buyout market is enjoying unprecedented activity, spurred on by the
increasing entry of major corporate customers. However, concerns
that the insurance industry’s capacity to meet increasing demand
will not be adequate are growing daily.
The UK’s defined benefit (DB) pension scheme buyout market is
booming with the value of transactions in the second quarter of
2008 reaching £2.7 billion ($4.8 billion), £1.2 billion more than
the first quarter of the year and £847 million more than in the
then record-breaking fourth quarter of 2007. But it may just be a
case of too much of a good thing, says consultancy Aon Consulting
which cautions that a number of insurers are “under considerable
stress” to cope with demand.
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“The [DB] pensions buyout market has continued to be a beneficiary
of the worsening economic conditions, picking up record levels of
business during the second quarter of this year,” commented Aon
Consulting’s principal and actuary Paul Belok. “The amount of
activity in the market raises serious questions over capacity of
providers.”
He explained that high activity has had an impact on the speed at
which quotations can be turned around. Insurers are also becoming
more selective in what schemes to work with, and for cases below
£20 million this means there is now less competition.
Based on information provided by leading market players, Aon noted
that 84 cases were placed in the second quarter of 2008 compared
with 86 in the first quarter. The average value per scheme in the
second quarter thus increased to about £32 million from an average
of about £17 million in the first quarter and an average of about
£5 million in prior quarters.
The upward trend in the average buyout value appears set to
continue, according to Belok: “We are seeing increased
interest
from the big beasts, including a number of schemes over £1
billion. These cases are too large for many providers to swallow
whole, so we are advising clients of this size on issues relating
to syndication, coinsurance and the most effective ways of breaking
things down into smaller chunks so that they can then be placed
with more than one insurance company.”
A number of other indicators suggest strongly that the UK’s DB
pension buyout market is set for further significant growth. Not
least of these is the mammoth aggregate pension fund deficit of the
100 largest listed companies (FTSE 100). According to actuarial
consulting partnership Lane, Clark and Peacock (LCP), under
International Accounting Standard (IAS) 19 the aggregate pension
deficit of the FTSE 100 companies stood at £41 billion as at
mid-July 2008, a £53 billion reversal compared with a surplus of
£12 billion in July 2007. LCP noted that only eight FTSE 100
companies reflected no evidence of material DB pension
liabilities.
The huge deficit was incurred despite FTSE 100 company
contributions to DB pension schemes totalling £13.1 billion in
2007. This amount was overwhelmed by what LCP termed “the sheer
scale of movements in equity and corporate bond markets, and the
impact of inflation expectations.”
LCP pointed out that had it not been for IAS19 and higher corporate
bond yields the deficit would have been considerably worse. IAS19
requires that future pension costs are discounted back to the
present day, using discount rates based on yields available on
high-quality corporate bonds.
FTSE 100 companies reporting under IAS19 were able to use higher
discount rates, thus lowering the reported value of their pension
liabilities. Had corporate bond yields pertaining in July 2007 been
used, LCP estimates that the total DB pension scheme deficit would
have been well in excess of £80 billion. As an example, British
Airways disclosed that a 0.1 percent per annum decrease in the
discount rate employed in its 2007 disclosures would increase its
UK pension liabilities by about £240 million.
LCP predicts that increasing numbers of FTSE 100 companies will opt
for the DB scheme buyout route, following the lead set by the first
two, Lonmin and Friends Provident this year. In May, mining house
Lonmin entered into an agreement with buyout specialist Paternoster
to secure its UK DB scheme’s liabilities reported as £66 million at
the end of 2007.
Insurer Friends Provident followed with a deal with Norwich Union
to secure pensioner liabilities of £350 million. LCP noted that
this deal was an example of a solution where a full buyout is out
of a company’s reach. In essence, explained LCP, the Friends
Provident deal involved the buyout of pensioners only with the
scheme retaining the liability to pay pensions and holding the
insurance policy as an asset. Partial buyout schemes of this nature
have come to be termed “buy-ins.”
Aon believes an indication of likely future business levels in the
UK buyout market is provided by the number of quotations being
given. This indicator, according to Aon, reached a record level in
the second quarter of 2008 with 706 cases quoted on, up from 401 in
first quarter of 2008. The total value of the schemes quoted on in
the second quarter was £104 billion compared with £46 billion in
the first quarter.
A boom in the buyout market has seen a rush of new entrants in the
recent past, but not all have stayed the course Belok explains:
“Interestingly, while the volumes transacting are historically
high, we have seen the first casualty in the battle for market
share, with Synesis pulling out of the fray.”
Synesis Life’s departure has, however, been more than countered by
the recent entry of Swiss Re into the market and, believes Belok,
more new entrants may follow.
Concluding, Belok predicted that there will be a “jockeying for
position” in the market and that inevitably some rationalisation of
market participants will occur.
