Pensions Arena

April 2019

Article

Buy-in now, while stocks last?

2018 was a record year for UK buy-ins and buy-outs but, with demand from pension schemes continuing to grow fast, are we about to see an end to recent attractive pricing for bulk annuities?

In this article we consider why bulk annuities have been so affordable in 2018 and early 2019 and whether this is likely to change soon. We also look at how to get your scheme into the best possible shape to approach the insurance market.

Record 2018, even stronger 2019

Bulk annuities transacted in 2018 in the public domain totalled around £25 billion, which included the largest buy-in to date of £4.4 billion for BA’s Airways Pension Scheme. This was almost twice the volume in the previous record year of 2014. In addition, there were two large insurer-to-insurer transactions, which took the overall 2018 total to more than £35 billion.

The majority of the transactions were pensioner buy-ins, reflecting the attractive pricing levels for pensions in payment relative to other low risk investments. Most pensioner buy-ins in 2018 were transacted on a discount rate in excess of gilts plus 30 basis points, meaning that a scheme which held a
portfolio of matching gilts could exchange them for a buy-in contract, simultaneously removing longevity risk and improving the scheme’s funding position.

The attractiveness of buy-in pricing has been due to:

  • insurers becoming more innovative in their sourcing of assets, moving away from corporate bonds to other debt-like investments (such as infrastructure and equity release mortgages) which are less liquid but have higher risk-adjusted returns
  • the dramatic reduction in the pace of mortality improvements.

Those two features have continued into 2019 and, when combined with increasing demand from pension schemes, seem certain to mean an even higher volume of bulk annuities will be transacted this year.

Supply and demand

Demand for bulk annuities is expected to continue to increase, given that recent good performance from growth assets and the slowdown in mortality improvements mean that a growing number of schemes are getting close to being fully funded on their long-term funding target.

But can insurer capacity keep up with this demand without causing prices to rise? In the very short term, the answer is yes – we believe attractive pricing will continue, as we explain below. However, looking a year or more ahead, it is much more difficult to be confident that capacity constraints will not have led to upward pressure on prices.

There are currently eight insurers in the UK bulk annuity market. Their capacity to write more business depends on the availability of four things; suitable assets in which to invest, reinsurance of longevity risk, ability to raise new capital and their own operational resources.

Probably the most significant potential constraint on capacity comes from the search for suitable assets. As we mentioned earlier, innovation here is what has made current pricing so attractive. If the pool of suitable assets is drained, and innovation does not lead to fresh sources, then bulk annuity prices will begin to rise.

In the very short term, it is actually operational resources which are already having an effect on the bulk annuity market, as some insurers reach their capacity limits. This is not pushing up prices but, as the quotation process is labour-intensive, it does mean that insurers are being much more ‘picky’ about those opportunities on which they quote. So what should pension schemes do, if they want to ensure good engagement from insurers?

Preparation, preparation, preparation

The key is for the trustees and sponsor of the scheme to be able to demonstrate their commitment to the bulk annuity process. For a start, insurers will expect a feasibility exercise to have been completed, so that both sponsor and trustees understand the likely financial consequences of the transaction (in particular, the need for any additional company contributions) and have agreed to proceed on that basis.

The governance structure is also important. Ideally, there should be a small group of trustees and sponsor representatives who are responsible for running the process, so that insurers feel confident that it will be a smooth process without any delays in the decisionmaking.

In terms of due diligence, preparation is needed in the following areas:

  • a programme of data cleansing
  • a comprehensive benefit specification, which identifies any past problem areas and outlines the solutions that have been agreed by the sponsor and trustees
  • a clear plan with a realistic timeline for the process of securing a bulk annuity.

The final piece of the jigsaw is to ensure you work with an experienced adviser who can act both as your guide for the process and your interface with the insurers.

For more details about how bac can support you in:

  • preparing your scheme so that it is ‘deal ready’
  • helping ensure you approach the insurance market in the most effective way

please contact us at info@bathactuarial.com.

