The rush to de-risk is gathering pace. The first three months of 2014 saw bulk annuities deals equal to half the total liabilities for 2013. As funding levels improve, bulk annuities are becoming affordable for more schemes keen to lock in gains. However, the ground is shifting under the feet of the insurance providers, which could fundamentally change the market dynamics.
In 2013 the total value of pension de-risking, according to figures from JLT Employee Benefits, was £16.35bn, including £7.45bn in bulk annuities and £8.9bn in longevity swaps. The year saw then record-breaking trades including EMI’s £1.4bn buyout, which was underwritten by Pension Insurance Corporation (PIC). The record has already been smashed in 2014 by the £3.6bn ICI Pension Fund buy-in and the £1.6bn deal by the Total Pension Plan.
Bulk annuity deals in Q1 2014 totalled £3.9bn in liabilities, over 50% of the total seen during the whole previous year and more than 75% of the annual volumes seen in each of the preceding three years. “2014 is going to be a bumper year for de- risking,” says JLT’s head of buyouts, Martyn Phillips.
Yet, in their rush to de-risk, schemes could be opening themselves up to other risks, especially where they are considering buy-ins and residual liabilities remain. This is particularly acute given George Osborne’s statement that “nobody will have to buy an annuity” in his March Budget speech. Although the Budget has more profound implications for the retail annuities market, the knock-on effect for bulk annuities could be significant.
The Budget effect
Since the Budget, individual annuities providers are having to face a harsh new reality. During the first quarter this year, Legal & General (L&G) saw a 40% decline in sales of individual annuities from £406m in Q1 2013 to £244m. L&G expects the market to decrease to a quarter of its pre-Budget size. The result could be positive for the bulk annuities market as insurance companies offering individual annuities look to reallocate the capital as demand slumps.
“Individuals are less likely to annuitise, which is positive for the outlook of the bulk annuities market,” says independent pensions expert, Ros Altmann. “There have been fears about capacity constraints in the bulk annuities market for a long time.”
The total capacity of the bulk annuities market for underwriting longevity and pensions risk is determined by the free capital among buyout providers and has been estimated at between £15bn and £20bn annually. As less and less capital becomes required in the individual annuities businesses of insurance companies, those firms are expected to reallocate to the bulk annuities market as that becomes an increasingly important revenue stream.
According to JLT’s Phillips: “Annuities, whether individual or bulk, all tend to end up on the same annuity book for the insurers so they tend to view the market as a whole. As the flow of new business decreases on the retail side, they will want to increase the flows in the bulk annuities market and will reallocate capital accordingly.”
In its 15 May interim management report for the first quarter 2014, Aviva revealed the value of new business in the UK declined 22% with annuity new business 43% down at £40m, compared to £70m in Q1 2013. In its statement Aviva said it expected its “increased focus on mid-size bulk purchase annuity transactions to partially mitigate the impact of the Budget proposals”.
In 2013, the individual annuities sold by members of the Association of British Insurers (ABI) totalled £11.9bn. If, as L&G expects, the market shrinks to 25% its pre- Budget size and capital is reallocated, the implications for bulk annuity capacity could be significant, adding up to as much as £9bn to total capacity.
Greater capacity and competition
With de-risking expected to accelerate as yields edge upwards and gains in risk assets plug funding gaps, extra capacity will be very beneficial to schemes, especially those at the smaller end who have found it harder to attract the attention of the big providers.
“It won’t take a big uptick in yields for buyouts to appear attractive to more schemes,” says Paul Sweeting, European head of strategy at JP Morgan Asset Management. “That will put a lot of pressure on capacity. If capacity becomes constrained, that could push up prices.”
The move by insurers from the retail to bulk annuities markets is also likely to involve some new entrants to the bulk market, which has seen contraction in recent years with L&G buying Lucida, and Rothesay Life buying Paternoster and MetLife’s UK bulk annuities business.
“Insurers who currently only play in the retail annuities market will have to completely change their view,” Phillips says. “We expect to see at least one or two new entrants to the bulk annuities market this year, which would be a good thing.”
The impact of greater capacity and competition is positive for pension schemes because it would likely lead to a reduction in the price of buyouts and buy-ins. New entrants will have to compete on price, at least initially, as it is the first measure of value for many trustees.
“There is mileage in a strong brand,” Phillips says, “but it is worth only a small margin.” The impact of new entrants in reducing pricing has precedence. When Paternoster entered the UK market in 2006, it quickly increased assets under management, jumping from around £121m at the end of 2006 to around £3bn in 2009 before its fortunes turned.
According to Altmann: “When Paternoster was trying to establish a foothold in the bulk annuities market, it drove down prices for a period. In any market where there has been an oligopoly, such as the bulk annuities market, the impact of new entrants should be positive by creating extra competition,” Altmann continues. “The need to compete properly should help pricing.”
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