rule for its clients: "If you think you're five years away from buyout, that really means you're anywhere between two and eight." It may pay to be optimistic.