More life insurers could enter the thriving U.K. bulk annuity market as pension funds increasingly look to sell the liabilities they have with retirees.
Many advisers are expecting 2018 to see a slew of deals for bulk annuities — where a pension scheme pays an insurer to write a policy that pays out retirement income to a chunk of its retirees — after roughly £12 billion worth were completed in 2017. Companies are keen to off-load "defined benefit" pension liabilities, which pay pensioners a set amount for the remainder of their lives, as they are expensive to fund.
Some insurance companies are sitting back and waiting before getting involved, as competition among insurers hots up in the £2.1 trillion market for defined benefit liabilities. In December 2017, Aon Plc predicted that 2018 would be "a bumper year" in which £30 billion of bulk annuity deals would be done, and has since reiterated that view.
'Never seen it as busy'
"We have always shied away from saying: 'It's going to be the biggest year on record' and 'Buy now while stocks last on pricing', but it is really difficult not to be talking about those messages at the moment," Aon's head of risk settlement, Martin Bird, told S&P Global Market Intelligence.
Also speaking to S&P Global, Aviva Plc Managing Director of Defined Benefit Solutions Tom Ground said he had "never seen it as busy as it is now."
Some deals have already been announced. Lane Clark & Peacock said Feb. 28 that it has been the lead adviser to Rothesay Life Plc's £450 million buy-in to the Post Office section of the U.K. Royal Mail's pension plan.
There are more to come soon. Bird said that, in the early part of the second quarter, there will likely be "quite a lot" of announcements of deals that happened during the first quarter.
The price is right
Around £15 billion of the deal flow is expected to be buy-ins and buy-outs. With buy-outs, the insurer assumes the assets and liabilities of an entire pension scheme and the scheme members become policyholders of the insurer. With buy-ins, the pension scheme buys a bulk annuity to cover a segment of the scheme members and the pensioners remain on the pension scheme's books.
The remainder is expected to be so-called back-book deals, where an insurer transfers its annuity portfolio to another insurer. There were no such deals, which are typically large, in 2017 but Prudential is thought to be close to announcing a transfer of roughly £10 billion of its £30 billion annuity portfolio, with Rothesay Life rumored to be in pole position to pick it up.
The market is so active because companies are keen to get defined benefit pension liabilities off their books; they are expensive to fund and expose the company running the scheme to risks such as investment and longevity risk.
Now is a good time for them to do so. The prices insurers are charging are attractive because the long-term, illiquid assets insurers are buying to match the liabilities they are assuming offer good yields compared with pension funds' highly conservative bond portfolios.
For insurers, the bulk annuity market is a rare opportunity for growth in the otherwise stagnant, mature U.K. life insurance market. And although the business is capital intensive, it offers attractive returns. Aviva's Ground said that the return on capital is between 12% and 15%.
The returns on offer have tempted players to market and encouraged existing players to do more.
Aviva, which previously focused on smaller deals, did its first big transaction in October 2017 following Ground's arrival in August, when it took £600 million of a £1.2 billion buy-in for the U.K. pension plan of education and training provider Pearson. Ground said the company has the appetite to do more big deals alongside its typical diet of smaller ones, and has added 35 people to the team since he joined.
Closed life book buyer Phoenix Group Holdings revealed its intention to enter the bulk annuity market when it announced its first half results in August, although it has yet to make its first move, and it is unclear whether its planned acquisition of Standard Life Aberdeen Plc's insurance business will slow its progress.
Waiting in the wings
More insurers and investors are keen to enter the market, but they are waiting in the wings for now, according to Lane Clark & Peacock partner Charlie Finch. He said most view the bulk annuity market as "highly competitive."
"While that persists, some of those will continue to just watch rather than participate," he said.
But he added that if the dynamics begin to change, and demand begin to outstrip supply, more insurance firms will probably aim to enter the market.
Aon's Bird said demand from pension funds has not yet tested the limits of insurance capacity.
But there are some indications it could come close this year, particularly if Prudential's £10 billion back book comes to market. Back books can absorb the capacity provided by an insurer for a year, as happened with Rothesay Life after it acquired Aegon NV's £6 billion back book in 2016.
If demand matched supply and capacity was used up, it would be "probably the first time this has happened since before the banking crisis", said Finch.