As medically underwritten bulk annuity deals reach record levels, Kristian Brunt-Seymour examines the anticipated growth of this practice and which schemes could benefit most
At a glance:
- Medically-underwritten deals have risen to £1.5bn and could hit £2bn this year
- There is still a small part of the bulk annuity market with room to grow
- MU bulk annuities particularly benefit smaller pension schemes
The medically underwritten (MU) bulk annuity market had a record-breaking year in 2015 with LCP figures revealing at least £894m of new deals, bringing total volumes to over £1.5bn.
The market has grown quickly in just three years since the very first buy-in was written using medical data. Legal & General completed the biggest ever MU bulk annuity for a defined benefit scheme at the end of December 2015 for £230m, highlighting the potential size of future transactions.
The Pensions Institute predicts a boom in this market in its triennial report published in January as schemes turn to ‘top-sliced' deals and traditional insurers enter the market.
The Good, the Bad and the Healthy: The medical underwriting revolution in the defined benefit de-risking market paper found that 15% of all sub-£100m deals in 2015 used MU to price the risk, up from 3% in 2013 and 5% in 2014.
The main benefit of using a medical underwriter is that a scheme can get a lower price for a bulk annuity if specific members might be in worse health than expected under a traditional underwriter.
Pricing should be driven even lower by increased competition among insurers to write new business, especially the merger of Just Retirement and Partnership.
The value of MU deals written this year is predicted to go beyond 2015 levels. Hymans Robertson partner and head of buy-out solutions James Mullins believes the total value of all MU deals could reach £2bn by the end of the year. "£2bn is quite a big number for a young market that's had good growth," he says. "I think that's very achievable because there have been a couple of FTSE 100 companies that have done medically underwritten buy-ins, which sends a message to all large pension schemes to follow suit."
Just Retirement director Stephen Lowe says while it is an exciting time for the market, he has heard of or seen little evidence from most consultants that total volumes could reach £2bn this year.
However, he says: "The evidence from the employee benefit consultants that we speak to is very bullish. They believe there is significant head room for growth."
The number of insurers which do buy-ins on an MU basis has risen and others are expected to follow suit including LV= which will enter the market this year.
Lowe says there have been higher levels of both post-deal underwriting and top slicing, both at the top of the value chain as well as the bottom.
"On its growth curve it's in the introductory phase," he says. "We're nowhere near reaching maturity so I think for consultancies to be talking about headroom for growth is significant."
It still represents a relatively small part of the wider bulk annuity market which over the last two years has ranged between £10bn and £15bn, and is likely to go beyond £11bn for 2015.
Pension Insurance Corporation head of business origination Jay Shah (pictured) says the potential doubling or even quadrupling of the MU market is not implausible.
Schemes with a small number of members are likely to benefit more from MU than very large schemes, for example those with up to 50 members.
This is because having smaller pools of employees to analyse will make it easier to identify trends and patterns in their health.
"If the scheme is so small that a factor specific to the members may not be picked up by the normal analysis that an insurer does, then it's worth doing," Shah says.
"The downside of it is that once schemes have that information, they cannot ignore it if members are healthier than expected and the cost of insuring increases," he adds.
A main consideration for trustees will be whether MU provides schemes with a cheaper solution than a non-medically underwritten bulk annuity.
"I think there's been quite a lot of froth around the price advantage of medical underwriting of bulk annuities which isn't supported by the actual process of medical underwriting," says Shah.
As for the future, MorganAsh managing director Andrew Gething points out that while there were some very big deals in 2015, he in believes the increase in the size of deals may eventually plateau.
"We know that two deals have been done at over £200m but whether that is the natural point or top level in the market remains to be seen," he says. "There are a few deals I know of which are more like £300m so the average may turn out to be hundreds of millions."
Hymans Robertson's Mullins does not believe the market will see medically underwritten buy-ins of more than £500m. "I don't think that's where the market will ever go," he adds.
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.