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The UK de-risking market. Does size really matter?
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Contents
05
06
04
03
02
01
Foreword
What Next?
Preparatory Steps for Schemes
Access to the market
Buy-in & Buyouts
Longevity risk
Attitudes to risk
We are delighted to share the findings from research we carried out earlier this year in conjunction with Professional Pensions. The de-risking market continues to expand and evolve, with innovation and efficiencies increasing the range of options available to schemes of all sizes.
Our aim was to understand trustee and employer views on the de-risking options available to them. For example, is the full range of options understood and are there any preconceptions about the ease of accessing the options for schemes of different sizes?
You will see from the findings that longevity risk and the options available to settle it are viewed differently by schemes of different sizes. This may be because smaller schemes have less sophisticated hedging strategies for interest rate and inflation risks, and therefore the unhedged longevity risk is not yet a priority. Or it may be because remarks by market commentators have led key stakeholders to believe that the market is not open to schemes of all sizes.
One key message that we would like readers to take away from this report is that there is currently a wide range of de-risking options available to schemes of all sizes. The ways in which schemes of different sizes engage with the market may vary, but no scheme should think they are too big or too small for de-risking to be appropriate and achievable.
I would sincerely like to thank Professional Pensions’ readers for helping us with the research, and I very much hope you will benefit from the insights set out in this report. Please let us know if you would like us to help you 'size up' your de-risking options.
Martin Bird Senior partner and head of risk settlement, Aon
While longevity risk is one of the top concerns among schemes, particularly for medium and large schemes…
… Longevity swaps are rarely seen as accessible by smaller schemes due to their perceived complexity and cost
Smaller pension schemes perceive their size to be a barrier to accessing the insurance market: 27% of small schemes believe a buy-in is a viable option, compared to 62% of large schemes
Yet growing evidence shows insurance companies are both willing and able to consider smaller transactions
With almost half of schemes considering risk settlement in stages, it is important that schemes have a de-risking plan, to maximise insurer engagement and benefit from opportunities
There are several measures trustee boards can and should take to improve their scheme’s readiness for an insurance transfer
The report is based on the findings of a quantitative survey of 100 pension scheme representatives and in-depth interviews with six professional trustees. All references to small schemes mean those with assets of less than £100 million; mid-sized schemes have assets between £100 million and £1 billion; large schemes mean those with assets of £1 billion and over.
About the research
Executive Summary
'There is currently a wide range of de-risking options available to schemes of all sizes'
In 2019, more than £43 billion worth of defined benefit scheme liabilities were transferred to insurance companies.
£43bn
+ See Chapter 01
Chapter 01: Attitudes to risk
In 2020, the COVID-19 pandemic has brought investment and covenant risks to the fore. However, given the long-term nature of pension savings, it is the life expectancy of members – and its effects on contributions, investment strategy and affordability – that remains one of the biggest threats to the ability to pay member benefits in the future, especially for medium-sized and larger schemes.
Risk management is a vital component of running a pension scheme – and schemes have arguably never had access to more tools with which to carry out the task. The insurance market offers several ways in which to mitigate longevity risk, including through longevity swaps, buy-ins, or full scheme buyouts. Solutions that sit outside the insurance market include the ‘new kids on the block’ – commercial consolidators and capital backed solutions – as well as tried and tested methods of de-risking interest rates and inflation through liability driven investment.
The market for risk settlement has exploded in the past two years. In 2019, more than £43 billion worth of defined benefit scheme liabilities were transferred to insurance companies . Despite the challenges posed by the COVID-19 pandemic, appetite among insurers and pension schemes remains high. In the first five months of 2020, Aon had advised on more than £3 billion worth of transactions .
While the insurance market is not going to be the right solution for all schemes, there is a healthy level of interest in accessing the market in the near future. Almost half of the survey respondents believe buy-ins could be part of their de-risking journey, and more than 1 in 5 consider longevity swaps to be an option.
De-risking options – buy-in, buyout and longevity swap
Much has been said about the potential for a future capacity crunch in the insurance market if all schemes look to de-risk at a similar time. The survey respondents suggested that the market may see more orderly de-risking.
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
Buy-in (liabilities partially insured)
Buyout (liabilities completely insured)
Longevity swap
45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
The next 12 months
1 - 2 years from now
3 - 4 years from now
5 - 6 years from now
7 - 8 years from now
9 - 10 years from now
More than 10 years from now
47%
35%
21%
1%
8%
13%
17%
11%
9%
41%
Chapter One Attitudes to Risk
£43 billion £3 billion
1 / 5
High Risk
Low Risk
Investment Risk = 1
Longevity Risk = 2
Biggest threats to ability to pay member benefits in the future, ranked in order of size of risk
Attitude to risk
Hover to reveal
Interest Rate Risk = 4
Covenant Risk = 3
Inflation Risk = 5
Regulatory Risk = 6
Legacy Issues = 7
In 2019, more than £43 billion worth of defined benefit scheme liabilities were transferred to insurance companies .
Almost half of respondents consider buy-ins to be an option.
50%
More than 1 in 5 of the survey respondents consider longevity swaps to be an option.
+20%
Source : Aon 2020 Risk Settlement Market Review. Source : ‘Aon says volatility has driven the widest range of pricing in the bulk annuity market for over 10 years’, Aon press release, 14 May 2020.
