The result is a significant increase in latent demand for buyout solutions, which will only increase as yields rise further. Many schemes are believed to be tracking similar de-risking trigger points, such as 4% on 30-year gilts. If that proves to be the case, the likelihood of a flood of schemes wanting to de-risk over a short space of time could lead to significant problems.
Mercer’s UK bulk pensions insurance leader, David Ellis says: “Companies are putting tens of millions in to get deals done so they can put the risk to bed. It is not all about attractive pricing economics on buyouts.
“The technical measures all converge as everybody gets older,” he continues, “which is a powerful force towards buyout. There must be several hundred billion pounds of pension assets that would transact if they could, which potentially presents a massive capacity problem.”
Indigestion and heartburn
Capacity in the buyout market is determined by the free capital among buyout providers. Depending on the profile of the scheme members, a £100m buyout may require an insurer to commit £5m in capital. Scaling that up across the market, experts generally believe current total market capacity is around £15bn to £20bn each year.
“It is not that straight forward,” Ellis points out, “but this is about the extent of business the insurers would want to write based on profitability. The monolines are of the same view.”
If, as Mattingly expects, the volume of buyout and buy-ins rises to £15bn the industry will be running at or very close to its capital capacity.
The ability of the few buyout providers to commit this capital will be largely dependent on the nature of the flow. A gradual increase would be more easily managed, but if a sudden flood of interest does occur, or a number of bigger schemes transact simultaneously, there may not be enough capital capacity to cope.
“From an insurers’ perspective, buyout and buy-ins are capital intensive,” PIC’s Collinson says. PIC transacted £3.7bn in buyouts and buy-ins in 2013. “If we see several large deals going through at the same time that could create a crunch in their ability to absorb the flow.”
Capacity is also affected by resourcing at insurers and whether they are staffed to respond to all the requests for quotes they receive. Post-Lehman buyout pricing looked very attractive due to widening bond spreads for a short period.
“Around one-in-six schemes suddenly requested quotes for buyout totalling around 1000 requests across only seven insurers,” JLT’s Phillips recalls.
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