The difficulty of selling, regulatory capital constraints and valuation/due diligence complexity are all reasons why the inclusion of illiquid assets in the portfolios of defined benefit (DB) pension schemes can be a hindrance to the process of completing a bulk purchase annuity buy-ins or buy-outs in the UK.
Insurer appetite to capitalise on booming pension risk transfer (PRT) deals means that any resistance is not as pronounced as it was previously, however; more are willing to give trustees leeway in unloading sticky assets like private equity and private credit fund holdings and directly held assets such as property. Some have also begun accepting them in part payment of transaction premiums as growth in private markets has boosted the assets’ value and appeal.
“It isn’t necessary that all the assets are sold before approaching the market in order to get to the front of the queue,” said Russell Chapman, Head of Investment Risk Transfer at Hymans Robertson.
“Plus, there are often various other options of how to deal with any illiquid assets, which can be worked through as part of the deal and may or may not be a big issue depending on affordability – that being the scheme’s overall funding position and surplus.”
Insurers generally require de-risking schemes to liquidate their portfolio holdings and pay for bulk-annuity purchase transaction in cash to avoid the post-deal cost of doing it themselves. As well, private and alternative assets aren’t the sort of matching adjustment-eligible securities that insurers would usually invest in to back policies.
Greatly improved scheme funding levels are making de-risking more affordable. According to LCP’s latest estimates, 45% of schemes are already buy-out funded, up from 5% in 2021. That’s forecast to rise to 80% in the next five years.
Consequently, trustees have elevated the sale of illiquid assets up their priority lists in preparation for de-risking at the same time as insurers have tempered their aversion to them.
An LCP report earlier this year found that during 2023 and 2024 a handful of insurers accepted illiquid assets in the form of private markets assets in part-payment for bulk-purchase annuity premiums totalling more than £3bn, about 4% of total paid in the period.
Even among insurers still unwilling to absorb illiquid assets, some are giving schemes additional time to offload them.
“One of the things that we’ve seen in the market is insurers willing to defer bigger portions of the premium and for longer,” said Huw Evans, Professional Trustee and Director at BESTrustees.
“It used to be that you could defer, say, 2.5% for a year but now you can defer 5% for three years. The terms become more flexible the bigger you are.”
Larger schemes have the economies of scale for insurers to absorb the potential cost of holding sticky assets. Larger schemes are also more likely to invest in directly held assets that are easier to sell; smaller schemes will more often opt for more affordable but less liquid indirect securities, such as fund holdings.
The new landscape has put schemes in a better position to transact without liquidating all their holdings. This year’s LCP report, for instance, said that the influx of overseas insurers and capital providers into the UK PRT market has included companies with expertise in illiquid holdings.
The growth of a secondary market, where investors buy assets from other investors, has also provided more liquidity for trustees and insurers alike. Standard Life research published earlier this year that said just over half of DB trustees were planning to go to sell in the secondary markets to improve their liquidity positions.
“Secondaries fund investors are certainly active in the market and provide a good pool of potential buyers for illiquids from DB funds,” said Chapman.
“However, there are other investors active in the market, such as other pension funds which remain open or in run-on, public sector funds, overseas buyers and so on.”
More schemes are also seeking loans against illiquid assets to boost their cash holdings before a buy-in or buy-out. The Standard Life report said two-thirds of trustees are considering such loans because they can be a more cost-effective way to dress their cash holdings than alternative liquidity strategies, such as deferred premium payments. They also enable the eventual realisation of returns from those assets.
Insurers’ tolerance for illiquid assets has hinged in part on schemes’ willingness to accept discounts on the value of their holdings. The extent to which they are ready to accept such “haircuts” can depend on the characteristic of the asset and the size of the scheme.
“The discount can vary quite significantly by asset; some popular private debt funds can now be sold at or very close to net asset value (NAV), while for funds that are less popular or have perhaps underperformed, discounts can be 30%-40%,” said Chapman.
The private market assets that account for schemes’ illiquid positions became a feature of UK DB scheme portfolios because they offered higher risk-adjusted returns at a time when funding levels were lower.
Of the £1.7tn of assets held by UK DB schemes in 2024, about £274bn was allocated to alternative assets. Trustee interest in them is likely to continue after the Pensions Schemes Bill, published this year, made it easier for trustees to allocate capital to them – despite the Bank of England warning that the risks associated with large investments, especially in private credit markets, are untested and potentially dangerous.
“The private credit market is relatively new and has ballooned over the last couple of years and it is interesting to see the push to invest,” said Miki Fairfax, also a Professional Trustee at BESTrustees.
“But I am surprised there is still such a push for private credit knowing that we’ve got some red flags going up.”
The uptick in flexibility towards illiquid assets doesn’t mean insurers have experienced a Damascene conversion. Only a quarter of deals in 2023-2024 accepted such securities as part payment on premiums and a Standard Life report published in November found a third of trustees said illiquids remain a stumbling block to their endgame ambitions.
Even a change to the matching adjustment solvency regime that has made it potentially easier for insurers to take sticky assets onto their books is not seen as a vector for change yet.
“We expect it will start to help at the margins, but we haven’t seen significant changes so far,” said Chapman.
While illiquid assets may yet endure among schemes that run on, they are set to remain a prefer-not-to-have for insurers.
“Insurers are very interested in transaction certainty; a scheme with fewer problems goes up the list, and disposing of or integrating an illiquid asset is definitely a problem,” said Evans.
“If you don’t have that problem, that’s definitely a good start for you if you are an insurer.”