Trustees of defined benefit (DB) pension schemes looking to de-risk through bulk purchase annuity (BPA) buy-ins or buy-outs are thinking like insurers as their counterparts switch investment strategies.
For the past few years, UK-based insurance firms have been buying more UK sovereign bonds and fewer corporate credit and other similar instruments – a reversal of the pattern of just a few years ago.
This gilts-based approach has fed through to the prices they offer pension schemes entering BPA transactions that are at the core of the surge in activity in the pension risk transfer market.
That switch poses a potential headache for trustees and sponsors. When schemes are ready to de-risk, they will either liquidate their assets to pay for the deal or pass on those assets as part-payment.
Consequently, insurers are increasingly baulking at scheme portfolios that include corporate credit assets.
“Insurers have reduced appetite for taking on corporate bonds from pension schemes, with a preference for taking on gilts,” said Michael Abramson, Partner and Risk Transfer Specialist at Hymans Robertson.
Hymans Robertson now advises that schemes close to de-risking should reduce their exposure to corporate bonds in line with insurers.
Insurers seek to match the cash flows of their liabilities by purchasing a variety of assets whose returns will amply cover those costs, which means they choose assets that are going to give them the best risk-adjusted returns. That has traditionally meant buying investment-grade corporate debt and higher-quality credit-like instruments such as equity-release mortgages, infrastructure debt and private issuance.
To gauge the value of their non-gilt holdings, insurers compare the returns they can get on them with those available from interest-rate swaps, so-called risk-free rates that reflect the pay-outs that can be had if cash is simply deposited with the Bank of England. The final calculation also takes into account the matching adjustment permitted on credit spreads, and the fundamental spread, which is an allowance for future defaults and downgrades of the debt.
For many years the yield spread between corporate bonds and swaps had been wider than that on gilts – meaning they offered better value. But in the past few years, corporate-bond spreads have tightened.
This is partly because higher interest rates have made it less appealing for company finance bosses to sell debt, reducing liquidity in the market for such instruments and lowering yields on outstanding obligations.
At the same time, rising yields on government bonds have widened gilt spreads as the UK government has issued record amounts of debt to fund increased spending programmes amid sustained economic weakness.
“Investors want more compensation for holding long-dated UK debt, owing to uncertainty about the long-term growth and inflation outlook, and the durability of fiscal plans,” Hymans Robertson wrote in its 2026 Risk Transfer Report.
Tracking the trend hasn’t been easy given that BPA pricing methodologies and insurers’ investment holdings aren’t always made public.
Thanks to a handful of announcements from insurers and a bit of detective work, market participants have been able to ascertain the switch to gilts. Legal and General explicitly said in its 2024 full-year results, released last March, that it had adopted a gilts-based investment strategy in the UK.
“This gilts-based approach results in a highly attractive return on capital,” it wrote, adding that the move had helped the company write £8.4bn of PRT deals in that year.
Other signals of the turning tide have been seen in PRT pricing, which has become more closely correlated with gilt yields. As well, advisers like Hymans Robertson have been privy to insurer thinking thanks to their dealings with pension scheme clients.
“Our clients are pension schemes, and those clients are often procuring insurance,” said Abramson.
“So, we see the pricing, we see how the pricing moves, we see the appetite from insurers for taking on certain assets.”
The beginnings of the reversal became apparent before the mini budget of 2022 that saw gilt yields surge when then Prime Minister Liz Truss sought to slash taxes and public spending, sparking worry among bond investors that the policy would put too much strain on the UK economy.
“I wouldn’t put all of that down to the rise in gilt yields we saw at the back end of 2022 – even before then we were seeing gilt yields climbing and they’ve continued to rise since,” said Abramson.
“But it’s in particular relative to the swap yields that the gilt yield has looked attractive. And gilts are far more capital efficient for the insurers than corporate bonds.”
With analysts forecasting that gilt yields will remain elevated, it’s reasonable to assume that insurers will continue to pursue a gilt-focused investment framework into the near future. Despite their relative safety, they do carry some risk.
In particular, some insurers are adding leverage to their gilt positions through strategies such as forward gilt trades, in which the bonds are effectively swapped for corporate debt of the same tenor that pays a better rate. Another strategy is a so-called par-par asset swap, another derivative trade.
These have raised eyebrows at the Prudential Regulation Authority (PRA), which warned insurers to adjust their risk management processes at the beginning of the year as they make “more use of strategic structured and synthetic investments which can introduce potential liquidity risk”.
“We expect firms to consider the cumulative impact and potential leverage of any such strategies and ensure appropriate risk appetite and limit frameworks are in place to manage potential aggregate cashflow risks including in stressed conditions,” the PRA wrote.
A sudden shift in gilt yields can’t be ruled out altogether. If that happened, the risk-adjusted premium that UK bonds enjoy relative to corporate debt would flip again and insurers would likely change their investment plans in lockstep.
“A future shift back could introduce complexity or volatility for insurers and the wider market, requiring constant adaptation of investment strategies,” Schroders wrote in a late 2024 paper.
While gyrations in insurer investment strategies are having an impact on PRT pricing, they’re not expected to affect PRT deal volumes. In its latest annual De-Risking Report, WTW forecast that deals in 2026 would reach £70bn – including a record £50bn in the BPA space. Improved scheme funding levels are expected to continue stoking the market.
“The bigger driver of the amount of PRT deals being struck is demand from pension schemes,” said Abramson.
“There’s more than ample supply, both in terms of capital appetite from insurers and the assets that they’d use to back these.”