U.K. pension buyout market slowly returning

The U.K. pension fund buyout market, after being clobbered in the past year by the financial crisis, might be on the mend.

After an exceptionally slow start to 2009, interest in buyouts has returned in the past two months, providers say.

Executives at Pension Corporation LLP, a pension insurer, whose 2009 business through Sept. 30 was just £500 million ($817 million), expect to make final deals worth at least £1 billion by the end of the year.

“The downturn in demand was only temporary,” said David Collinson, partner and head of liability acquisitions at Pension Corporation in London. In the past two months, the insurer added £6 billion to its pipeline. “That tells us (the buyout boom in 2008) definitely was not a fad.”

In the U.K., buyouts are part of the bulk annuity market. In a buyout, a pension fund offloads all liabilities to an insurer in exchange for its assets plus a premium. In a buy-in, dominant over buyouts in recent years, a pension fund usually buys an annuity for only a portion of participants — typically the retirees. Broadly speaking, both buyouts and buy-ins are often referred to as “buyouts,” as both involve transferring liabilities to insurers via annuities.

More recently, longevity hedging, often using swaps, has been gaining popularity.

Hugo James, sales development director for bulk-purchase annuities at Legal & General Group PLC, London, the largest U.K. buyout firm, said interest in buyouts has returned, among both pension funds and insurance companies, some of which are pricing “quite aggressively.”

“We are seeing a number of schemes that missed opportunities in 2008 (to use bulk annuities) that are looking to take advantage of this cycle,” Mr. James said.

Not everyone's outlook so rosy. In a recent report, Mercer LLC estimated that buyout and buy-in deals industrywide would total £3 billion in 2009, down considerably from £8 billion in 2008. Total business through Sept. 30 was £2.4 billion.

In a separate report titled, “The False Dawn,” Punter Southall Transaction Services officials said that lower activity in 2009 proved their prediction in 2008 that “despite the hype ... the (bulk annuity) market would not take off to the extent that some of the new entrants ... were optimistically envisaging.”

The report added: “We do not expect activity to pick up to any great extent in the foreseeable future.”

“Demand has fallen off a cliff,” said Richard Jones, London-based principal at Punter Southall and co-author of the report. He acknowledges that “everybody wants to get to” the point where they can offload liabilities, but argues that the gap between pension assets and annuity pricing is wider than insurers want to admit.

“That's going to take five years to fix,” Mr. Jones said.

Consultants agree that long-term trends are in annuity providers' favor.

“All roads lead to the insurance companies,” said Anthony Hayes, head of U.K. risk transfer at Hewitt Associates Ltd., London.

Consultants say that while costs and decimated pension assets caused demand for annuities to evaporate in the past year, the urge to take risk off the table pervades the defined benefit plan industry as most employers look to close — and then freeze — their defined benefit plans.

“At that point it becomes a financial management exercise around when you have enough assets to match your liabilities,” said Kevin McLaughlin, London-based principal in Mercer's financial strategy group. In other words, it's not a question of if, but when.

“The key issue today is affordability. Once that changes, we'll definitely see more buy-ins,” Mr. McLaughlin said, adding that buyouts rely more heavily on improvements in plan funding levels.

Ian Maybury, senior actuary at consultant Redington Ltd., London, said: “There is still a strong desire for pension funds and their corporate sponsors to reduce or eliminate risk, and a buyout is a very good route to eliminate that risk. The question is (whether it is) a good value for money.”

The crisis has left a mark on buyout firms.

Paternoster UK Ltd., also of London, grabbed the largest chunk of market share in 2007 with about £1.4 billion in deals and added roughly another £1 billion in 2008. However, the firm has not added new business since September 2008, and last month announced it would raise £500 million from existing shareholders. As part of that reorganization, Paternoster cut staff, and Ed Jervis took over for founder Mark Wood as CEO. Mr. Wood became deputy chairman, a new position.

Pension Corporation is looking to raise £400 million to enable it to write new business.

In the U.S., meanwhile, bulk-annuity options are still nearly nonexistent, said Ari Jacobs, principal and North American retirement solutions leader for Hewitt. Regulations and the economic environment have cut off most efforts to build businesses that take over pension liabilities, he said.

It's not for lack of interest or capital, experts say.

Richard MacMinn, professor and holder of the Edmondson-Miller chair in insurance and financial services at Illinois State University, Normal, said investment banks are promoting longevity hedging in the U.S. as a way to unburden companies of some pension liabilities to grease the gears of M&A activity.

“There's enough capital out there for a fair amount of (pension risk reduction), but there isn't a strong push (from pension funds) for these things right now,” Mr. Jacobs said.

In the U.K., while interest waned in the past year for buyouts, pension funds have moved into more affordable ways of reducing risk, including longevity hedging, liability-driven investing and some types of fiduciary management in which providers guide funds' solvency levels by applying synthetic risk management tools to assets and liabilities.

There's been a “step change” in thinking among trustees, Mercer's Mr. McLaughlin said. “They're looking at all the derisking angles now.”

The Hewitt Global Pension Risk Survey 2009, due for release in late November, will show that increasing numbers of pension funds are putting trigger points into place that take out risk as funding returns and prices are right, according to Kevin Wesbroom, principal and U.K. lead of global risk services at Hewitt.

Consultants and insurers say longevity swaps are poised to take off as a way pension funds can shed some risk while preparing for a buyout or buy-in. A longevity swap allows a fund to invest in higher risk-return assets in the hope that returns will boost its funding level. Plus, providers are priming the market with attractive pricing, and two major deals — involving Babcock International Group PLC's £1.7 billion Devonport Royal Dockyard Ltd. fund and RSA Insurance Group PLC's two U.K. pension funds with combined assets of £4.4 billion — inked earlier this year have let trustees know the market is for real, experts say.

While the crisis has left some trustees unwilling to make any major changes, it has raised most trustees' awareness of risk.

“(Trustees) realize there were questions that needed to be asked that they didn't know were questions in the past,” said Kerrin Rosenberg, London-based U.K. CEO of consultant and “solvency management” provider Cardano Risk Management BV. “That's definitely benefited us.”

Cardano has raised £2 billion in two years in solvency management, including about £200 million for the £1 billion ASDA Stores Ltd. Group Pension Scheme, Leeds, England, in January.