Dashboard

Investment returns by asset class

Investment yields

Annual rate of inflation (%)

31/03/2018 30/06/2018 30/09/2018 31/12/2018 31/03/2019
Expected RPI inflation over 20 years
3.46%
3.42%
3.52%
3.58%
3.59%
Index-linked gilts
-1.66%
-1.59%
-1.50%
-1.59%
-1.86%
Fixed interest gilts
1.74%
1.76%
1.93%
1.81%
1.54%
Corporate bonds
2.58%
2.72%
2.81%
2.76%
2.36%

Investment yields

31/03/2018 30/06/2018 30/09/2018 31/12/2018 31/03/2019
Expected RPI inflation over 20 years
3.46%
3.42%
3.52%
3.58%
3.59%
Index-linked gilts
-1.66%
-1.59%
-1.50%
-1.59%
-1.86%
Fixed interest gilts
1.74%
1.76%
1.93%
1.81%
1.54%
Corporate bonds
2.58%
2.72%
2.81%
2.76%
2.36%
  • 31/03/2018    ~    3.46%
  • 30/06/2018    ~    3.42%
  • 30/09/2018    ~    3.52%
  • 31/12/2018    ~    3.58%
  • 31/03/2019    ~    3.59%
  • 31/03/2018    ~    -1.66%
  • 30/06/2018    ~    -1.59%
  • 30/09/2018    ~    -1.50%
  • 31/12/2018    ~    -1.59%
  • 31/03/2019    ~    -1.86%
  • 31/03/2018    ~    1.74%
  • 30/06/2018    ~    1.76%
  • 30/09/2018    ~    1.93%
  • 31/12/2018    ~    1.81%
  • 31/03/2019    ~    1.54%
  • 31/03/2018    ~    2.58%
  • 30/06/2018    ~    2.72%
  • 30/09/2018    ~    2.81%
  • 31/12/2018    ~    2.76%
  • 31/03/2019    ~    2.36%

Annual rate of inflation (%)

Sources for market indices​

  • UK equities: FTSE Actuaries All-Share Index
  • Global equities: FTSE All-World Index (Large/Mid Cap) – in sterling
  • Index-linked gilts: FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
  • Fixed interest gilts: FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
  • Corporate bonds: iBoxx over 15 years AA corporate bond index
  • Expected RPI inflation over 20 years: Bank of England RPI implied inflation spot curve at 20 years (force of interest)
UK equities
FTSE Actuaries All-Share Index
Global equities
FTSE All-World Index (Large/Mid Cap) - in sterling
Index-linked gilts
FTSE Actuaries Index-linked Index over 5 years, assuming 5% inflation
Fixed interest gilts
FTSE Actuaries Fixed Coupon Index over 15 years (yield is 20 years)
Corporate bonds
iBoxx over 15 year AA corporate bond index
Expected RPI inflation over 20 years
Bank of England RPI implied inflation spot curve at 20 years (force of interest)

Almanac

Governance actions

Governance framework

  •  Is your trustee board equipped to manage a major sponsor event, like a takeover? Does it have the right skill sets and could conflicts of interest emerge? It is far better to put contingency plans in place now.
  • When did you last audit the quality of your scheme’s membership data and the correctness of your administrator’s processes? Would these be adequate if a large-scale transaction, like a buy-in, was to take place in the short term?
  • When did you last review your risk register and business plan. Do they remain fit for purpose and, in particular, are your risk controls up-to-date and tested?

Transfers

  • The volume of transfers out remains high, which helps improve scheme funding but also creates risks for trustees. Are your scheme’s anti-scam procedures up-to-date and working effectively?

GMP equalisation

  • Have you reviewed, with the help of your advisers, the recent helpful guidance from the DWP on the use of GMP conversion to equalise pensions for the effect of unequal GMPs, whilst at the same time removing the complexity which GMPs bring?

Corporate actions

March/April 2019 valuations

  • When finalising your valuation strategy, make sure you consider how the Regulator’s 2019 annual funding statement will affect your trustees’ thinking, for example about your future dividend policy.
  • If not already a feature, you will need to introduce a long-term secondary funding target. You will want to be on the front foot in framing the structure for this and its flexibilities.
  • The slowdown in the pace of mortality improvements should mean a 5% or more reduction in liabilities at this valuation, but the scheme actuary may resist the full extent of this change.
  • Have you reviewed recent transfer experience? Building an allowance for a continuing flow of transfers into the recovery plan could have a significant impact on deficit contributions.
  • Post-valuation experience could be an important consideration, given market conditions at 31 March 2019 and Brexit uncertainty.

Brexit

  • How is your business likely to be affected by the continuing delay and uncertainty over Brexit and have you been managing your trustees’ expectations carefully?
  • Are you aware of the volatility of your scheme’s funding position in the current uncertain market conditions?

