The total surplus of the approximately 5,000 defined benefit (DB) pension schemes in the UK reached a new record of £300bn in September according to PwC, which has brought with it the luxury of choice with regards to scheme’s end-game options.
So, rather than rushing to seek an insurer-led buy-out, some trustees are having what Goldman Sachs’s Henry Hughes and Cyprian Njamma call in Beyond Buy-out: Rethinking the Endgame for UK Pension Schemes, a recent article published on the firm’s website, a “strategic rethink about the endgame planned for their schemes”.
Goldman Sachs’ article discusses the benefits to a DB pension of either going the buy-out route or running on, and pensions consultancy Lane, Clark and Peacock (LCP) said it was finding a marked increase in schemes considering run-on strategies versus full insurance at an earlier stage.
In Reaching cruising altitude, a recent report by the firm, LCP said while funding positions remain important the position in 2024 had been “more nuanced”.
The report found trustees are using their funding position to buy time, so taking stock in key areas including data readiness, benefit certainty, illiquid asset run-off, and member experience. Sponsoring companies were also using this pause to look at whether deferring a buy-out would result in better value for both themselves and scheme members.
The report also cited Mansion House reforms, a rise in pensioner action groups lobbying for discretionary pension and increased media scrutiny of deals as other reasons why schemes may be looking at their options.
“Our 2024 survey showed a marked increase in schemes considering run-on strategies versus full insurance at an earlier stage, except for giant schemes over £5bn,” says the report.
According to Charlie Finch, Partner at LCP, there may indeed be something of a plateauing of activity in the market in the short term.
“Our projections show a slight dampening over the next five years with higher demand in later years and demand remaining at circa £400bn to £600bn over the next decade,” he said.
The main alternative to an insurance buy-out is for the scheme to run on. Hughes and Njamma’s article says that there is increased interest from trustees in fiduciary management, where schemes take on a third-party asset manager specialising in implementing a bespoke run on investment strategy.
“Fiduciary management is becoming a standard tool, with 18 per cent of UK pension schemes using this service in some form,” the article says.
The cost of a buy-out was a consideration in the decision to run on but Goldman was also finding that sponsoring companies were using fiduciary management to keep a pension scheme running out of a sense of responsibility to current and former employees.
“It is our opinion that trustees who are charting a course toward a buy-out agreement with an insurance company will also need to be sensitive to how insurers invest, taking into account solvency capital, regulatory and accounting considerations, and other inputs to target better risk-transfer pricing,” says the article.
“Conversely, trustees who see value in retaining control of their schemes, and have the investment capability to run on successfully, may have the opportunity to invest in areas of the market often eschewed by insurers, such as securitisations.”
There are other alternatives emerging to both buy-out and run on. Last month, M&G announced it had completed a risk-sharing buy-in with an unnamed pension scheme and its sponsor.
The deal involved 3,200 members and came in at £500m. Members were insured in the same way as they would be via a traditional buy-in, but instead the sponsoring employer remains involved, sharing the financial risks and any potential upsides.
M&G completed the deal using its ‘value share bulk annuity’ service. This involved a Guernsey-based reinsurer owned by M&G, alongside The Prudential Assurance Company, M&G’s parent company.
The sponsor also retains the option to withdraw any excess from the reinsurer once a year.
“The solution we have achieved ultimately enables the trustee to achieve their derisking objectives and secure members’ benefits, while enabling the sponsor to access risks and rewards that would be passed to an insurer in a more traditional transaction,” said Alison Fleming, Partner at PwC, an adviser on the deal in the press release that accompanied the announcement.
M&G life insurance CEO Clive Bolton, said it was a “ground-breaking” transaction that provided scheme members with the security of a buy-in, while sharing the financial risk and upside with the corporate sponsor.
“This significant de-risking milestone has been made possible thanks to the strong alignment of interests, collaboration and commitment between all parties involved,” he said, in the same press release.
Even with options such as these, the growth in the number of market participants this year means that UK DB pensions have options galore in terms of choosing an insurance partner for those that still wish to enter into a full-scheme buy-out transaction. It’s mainly a question of when.
“With total annual insurer capacity comfortably over £50bn and new insurer entrants taking total market participants to record numbers, pension schemes are finding that the emerging supply /demand dynamics are delivering great outcomes in current transactions,” said Finch.
“How these dynamics will evolve into 2025 is a fascinating question. With some of the best full scheme buy-in pricing we have seen for years, could this speed up the decisions for some well-funded schemes to move to insurance, or will they judge the risks and rewards of a period of run-on ahead of insurance as acceptable and appropriate?”
