While executives working in the risk transfer market argue over whether a capacity crunch is approaching, they agree on one thing: Recent changes to the U.K. pensions market could encourage new players to the bulk annuity market.
In March, George Osborne, the U.K.'s chancellor of the exchequer, announced changes to the way retirees can access their pension savings starting in April 2015. Gone will be the days when defined contribution plan participants could take only a 25% tax-free lump sum and then effectively had to purchase an annuity with the remainder of their assets, because of high taxes and hurdles.
“The primary insurers have been very full up on annuity risk up to this time because of what felt like pretty close to compulsory annuitization of 75% of each retiree's DC savings,” said Amy Kessler, Woodbridge, N.J.-based senior vice president and head of longevity reinsurance in Prudential Financial Inc.'s retirement business.
Those personal pension savings being annuitized “took up a lot of the capacity that the U.K. primary insurers had for buyout, buy-in and longevity swaps from the U.K. pension plans,” she said. Now, with the rule change, there is an expectation that capacity — potentially representing up to half of the £12 billion ($20.2 billion) individual annuity market — will be freed up.
On the flip side, that is a drag on individual annuity providers' business. But it is also an opportunity.
“Those providers could come into the bulk annuity market,” said Jay Shah, co-head of business origination at Pension Insurance Corp. Ltd. in London. “We have not seen that yet — it may become a factor for smaller transactions.”
However, risk-transfer executives warn that it is a big change. “(It) requires different infrastructure and marketing abilities. Individual annuities are very standardized products, which are distributed through independent financial advisers. Bulk annuities by contrast are not standardized, and need to reflect individual schemes' requirements. And the buyers are the company sponsors or pension scheme trustees direct,” said Mr. Shah.
Insurers should also not underestimate the time it takes to become approved by the Prudential Regulatory Authority in the U.K., which oversees insurers, said Emma Watkins, partner at Lane Clark & Peacock LLP in London.
But this extra capacity might be set to come in at the right time, she said, given other potential changes to U.K. pension rules.
The government is currently seeking comment on whether to ban the transfer of defined benefit participants to defined contribution plans to take advantage of the new access to retirement funds. “If it is not limited and DB members do transfer out, the amount paid out through (that) enhanced transfer value exercise (which is also a way for sponsors to derisk without going to buyout) will likely be less (cost) than the buyout cost of securing that individual. That would reduce liabilities for DB schemes, and potentially improve funding positions and therefore the distance between scheme assets and buyout costs,” said Ms. Watkins.
In a bid to bring in longevity-only insurance business from smaller pension funds, some firms are launching so-called “simplified” longevity swaps. “(They) are being brought to market very soon — there may be two or three providers,” said Suthan Rajagopalan, London-based principal, financial strategy group at Mercer Ltd.
These contracts likely will not involve collateral, similar to most bulk annuity transactions, which are also uncollateralized. “Insurance regulatory protections (such as solvency requirements, supervision and compensation schemes) have made most trustees comfortable with non-collateralized arrangements for bulk annuities, which present trustees with a much greater risk than an uncollateralized longevity insurance contract.” Mr. Rajagopalan said. That, he said, is because bulk annuities require the full premium to be paid upfront rather than being paid across the term of a longevity-only deal. “Medium and smaller schemes don't want collateral if the operational costs and complexity outweighs the benefit,” he said.
In fact, Legal & General PLC has launched such a product. Tom Ground, London-based head of bulk annuities and longevity insurance for L&G's retirement business, confirmed the company has launched a longevity insurance proposition that is targeted at pension funds with liabilities as low as £50 million. “The contract will be much more standardized to avoid heavy legal and consulting bills, and have no collateral which makes it a much simpler structure that is more attractive to smaller schemes,” he said.