A report published by Legal & General at the end of the first half of 2023 predicted the UK’s pension risk transfer (PRT) market was on course for one of its busiest years on record and activity has continued at a hectic pace since.
On one day in November two transactions worth a combined $11bn were announced: a $6bn transfer from pharmacy chain Boots’ pension fund to Legal & General, and a $5bn bulk annuity deal between retailer Co-op and Rothesay Life.
The background to the high level of activity in the UK’s PRT market is the series of 14 interest rate rises by the Bank of England which started in November 2021.
These have moved the base rate from 0.1% to 5.25% and have had the knock-on effect of improving UK pension scheme funding levels.
The explanation is that while rate rises depress asset values they reduce pension scheme liabilities even more, with UK corporate accounting standards discounting pension liabilities using – now elevated – AA corporate bond yields.
The UK Pension Protection Fund says a rule of thumb is that while a 0.3% rise in gilt yields reduces scheme asset values by 2.6%, the same increase will see liabilities fall by 5.2%.
But according to Shelly Beard, London-based partner at WTW, it was chaos in the UK gilt market in October 2022 which has been a significant driver of PRT activity in 2023, rather than the overall improvement in scheme funding levels.
A September 2022 budget statement by the UK government spooked the markets, driving a 120bps gilt yield spike in just three days at the start of October. This prompted a panic for pension funds with large liability driven investment (LDI) portfolios which scrambled to meet margin calls on their positions.
“Following the LDI crisis there’s been an increased focus on the risks linked to DB pension schemes, leading sponsors to say: ‘although we have de-risked the scheme it’s still exposed to left field events’,” she says.
“Given that the cash contribution to fully settle obligations has moved down with the rise in risk-free rates, the result has been a number of transactions where sponsors have recognised that not having a DB pension scheme on their corporate balance sheet is helpful for their business strategy,” Beard adds.
Several trends have emerged among the UK PRT sector as sponsors look to de-risk.
One feature of publicly-announced deals is the high number of repeat transactions. One example of this is the Deutsche Bank UK Pension Fund.
The scheme struck a PRT agreement with Legal & General in November. The $610m deal was the second one signed by the bank’s pension fund in 2023, after it agreed a $500m transaction with Aviva in April.
It was the scheme’s third PRT in total, following a 2021 transaction with Legal & General.
Beard says that schemes which have already completed transactions will have done the preparatory work such as outlining benefit specifications and cleaning up their data.
“Schemes which have previously completed deals will be viewed by the market as having a lower execution risk because they already have the knowledge and governance in place.
It could also be that schemes which were better placed to react post the LDI crisis were the ones which have transacted before. Next year we could see pension funds which haven’t previously completed bulk annuities come to market,” she says.
The UK’s Pension Regulator warned in its annual funding report that the rapid increase in pension scheme funding levels meant that demand for buyouts could potentially outstrip supply in 2023.
Beard says that so far this has not been the case, but while there is sufficient financial resources available the pool of people needed to execute buyout deals is more limited.
“The reinsurance, the assets, and the capital are there. Human resources is the biggest pressure point at the moment and while the market has coped with this, the biggest capacity restraint is currently the availability of people.”
Beard also says that one knock-on effect of the strain in human resources has been slow progress by insurers in integrating technology into the buy-out process.
She says the sheer number of deals happening in 2023 limited the amount of time that specialists can dedicate to developing this aspect of the business.
According to the managing director, the idiosyncratic nature of pension schemes makes developing standardised tech products for the PRT market difficult. Pension schemes often have a long history and pay different levels of benefits to members.
Add the difference in size from ones containing a handful of members to others which number tens of thousands, and the task of developing a standardised technology solution which can be rolled out across the market becomes more complex.
“If you took 100 pension schemes and asked them for their membership data you would receive 100 different extracts. There’s no simple way of adapting processes to allow for that and while the sector wants to use more technology it will be a while before that happens.”
Away from the pure bulk annuity sector there have also been some major longevity swap transactions in 2023, such as the $6.4bn deal between the Reinsurance Group of America and the telecoms firm BT in August.
While on a slightly smaller scale Zurich UK and Prudential Financial teamed up to provide a $2.1bn swap for the pension fund of lender Nationwide two months earlier.
Beard points to two drivers for funds opting to strike a longevity swap instead of a bulk purchase annuity.
The first comes from schemes which have not yet reached their buy-out funding target but which have already de-risked their interest rate and inflation risk. This group is looking to stabilise their longevity exposure until it’s possible to offload a scheme to an insurer.
Secondly, she says that certain pension funds have the scale and in-house infrastructure to manage their DB pension fund and simply do not aspire to buy-out.
“Some of the schemes which have done longevity swaps in recent years are large and capable of running themselves. Because there are fewer of these funds, the longevity swap sector won’t take off in the same way as the bulk annuity market, but I expect steady volumes of about £10bn a year will continue.”
Another non-bulk annuity pension de-risking deal happened in November, when Clara Pensions signed the first Superfund transaction, which saw retailer Sears transfer 9,600 pension scheme members to the start-up.
The Superfund concept emerged in 2018, and was a UK government initiative intended to form a bridge to insurance buyouts for a pension sector which was then hampered by low interest rates.
Given the recent rapid rise in rates, and in consequence sector-wide funding levels, over the last 18 months the Superfund concept could appear to be past its sell-by-date even before a second deal has been struck.
But Beard says that there are still enough pension funds in need of a transition mechanism and that further players could enter the Superfund sector.
“The pool of schemes that Superfunds appeal to has definitely reduced since 2018, but it is still big enough to support the existing player, and potentially new entrants.
Getting the first deal done, combined with the government strongly reconfirming its support for the concept was important. It’s a valuable alternative option, albeit now for a smaller part of the market.”
