UK insurers’ £350 billion challenge

The country’s 100 largest listed companies (FTSE100) began the
month with what consultancy Watson Wyatt estimated at a combined DB
pension scheme deficit of £12 billion ($21 billion). By the end of
the month Watson Wyatt estimates that the deficit had swung into a
surplus of £30 billion.

During the month influences far more significant than a plunging
equity market were at work, explained John Ball, Watson Wyatt’s
head of defined benefit consulting.

“During the month, expected future inflation as implied by gilt
yields fell, reducing the projected payments that pension funds
will need to make in future,” said Ball. “Furthermore, because AA
[rated] corporate bond yields are used to convert a stream of
projected payments into a single liability number, significantly
higher AA corporate bond yields have made these liabilities appear
smaller.

“So, as far as the accountants are concerned, FTSE 100 pensions are
back in surplus. However, what will matter more to most companies
is the attitude of their pension plan trustees, who are unlikely to
take such a sanguine view of the current position.”

And indeed trustees do not appear to be complacent judging from the
rising level of activity in the DB pension scheme full buy-out and
partial buy-in (pensioner liabilities only) market. Deals valued at
a total of about £7 billion were executed in the first nine months
of 2008, up from £2.9 billion in 2007 as a whole and £1.7 billion
in 2006.

Deal size also appears to be rising, with ten deals between April
and September valued at well over £100 million reported. In the
largest, Prudential secured a buy-in deal in which it insured £1
billion of the final salary pension liabilities of UK
communications company Cable & Wireless’ superannuation fund.
In addition one major buy-in involving £500 million pension
liabilities of technology company Smiths Group was split equally
between insurers Paternoster and Legal & General.

Notably, eight of the £100 million-plus deals were buy-ins in which
trustees hold an annuity policy as a scheme asset and receive
payments from an insurer which match the benefits they pay
out.

“There are good reasons why pensioner-only deals have been
popular,” said Steven Dicker, a Watson Wyatt senior consultant.
“Higher corporate bond yields at short durations have made them
more affordable relative to bulk annuities for all members and many
companies are looking to de-risk their pension liabilities in
stages rather than pay the full cost of a buy-out up front.”

But whatever the chosen route, there is broad agreement that the UK
buy-out/buy-in market is on a rapid growth path. Indicatively, a
recent survey of trustees undertaken by consultancy Hymans
Robertson revealed that 31 percent expect their scheme will be
bought out within the next decade.

This, stresses insurer Pension Corporation (PC), will place major
demands on existing capacity which it estimates could support up to
another £25 billion of buyout transactions.

Based on the private sector’s buyout liabilities of about £1.2
trillion, if 31 percent of these transact over the next decade
nearly £350 billion of additional capacity will be needed,
estimates PC’s senior quantitative analyst Amarendra Swarup.

He also noted that much of the additional capacity – almost £250
billion – will be required within the next three years if current
levels of demand are to be met. Adding to this challenge, he
estimates that £30 billion of additional solvency capital will be
required.

For good reason it seems PC’s executive vice-chairman John Coomber
commented: “I believe we are witnessing a paradigm shift in the
pensions’ industry.”