U.K. expects a strong year for offloading of liabilities

The risk transfer market in the U.K. will continue to flourish in 2021 as an increase in U.K. long-term interest rates in the first quarter resulted in improved funding levels for many defined benefit funds, consultants said.

Over the course of 2021, consultants expect that at least £30 billion ($41.6 billion) in risk transfer deals will materialize across the U.K. The ultimate opportunity set could be closer to the £60 billion mark, conditional upon some plan sponsors moving ahead with exceptionally large longevity swaps and buy-in transactions or alternative strategies such as capital-backed journey plans, consultants said.

But the year will belong to buyouts, consultants believe, as insurance companies have been improving their capabilities and capacity to insure the liabilities linked to plan participants that are yet to retire, known as deferred participants.

"My expectation is that 2021 will be another busy year … It is hard to predict (exact) volumes, (which) can be swayed one way or the other. My best guess today is that we will see similar volumes to last year … in excess of £30 billion," said James Mullins, partner and head of risk transfer at U.K. consultant Hymans Robertson LLP in Birmingham, England, referring to the buy-in/buyout opportunity set.

The value of buy-ins and buyouts in 2020 was £31.8 billion, while a record £24.2 billion in longevity swaps drove the total deal value to £56 billion.

Some of the largest 2020 deals were:

• A £5 billion longevity swap conducted by Barclays Bank U.K. Retirement Fund, Redhill, England, with Reinsurance Group of America Inc. in December.
• A £3 billion longevity swap conducted by BBC Pension Scheme, London, with Zurich and Canada Life Reinsurance in December.
• A £2 billion buy-in agreed by Old British Steel Pension Scheme, Glasgow, Scotland, with Pension Insurance Corp. in October.
• A £1.1 billion buy-in conducted by Maersk Retirement Benefit Scheme, Ware, England, with Legal & General Assurance Society Ltd. in December.

Hymans Robertson's Mr. Mullins, who noted that an increase in the number of plans moving to a buyout could be in the cards this year, said the last few months have been very positive for pension funds due to improving funding levels combined with an improved ability to afford risk transfer.

"We will see more and more schemes being able to afford insuring all of their liabilities," he said, adding that plans could move with buyouts outright or could continue their derisking journey to a full buyout under existing buy-in contracts. Under these so-called umbrella contracts in the U.K., plan sponsors pre-agree terms with insurers for future risk transfer deals, allowing them to move quickly when market conditions are advantageous for such transactions.

"Schemes that have already done buy-ins are ahead of the game on risk management and they on average tend to have better funding levels," Mr. Mullins said.

Gavin Markham, partner and head of bulk annuities at U.K. consultant Barnett Waddingham LLP in London, agreed with Mr. Mullins that 2021 volumes could reach between £30 billion and £35 billion as the financial positions of U.K. plans have improved in the first quarter of the year. "Schemes may not have been as well-hedged against the movement of interest rates. That position would have moved favorably for them," he said.

Over the first quarter of the year, long-term interest rates have risen significantly with gilt/swap yields increasing by around 60 or 70 basis points and were back toward the levels at the start of 2020, Mr. Markham noted.

Fifteen-year gilt spot rates were 0.5% as of Dec. 31, and have since more than doubled to 1.2%.

In addition to improving funding levels, deal pricing continues to be favorable for U.K. plan sponsors, consultants agreed, even if discounts found in the second quarter of last year are no longer available.

Charlie Finch, partner at U.K. consultant Lane Clark & Peacock LLP in London, said that in 2020 deal pricing was exceptionally attractive for pension funds, with sponsors securing transactions at a 10% discount.

The reduction in price occurred due to the widening of credit spreads at the height of the coronavirus pandemic.

However, despite the fall in credit spreads, Mr. Finch said: "Pricing is still favorable by historic levels," adding that the firm is working on a number of £500 million to £1 billion transactions.

Mr. Finch added that while last year's pricing provided good value for money, some pension funds — due to lower funding levels — could not take advantage of favorable market conditions at that time. Fast forward 12 months and DB plans are better funded and have more capacity to derisk even if pricing is not as exceptional, he said.

Mr. Finch also thinks buyout opportunities have improved steadily over the last few years despite the economic backdrop of the U.K.'s withdrawal from the European Union and the coronavirus pandemic, as the pace of increases in longevity has slowed down.

Other sources added that insurers' willingness to cover the liabilities of deferred participants is an important factor that will further support the U.K. risk transfer market in 2021.

Mike Edwards, partner at Aon PLC in London, said the U.K. insurance market has matured enough in recent years to support a greater number full buyouts. Mr. Edwards noted that more recent entrants to the providers market, such as Phoenix Group Holdings PLC, have been building their capabilities over the last few years to offer insurance contracts that cover the liabilities of deferred participants as well as retirees.

Similarly, he added, more reinsurance companies are now also developing capabilities to take on risks relating to the liabilities of deferred participants. "This partly reflects an acknowledgement that the market for full scheme transactions, including deferreds, is expected to grow as more pension schemes reach their objectives," he said.

Some consultants expect that 2021's total deal value could end up higher than in 2020, reaching up to £60 billion, driven by pension funds entering the market for the first time, selecting capital-backed journey plans, or those conducting longevity swaps that cover deferred participants.

For example, on March 18, AXA Pension Scheme, London, conducted a £3 billion longevity swap with Hannover Re Holdings (U.K.) Ltd., which covers plan participants that have not yet retired.

Though longevity swaps are more likely to be secured by financial services firms for their own plans, any arrival of new solutions such as capital-backed journey plans or DB consolidators in the U.K. market in 2021 could unlock a whole new pipeline of companies looking to offload pension risk.

Plan sponsors can choose capital-backed journey plans to help provide additional support to DB funds to keep assets invested for longer rather than plugging the funding gap with cash. Investment returns over a longer period of time are expected to enable the plan to move to a buyout. Another alternative is to part with the plan and move it to a consolidator.

Ruth Ward, principal at Mercer Ltd. in Bristol, England, said that her firm is working with a number of plans that could move closer to risk transfer this year through outsourcing.

"The front-runners (in terms of plans) are already in conversations with the regulator ... That should speed up the process," she said.

Ms. Ward added that plans that are already being assessed by the £36 billion Pension Protection Fund, London, the lifeboat fund for the DB plans of insolvent companies, could be strong candidates to enter consolidators, which can enable them to secure the benefits of employees when the sponsoring employer has failed.

Consolidators could offer higher benefits to the employees of struggling employers compared to the benefits the PPF would offer.