Bulk Annuities - 2017 NOT the year of the buy-out?
A couple of articles on the bulk annuity market caught my eye this week and reminded me of a great blog post authored by my Seattle based colleague, Bob Collie back in October, “What about the 98% of plans NOT doing annuity buyouts?”.
Wednesday’s Financial Times contained an article* predicting a big recovery in the bulk annuity market in 2017. After a relatively quiet 2016, “Willis Towers Watson are forecasting a jump to more than £30bn this year”. Willis Towers Watson’s own estimate of the total UK DB pension liability is between £2tn and £3tn. So by their estimates and forecasts, between 1 and 1.5% of the total pension liability might get transferred to insurance companies during 2017. So to echo my US colleagues, “what about the other 98%?”
It shouldn’t come as a surprise that actuaries, insurance brokers and insurance companies are banging the drum of the bulk annuity market. There’s lots of professional advice required to get a pension scheme to an insurance solution. Lines like, “pension schemes were able to get better prices than they had over the preceding 18 months” are far from the whole picture. Sure relative to a fully funded portfolio of matched gilts, prices are relatively cheaper today. However, most pension funds aren’t invested in a portfolio of matched gilts and have a significant deficit to recover before an insurance solution is remotely viable. With the sharp falls in interest rates and increases in inflation expectations since June 2015, the absolute price of a bulk annuity is much higher.
Insurance solutions are, with very good reason, the aspiration for many corporate DB pension schemes. For most schemes, irrespective of whether they’ll be in the 2% or the 98%, the current focus still needs to be on managing investments to generate the required returns, identifying the key risks and managing them appropriately.
Where partial buy-ins become a viable part of the strategy, there can be huge implications on the remaining investments, which must not be underestimated. A buy-in can help reduce risk, particularly longevity, but can result in a need to increase investment risk across the remaining assets to recover any deficit. The full balance sheet effect needs to be considered, even if the buy-in pricing is described as attractive.
A buy-in is the ultimate illiquid investment for a pension fund and highly capital intensive. In an environment where liquidity requirements, particularly for derivative strategies, are increasing, the reduction in eligible collateral needs to be well understood.
I won’t try to argue with the view that 2017 will see an uptick in pension insurance activity relative to 2016. However, despite the headlines, the conferences, and some vested interests, it will continue to be a minority activity.
*UK companies look to sell of pension liabilities, Financial Times, 4 January 2017.