Pension risk transfer (PRT) – the process whereby a defined benefit pension fund transfers its longevity risk to an insurance company – has been around for more than a decade and the United Kingdom is the most active market. But despite its longevity – pun intended – growth has been anaemic, at least until recently.
According to consulting firm Hymans Robertson, the value of deals in the U.K. across the three variants of LRT – buy-ins, buy-outs and longevity swaps – only exceeded £20bn once, in 2014, when £26bn of longevity swaps pushed the overall total value to almost £40bn. In 2018, the market value jumped to almost £30bn, and then it jumped again in 2019 to around £55bn. A drop-off in 2021 – 156 deals worth less than £28bn were completed last year – is an aberration of an upward trend that’s set to continue, says James Mullins, Partner and Head of Risk Transfer Solutions at Hymans Robertson in Birmingham, U.K.
“The first six months of 2021 were quiet, but a lot of pension funds had other things to worry about due to the uncertainty around Covid-19, so they weren’t starting a new process. There is a lead time to these deals, and they came back strongly in the second half of last year and the market was incredibly busy. The switch to work from home didn’t really stem the deal flow.”
Defined benefit pension funds’ exposure to longevity risk is growing as humans live longer. But the increase in activity in the LRT market isn’t necessarily being fuelled by this trend.
“I’d say that it’s more just being prudent and taking advantage of the ability to insure longevity risk,” said Mullins. “Pensions in the U.K. have done a lot of hard work to tackle other risks, such as investment risk. If you tackle investment risk, longevity risk is the key remaining risk which is why buy-ins and swaps are seeing interest.”
The LRT market sees less activity in longevity swaps than in buy-ins or buy-outs; longevity swaps are much more complicated to execute, which is why, according to Hymans Robertson’s report, only 53 deals have been completed since 2009. Buy-ins are more common, with around 150 deals done in 2021 with plenty of capacity for more. But, going forward, buy-outs are likely to be where the fastest growth is.
“We’ll see more, full buy-outs going forward. Funding levels at pension funds have improved, managing investment risk has improved, and pricing from insurers to take on liabilities from pension funds has become more competitive. Many pension funds can now afford to insure the whole scheme,” said Mullins.
Some pension funds have a well-funded scheme but a financially weak sponsor; some schemes are insolvent and have to enter the U.K.’s Pension Protection Fund; sometimes the sponsor wants to undertake corporate M&A activity but can’t because that acquisition or divestment is contingent on not having pension assets and liabilities on its balance sheet. Trustees and sponsors in these situations, and those where buyout is not affordable, didn’t have access to the PRT market until very recently.
The U.K.’s appropriately named The Pensions Regulator approved its first ever consolidator, Clara, in November 2021. Ashu Bhargava, Senior Actuary and Head of Clients at Clara, says that the approval, which came after a lengthy review process, means that the market for pension risk transfer in the country is now bigger.
“There are over 5,000 pension schemes in the U.K., and the top five to ten per cent are candidates for the insurance market [from a PRT perspective] because the gold standard is insurance. Schemes which can afford the insurance-based buyout get the greatest level of security” he said. “But the next ten per cent is where consolidators like Clara come in. Until now, these schemes didn’t have an option for risk transfer.”
Clara expects to close its first deal towards the end of this year and expects to have closed £5bn worth of deals by the end of 2025. Part of the reason that this level of dealmaking can happen so quickly is that Clara, and any other ‘superfunds’ that get approved in future, can hold a lower level of capital than an insurance company has to (at a 1 in 100 level rather than a 1 in 200 level), meaning that schemes that cannot afford buyout are now able to improve security for members. But, Clara’s model also acts as a bridge to the insurance model, because it doesn’t hold pension scheme assets and liabilities ad infinitum. This will create a kind of secondary market in years to come, fuelling even greater activity in this corner of the pensions world, and an age-old problem is what Clara is solving for.
“We can be a good pipeline for the insurers, partly because we can remove the capacity constraints in the market from a people perspective, by making the transfer process more efficient – there are a limited number of people who have PRT experience, which acts as a constraint to growth in this market,” said Bhargava.
The U.K. is expected to approve other superfunds in the coming years, and some will have different models to the one adopted by Clara. Whilst each transfer into a superfund has to be reviewed and approved by The Pensions Regulator, Bhargava sees yet another possibility to broaden the pool of defined benefit pensions that could make use of a consolidator and, over time, become the largest sub-sector in the country’s PRT market.
“When the pensions industry gets comfortable with the consolidator model, it wouldn’t surprise me if we see some kind of ‘superfund lite’, which could first transfer to Clara and ultimately to an insurer. There’s absolutely scope for the consolidator version of pension risk transfer to become bigger than the insurance-based market in years to come,” he said.
Other developments in the PRT market should provide for increased deal flow in the coming years. The private equity industry is increasingly getting in on the insurance game by acquiring insurance companies or setting up reinsurers in Bermuda. Insurance companies have natural capacity constraints because of regulatory capital requirements, and private equity sees funded reinsurance as a way to access consistent cashflows and investable assets.
Regardless of the counterparty, at the deal level, Mullins says that the relative health of the defined benefit pension sector in the United Kingdom should naturally translate to an increase in a specific type of LRT deal in the coming years.
“Up until now there have been a lot of buy-ins – pension schemes insuring only part of the scheme,” he said. “Many can now afford to insure the whole pension scheme which means we’ll see more and more full buy-outs as opposed to buy-ins. Additionally, pricing from insurers to take on liabilities for whole schemes has become more competitive in recent years. I’d expect more and more full schemes insuring in the coming years than we’ve seen so far.”