EY recently appointed Swapnil Katkar as a new Partner in the firm’s London office where he will lead the bulk purchase annuity (BPA) and capital markets solutions business at the firm. Greg Winterton caught up with Katkar to get his take on the current state of the BPA market and his views on the outlook for the coming 12-18 months.
GW: Swapnil, the growth in the UK BPA market is not only made manifest in the number of deals being completed, but also evidenced by the recent and planned entries of new insurers into the market. What is your view of the reality of just how large this market can grow to on an annual basis?
SK: The BPA market experienced substantial growth during 2023. This was largely driven by higher interest rates and credit spreads making BPA transactions a lot more affordable compared to 2022, and attractive in terms of value for money that these transactions offered to pension schemes. We estimate that around 225-250 BPA transactions were executed across nine BPA providers in 2023, covering a total deal volume of c.£45-50bn (compared to c.£25-30bn in 2022).
The growth in the BPA market during 2023 attracted new entrants, and we expect around 11 BPA providers to be ready to conduct business by H1 2025. New entrants will likely focus on smaller deals initially, giving pension schemes under £200m in size additional options and potentially better pricing.
Despite this, we are seeing more subdued growth in the BPA market in 2024 so far and anticipate lower annual growth in total deal volume this year. This is largely a result of weaker affordability due to tighter pricing (driven by low credit spreads) and due to fewer deals over £1bn in size – which were key in driving deal volume in 2023.
GW: Let’s talk interest rates. The Bank of England reduced rates recently, and there are doves on the Monetary Policy Committee that want further cuts. What is the hedging status of most of the plans you work with? Are they sufficiently protected from further cuts? Indeed, are the days of schemes’ funding status whipsawing gone now?
SK: Interest rates are forecast to continue to fall over the coming years, although the level and timing of future rate cuts remains to be seen. However, for pension scheme hedging, the most important aspect is long dated interest rates.
Looking back, a ten-year gilt yield – which could be seen as proxy interest rate for hedging purposes – has jumped from less than 1% pa to around 4% since 2022, substantially improving the pension scheme funding levels.
Many pension schemes have hedged their interest rate and inflation exposure embedded in pension liabilities on the scheme’s funding basis. However, the majority of pension schemes likely remain under-hedged on a buyout basis, representing a higher liability compared to an average funding basis.
Overall, we anticipate that the days of schemes’ funding status “whipsawing” – when pension liabilities go up and down materially more than pension scheme assets due to interest rate fluctuations – are largely gone, as the vast majority of schemes have largely hedged this exposure. However, that’s not to say that other factors won’t contribute to future fluctuations in funding levels.
GW: What’s your view on concentration risk? There is an awful lot of pension liabilities hitting the balance sheets of life insurers and consequently, reinsurers.
SK: Concentration risk is currently an issue for the life insurance industry and its regulator, the Prudential Regulation Authority (PRA). It is mainly driven by funded reinsurance transactions whereby, for instance, a UK BPA insurer reinsures a proportion of its pension liabilities with an offshore reinsurer. Given its limited oversight and control over offshore reinsurers, the PRA has been looking at this area closely and has recently published the final policy statement on the use of funded reinsurance. This statement focuses on the need for BPA providers to consider diversification between funded reinsurance counterparties, and how they will set internal limits for any recapture of collateral from a single reinsurance counterparty.
This is likely to create significant operational change for BPA insurers as they put new processes in place to demonstrate compliance and how they are mitigating the concentration risk.
From a pension scheme standpoint, typically, an entire pension scheme liability is insured with a single BPA insurer under the BPA contract. This is the concentration risk the pension scheme is directly exposed to, in addition to indirect exposure to sources like concentration risk within the BPA insurer’s investment strategy or its funded reinsurance strategy. This means pension schemes need to carefully consider all aspects of concentration risk when looking into executing a BPA transaction and the potential measures to mitigate this risk.
GW: What’s on your radar in terms of longevity/mortality trends? What are insurance companies and pension fund trustees currently discussing here that is impacting pricing, if at all?
SK: From a risk standpoint, post the Covid-19 pandemic, we are seeing less excitement among pension schemes to hedge longevity risk. In fact, the growth in the BPA market means that several schemes with legacy longevity hedges in place continue to assess opportunities to convert these into funded BPA contracts, especially as a number of these legacy longevity hedges are running at a loss.
We also see that the mortality assumptions used by pension schemes are now more aligned with the assumptions used by BPA providers, creating less impact in terms of any deficit on BPA basis.
Separately, there are continued developments in the reinsurance market which means the reinsurers now have substantial ability and appetite to provide longevity protection against longer duration liabilities (i.e.: on younger lives). This means pension schemes now have more choice in terms of hedging longevity attractively, either via BPA transaction or a longevity swap directly in the reinsurance market.
GW: Lastly, Swapnil, if you’re a pension trustee reading this who has not yet begun the journey towards an insurance solution, what’s your recommendation in terms of where to start?
SK: A pension trustee looking for an insurance solution could start by reviewing their strategic objectives as a key part of their journey planning. This could either be done upfront before executing any strategy or on a regular basis, for example, when the trustee board meets quarterly. Given the financial environment tends to change at pace, a more regular review would be recommended to ensure previously agreed objectives remain relevant and suitable.
In addition, given the range of strategic options available to pension trustees today – from run-on to buyout, from captive insurance to DB superfunds, from longevity hedging to self-insurance – it is recommended that these options are carefully considered before deciding on a chosen strategy. This could make a substantial difference to the long-term outcome for scheme members in terms of benefits received and the security of those benefits. This will also ensure that the pension trustees and corporate sponsors are reasonably aligned on the chosen strategy.
Swapnil Katkar is a Partner at EY in London
