Feature | Bulk annuities
Longevity risk is not like other risks. Unlike market and investment risks, people living longer than expected is a risk without reward for pension schemes. Yet longevity is an issue that comes as standard with defined benefit (DB) pension schemes. People living longer than ever before, despite the projected rate of growth easing in recent years, means sponsors must find more money to fund their for- mer employees’ retirement. Even a slight change to the projections can make a big impact on the amount of cash trustees need to generate from their portfolio. Indeed, a year’s increase in life expectancy could push a scheme’s liabilities up 4%, says Mitul Magudia, head of business development at Pension Insurance Corpo- ration (PIC). “Even a small six-month change can have a material impact on some of the large schemes,” he adds. “A 1% or 2% increase
which at the time was a record. Risk settle- ments this year include the National Grid’s £2.8bn and £1.6bn buy-ins, Rolls Royce’s £4.6bn buy-in and the £4.7bn buyout for tech company Telent.
A third of FTSE100 companies have reduced longevity risk in their final salary pension schemes through the bulk annuity market, according to Aon. The 86 mem- bers of the index that have a final salary scheme account for £70bn worth of such de-risking deals.
EVERYONE’S A WINNER Risk settlements are popular because every- body wins, says John Towner, head of origi- nation at Legal & General Retirement Insti- tutional. “It frees a company from its legacy obligation to what typically are past employees, therefore removing costs and risk from the balance sheet so it can focus on growing the business,” he adds.
four years, and it has become more affordable.”
Pricing in the bulk annuity market is based on an insurer’s longevity assumptions and its ability to source strong assets that pro- vide good yields. Insurers look to lay off its longevity risk with the global reinsurance market because many have big term insur- ance books, so they want UK longevity exposure to offset that risk.
The big global reinsurers are offering good terms for longevity reinsurance which insurers pass onto pension schemes when pricing buy-ins and buyouts. “That is one of the things that has systemically become a feature of the market that means pricing has improved significantly in the past few years,” Magudia says.
I have not met an FD who would not be inter-
ested in transferring responsibility for his or her pension legacy obligations to us. John Towner, Legal & General Retirement Institutional
can be quite significant on a scheme’s fund- ing position.” So more and more sponsoring companies are shifting this risk off their balance sheet by transferring it to an insurer. The process falls under the banner of the bulk annuity market and takes two main forms. A buyout involves a sponsor paying an in- surer to take responsibility for paying the pensions of a proportion of a scheme’s members, while under the terms of a buy- in, the sponsor retains the responsibility, but the insurer pays the pensions of those insured. “There has been a huge pick up in appetite from pension schemes to look at using insurance,” says Mike Edwards, a partner in the risk settlement team at Aon. Indeed, in 2019 around £40bn worth of bulk annuity transactions were disclosed by insurers, up from £24bn a year earlier,
Such agreements are also a good move for the trustees as it settles their obligations to their members, Towner says. It is also good for members as the responsibility to pay their benefits moves from the pension envi- ronment, which is lightly regulated, to the insurance industry. “You get this kind of win-win-win across all the different stakeholders,” Towner says. “I have not met an FD who would not be interested in transferring responsibility for his or her pension legacy obligations to us.” One factor driving the rise in sponsors passing their pension obligations to insur- ers is that it is now within their reach. “Lon- gevity improvements have tailed off, which has helped pricing,” says John Baines, Aon’s head of bulk annuities. “Add to that that scheme asset positions have had a strong performance over the past three to
40 | portfolio institutional | December-January 2020 | issue 89
“It is more big systematic things as opposed to someone saying I want to write more business this year therefore I am going to have lower pricing,” he adds. “It is more fundamental than that.” So it is a combination of an increased appetite, better rein- surance terms and insurers sourcing good assets. Sponsors are also under pressure. They are facing increasing questions on how they are tackling risk in their pension scheme. “A de-risking transaction is simple and demonstratable, so you can tell your investors you are doing something to tackle the problem, be it a buy-in, buyout or lon- gevity swap [insurance against members living longer than expected], it is some- thing that is tangible,” Baines says.
A TREND SHIFT Yet it appears pricing was a huge factor in enticing schemes to the market in 2019 as they raced to beat potential price rises. The issue is that mortality growth is easing, and insurers are trying to work out if it is a long-term trend or a short-term occurrence.
In the UK, the mortality rate among those aged 65 and over fell by 3% a year between 2000 and 2011. “To be at 3% for 11 years is very, very high,” says Amy Kessler, senior vice president and head of longevity risk
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