Current market enticing more U.K. plans to let liabilities go

More U.K. trustees are finding they can afford to insure their defined benefit plan liabilities as funding levels remain high, longevity expectations have declined and insurers' fees have come down.

Consultants advising on buy-in and buyout deals said insurers' growing capacity to take on larger transactions compared with a few years ago has lured more trustees to the market with hopes of securing a buy-in while pricing remains attractive.

According to Aon PLC, the U.K. pension risk transfer market is set to break a record in 2019, reaching more than £30 billion ($38 billion). Data from consultant Hymans Robertson LLP show that deals completed in 2018 equaled £24 billion, doubling from £12.2 billion in 2017 and increasing 137% since 2016.

In the past few months, there have been several £1 billion-plus transactions:

• Rolls-Royce, Goodwood, England, insured £4.1 billion in liabilities of its £13 billion Rolls-Royce U.K. Pension Fund through a buyout with Legal & General Assurance Society in June.
• Marks and Spencer PLC, London, completed £1.4 billion of buy-ins with Pension Insurance Corp. and Phoenix Life for its £10.5 billion Marks and Spencer Pension Scheme in May.
• Commerzbank, London, insured £1.2 billion in liabilities for its Dresdner Kleinwort Pension Plan through a buy-in with PIC in April.

A combination of factors has improved insurers' position, allowing them to adjust fees. In the past, insurers shunned taking on the liabilities of deferred participants — those who stopped accruing benefits but are yet to start receiving their pension — due to higher capital requirements they faced under Solvency II regulation. Instead they focused on buy-in deals.

Through a buy-in, plan sponsors can insure a proportion of their plan's liabilities that corresponds with a set of benefits that are due to be received by retired participants. Conversely, a buyout deal includes securing the benefits of deferred as well as retired participants.

However, recent revisions of mortality figures and a growing number of participants choosing to transfer out of defined benefit into defined contribution plans boosted the certainty of outcomes for insurers. Life expectancy in the U.K. has been declining since 2014, according to World Bank data.

Richard Wellard, partner and risk transfer specialist at Hymans Roberston in London, pointed out that since 2015 when the U.K. introduced the pension freedoms regulation, there have been more than £70 billion of benefits transferred by participants out of DB funds and into DC plans.

Mr. Wellard said the volume of transfers out of defined benefit funds has increased the affordability of insuring the benefits that are left in the plans for trustees. "It generally costs trustees less to pay a transfer value (of benefits) if a member chooses to transfer their benefits than it does to insure those benefits if the member remains in the pension scheme," he said.

In turn, sources said plan sponsors in 2019 spent about 5% less on a full buyout and around 20% less on a buy-in than in previous years.

"Pricing is as good as it has ever been," said David Ellis, U.K. leader, bulk pensions insurance advisory at Mercer in London, which advised on the Rolls-Royce deal.

"Many companies don't want to hold off (insuring liabilities) if they can afford it," he added.

John Baines, partner in Aon's risk settlement group in London, said a "few years ago it was quite risky for insurers to write large transactions because if they had failed they couldn't readily use the assets elsewhere, because there weren't many other large deals in the market."

Mr. Baines expects more megadeals sized at between £3 billion and £4 billion to emerge as a result of insurers' eagerness to take on the liabilities and improved financial positions.

Insurers are expected to secure £14 billion worth of deals in the first half of 2019, Mr. Ellis noted. "(And) first half of the year is usually more quiet," he added. Building on the £14 billion, Mercer expects £30 billion or more for the full year, he said.

Mr. Baines noted that for plan sponsors it can be more affordable to do a buyout than to stay invested in low-yielding assets such as government bonds, as it removes the risk of having to make uncertain levels of pension contributions in the future.

Still, sources are questioning if buy-ins or buyouts will remain cheaper for trustees as insurers begin to struggle to source relevant assets such as long-dated credit, for example, 15-year corporate bonds.

"There is a global competition for assets to back liabilities," Mr. Ellis said.

The U.S. buyout market is simultaneously booming. Corporate pension plan buyout sales for the first quarter totaled about $4.7 billion, the highest first quarter in 30 years, according to LIMRA Secure Retirement Institute's quarterly survey. Buyout sales were $10.5 billion in the fourth quarter of 2018, according to LIMRA.

Russell Lee, head of client solutions, pension risk transfer at Legal & General Group PLC, said in the last 12 months credit spreads have compressed. "We have a pipeline of bulk annuity transactions for the next two to three years, but some schemes may have unrealistic views about the pricing that is achievable," he said.

Aon's Mr. Baines said: "I don't see it in 2019 but beyond 2020 we could start to see a capacity constraint."

David Salter, partner at Lane Clark & Peacock LLP in London, who advised on the Commerzbank deal, said "we are seeing a place where supply and demand start to balance each other out."

"Insurers are starting to choose which transactions they want to quote on. They can afford to be picky," he said.

To deal with the constraint, insurers have been expanding their investible universe and getting creative with the types of assets that could be used to match pension liabilities they take on, including infrastructure debt. "(Illiquid) assets are attractive only if the price is right," Mr. Lee said.

However, larger deals for sponsors with more complex defined benefit arrangements could take longer to complete.

"The decision on the Commerzbank deal was taken in the middle of last year. A buy-in was a targeted focus over a number of years as the plan became fully funded," Mr. Salter said.

But, "more generally, plans have just realized that buyout is affordable as pricing has improved," he said, adding that trustees could wait between three to four months to get a deal.