Pension developments/news

Pension developments

January

Cold-calling ban

  • The ban on pensions coldcalling came into effect, making it illegal for any member of the public to receive unsolicited calls about their pensions. Anyone disregarding the ban could face enforcement action and fines of up to £500,000.

Fixing RPI

  • The House of Lords Economics Affairs Committee urged the UK Statistics Authority to fix the most well-known error in the RPI, which is its treatment of clothing prices. This would be likely to reduce the long-term rate of RPI by around 0.3%.

February

Wake-up packs

  • The FCA released an update to its Retirement Outcomes Review, including reforms to pension “wake-up” packs. The packs should now be sent when the client reaches age 50 and comprise only a single-page summary and risk warnings.

New powers for TPR

  • The DWP published its response to the consultation on bolstering the Regulator’s powers. Most of what had previously been proposed will go ahead, when Parliamentary time allows. This includes extending the notifiable events regime, a requirement for sponsors to provide a “declaration of intent” for any significant corporate restructuring and strengthened antiavoidance powers. The DWP also plans to introduce new criminal offences, including up to seven years’ imprisonment and/or unlimited fines for the wilful or reckless mismanagement of pensions.

March

Costs and charges disclosure

  • The FCA published a consultation setting out rules that
    would require FCA-regulated DC schemes to disclose costs and charges to members and the compounding effect of those charges on a publicly available, free website.

Money laundering

  • In TPR’s first prosecuion for money laundering, a trustee was accused of defrauding the pension scheme of a charity for the disabled of £250,000, whilst his wife was accused of four charges of money laundering.

2019 funding statement

TPR clarified its expectations for the funding of DB schemes in its annual funding statement, namely that:

  • trustees should set a long-term funding target and how they plan to achieve it
  • maturity issues should assume greater significance in setting funding and investment strategies
  • greater focus should be given to any disparity between the level of a company’s dividends and its deficit contributions
  • recovery plans should be shortened from the current median of seven years.

MAPS for guidance

  • The Government rebranded the Single Financial Guidance Body as the “Money and Pensions Service” from 6 April 2019. MAPS sees the unification of The Pensions Advisory Service, Money Advice Service, and Pension Wise.

CMI 2018

  • The CMI released the latest version of its mortality projections model, which places more weight on the lower improvements in recent years.

First CDC

  • The government announced plans for the first Collective Defined Contribution scheme in the UK, which will be the Royal Mail scheme.

Pension news

Funding

  • Following the sale of Costa to Coca-Cola, Whitbread reportedly reached agreement with the Trustee of the Whitbread Group Pension Fund to make a one-off contribution of up to £380 million. This will significantly de-risk the scheme’s investment strategy and replace the current recovery plan.
  • The Plumbing and Mechanical Services (UK) Industry Pension Scheme began sending out section 75 debt notices to some employers in a bid to cover its liabilities. The move came after an action group for employers within the scheme accused the trustees of “failing in their duties”.
  • TPR decided not to take any further action against Johnston Press in relation to the “pre-pack” administration which saw its pension scheme enter the PPF assessment in 2018.

Pension design

  • In a surprise turn of events, the High Court overturned a ruling made by the Pensions Ombudsman about pension increases in the Coats Pension Scheme. The Ombudsman had previously decided that a rule amendment to restrict pension increases for a particular section of members was invalid. Whilst the High Court agreed about the rule
    amendment, it decided that the trustees’ intention to make the change (as evidenced by a trustee resolution) was enough to make it valid.

De-risking

  • The Pearson Pension Plan completed a further buy-in with Legal & General for £500 million. This covered the benefits of around 2,200 pensioners, with 95% of the Plan’s pensioner liabilities now having been insured. Legal & General also transacted a buy-in for £230 million with the Howden Group Pension Plan, covering all 2,000 current and deferred pensioner members.
  • Pension Insurance Corporation transacted a buy-in with the Co-operative Group’s Somerfield Pension Scheme, insuring around £425 million of its pensioner liabilities.
  • Just Group confirmed a £158 million buy-in with the Wyeth Group Pension and Life Assurance Scheme. The buy-in required the support of the sponsor, Pfizer, and covered 1,200 pensioners.
  • It was announced that the Lafarge UK Pension Plan had entered into a longevity swap of an undisclosed amount with Munich Re, after identifying longevity as the largest individual risk to the Plan’s funding.