Germany’s total pension assets are touching €730bn. But even with revised accounting standards, which explicitly brought pension liabilities onto corporate balance sheets, being introduced in the mid-noughties, activity in the country’s pension risk transfer (PRT) market has been muted.
Magnus Schmagold, Partner at German pension buy-out firm Funding Solutions, which has struck seven PRT deals worth a collective €324m since it was launched in 2018, says that this is about to change.
Schmagold says that in 2024 the firm has had two or three times the number of discussions around PRT transactions than in previous years, and that with transaction timelines typically around a year, he predicts there will be a significant pick-up in deal numbers next year.
“We certainly expect that 2025 will be the largest year in our history by transaction volume. We are also seeing more and more discussions covering schemes with obligations of more than €1bn,” he said.
“Markets, of course, don’t start with €1bn deals, and the German PRT sector is no different. Funding Solutions started with smaller transactions which evolved into bigger deals and I am positive that this will continue. In the next three to five years there will be activity involving schemes with liabilities that are €5bn plus,” Schmagold added.
PRT transactions in the more developed markets of the UK and the US have been dominated by insurers. Notable deals so far in 2024 include a $4.9bn deal between market veteran Prudential Financial and Shell US, while across the pond, SCA UK Pension Plan completed a £1.1bn deal with Legal & General.
German insurers are unlikely to play a leading role in the German PRT market, even if the sector expands to the size that Schmagold predicts due to an insurance regulatory framework which caps the guarantees carriers can offer.
Currently this cap – known locally as the maximum actuarial interest rate – is 0.25% a year, a figure which has been in place since the 2008 financial crisis. Schmagold says that even with a proposed uplift in the cap due next year it won’t be a big enough change to enable the country’s insurers to offer attractive structures to pension schemes.
In 2023, The German Association of Actuaries proposed increasing guaranteed rates to 1% and in April this year the country’s Finance Ministry acceded to industry pressure and said that from 1st January 2025, new policies could offer the proposed higher rate.
This marks the first increase in the maximum actuarial interest rate for 30 years, but it is still way below the returns available from investing in domestic fixed income instruments. At the start of July, German 10-year government bonds yielded 2.39%, and rates have touched 3% as recently as September 2023.
“The maximum actuarial interest rate that insurers can provide is not very compelling given where yields are so it’s hard for insurers to come up with attractive pension buyout proposals. Even when the rate increases to 1% next year it still won’t be appealing and that is why insurers have not been active in the German pension buyout market,” says Schmagold.
German insurers may not play an active direct role in the country’s PRT market, but Schmagold says that as Funding Solutions expands its portfolio it will look to offload individual risk, with longevity swaps potentially on the horizon.
German PRT deals can be structured in two ways. Broadly, either a specialist firm like Funding Solutions can acquire the shares of an existing pension company and continue to run it, or all the assets and liabilities can be transferred to a special purpose vehicle which is then run-off.
Both instances include the transfer of all risks, including asset, interest rate, inflation – and longevity.
While the UK pension buyout market has recorded a steady stream of longevity swaps from pension funds looking to de-risk their balance sheet, either as a precursor to a full buyout or to risk manage an ongoing portfolio, this instrument has not been used so far in the German market.
Schmagold says this is because German pension funds have typically had funding levels which are 15% – 20% lower than their UK peers and the country’s actuaries use less prudent mortality tables.
“The funding ratio for German pension funds has historically always been somewhat below the level of schemes in the UK, likewise the longevity assumptions. That presents a larger gap to full longevity swap pricing,” he says.
“Longevity swaps are certainly something we are looking at as a run-off provider and we are considering transferring-out longevity risk to specialised risk takers – essentially the same names that you see in the UK market,” he adds.
Longevity swaps such as the £6.4bn structure agreed between RGA and the BT Pension Fund in the UK, or the $14.2bn deal between Dutch financial services firm NN Group and two insurers in 2023, are typically done on a book of lives.
Schmagold says that German longevity swap transactions could be part of Funding Solutions’ risk management landscape as its portfolio evolves.
“Longevity swaps are something that we are constantly looking at, to see if at a certain scheme maturity, it might be useful and wise to transfer out longevity risk to an insurer which has a larger pot of obligations on its balance sheet,” Schmagold says.