Chapter 02: Longevity Risk
Time frame, all schemes
1
2
Data from the Office for National Statistics (ONS) shows that life expectancy in England & Wales generally improved far more slowly over the years 2011 to 2018 than in the previous decade . However, 2019 saw the strongest full-year improvement in a decade.
Source : CMI briefing note, March 2019.
CMI – investigating the numbers
For those considering an insurance-based solution, changes in life expectancy over recent years may have reduced the general cost of hedging longevity risk.
It is too early to ascertain the impact of the COVID-19 pandemic on longevity for the UK population, let alone for pension schemes. The impact of COVID-19 on population longevity over the remainder of 2020 will be influenced by the UK Government's decisions on balancing the restart of the economy with supressing the spread of COVID-19. Other important unknowns will have an influence:
In the more positive scenario, the UK may be over the worst, with the UK's test, track and trace being effective, immunity existing and persisting in those previously infected, and people who survive the initial wave of COVID-19 on average being healthier than the wider population was before the pandemic.
In the more negative scenario, the UK could suffer further waves of COVID-19, immunity could be short-lived and those recovering could suffer ongoing impairments to their health as a result of the disease.
The impact of COVID-19 for pension scheme members will not be exactly the same as for the population as a whole. The spread of the pandemic has not been uniform across the country, with some regions having been particularly badly hit, for example London and the North-West. Also, studies show that the impact of the pandemic has been greater for those in lower socio-economic groups, whereas in general, pension scheme members tend to belong to higher socio-economic groups. However, the direct impact of COVID-19 may be significant for some pension schemes and is worth monitoring.
Longevity insurance
Hedging longevity risk by using longevity swaps can feel complex and daunting – and many schemes believe it is not an option open to them. Smaller schemes in particular tend to feel that the longevity swap market is beyond their reach, or that providers will not consider them for potential transactions.
Longevity swap availability by scheme size
It is easy to understand why size might be seen as an issue with longevity swap transactions, and indeed they may not be appropriate or available for some of the smallest schemes. Most transactions – or at least those that are publicised – appear to take place less frequently than buy-ins and buyouts and are typically worth several billion pounds, although sub-£500 million transactions do occur periodically.
In addition, some respondents commented that a longevity swap appeared to be too complex. Others expressed concerns that to implement one could be 'detrimental' to a future buy-in or buyout if it proved incompatible with other potential insurance partners.
However, there are several examples of insurers being willing to convert longevity swaps into bulk annuities regardless of the initial insurer. Last year, as part of a pensioner buyout deal, Rolls-Royce successfully restructured its £3 billion longevity swap with Deutsche Bank into an insurance policy with Legal & General .
This is just one example of insurance companies investing in innovative ways to provide a wider range of schemes with greater certainty over their members’ benefits.
Source : 'How Rolls-Royce completed its £4.6bn buyout with L&G', Professional Pensions, 20 June 2019.
40% 35% 30% 25% 20% 15% 10% 5% 0%
Percentage of respondents
Small schemes
Medium schemes
Large schemes
5%
36%
Our survey indicated that scheme members living longer than anticipated was the second most cited threat to pension funds’ future ability to pay member benefits – but are they right to worry?
Chapter 02 Longevity Risk
1 - Very difficult 2 3 4 5 - Very easy
7%
12%
48%
26%
52%
16%
33%
Rolls-Royce successfully restructured its £3 billion longevity swap with Deutsche Bank into an insurance policy with Legal & General.
Longevity swap availbility by scheme size
How easy would it be to find providers interested in offering a longevity swap for your scheme?
Chapter 03: Buy-In & Buyouts
£3bn
3
4
Despite the all-time high levels of transactions in the past two years – and record-breaking individual deal sizes – many schemes do not fully understand the range of insurance options that is available to them. This is reflected in schemes’ beliefs on whether a buy-in was an option available to them (less than 4 in 10 of respondents from small and medium schemes thought it was), and the likelihood of achieving full buyout in future (just over one third of respondents felt that buyout was an available de-risking option for them in the future).
Sources small print and graph copy
It is important that schemes recognise that insuring all scheme liabilities in one ‘big bang’ transaction is not necessary. Increasingly, schemes are designing de-risking plans to include several smaller transactions that insure tranches of members, and gradually improve the scheme’s funding position.
As the de-risking market has matured, insurance providers have shown a willingness to provide flexibility to pension funds pursuing this approach. In the past few years, several schemes have worked with multiple insurance companies, ensuring diversification and price competition. The Co-operative Pension Scheme (Pace) is one such example, having now completed four buy-ins in 2020: two deals with PIC of £1 billion and £400 million, and two with Aviva of £1 billion and £350 million .
Some pension funds are now putting in place so called 'umbrella agreements' during an initial transaction, enabling them to lock in prices with providers at an early stage of future transactions, while taking the necessary time to prepare for transfer. Indeed, the fourth Co-op transaction was executed under the umbrella agreement already in place with Aviva, and took under two weeks to complete.
Source : 'Co-op agrees £350m buy-in with Aviva', Professional Pensions, 13 May 2020.
De-risking in stages, all schemes
Buy-in/buyout availability by scheme size
'Is your scheme intending to de-risk in stages? (eg, through several buy-ins as opposed to one single buyout)'
De-risking in stages can be helpful to demonstrate how insurance transactions can pay off in the short to medium term, and it can be easier to become comfortable with each smaller step compared to a decade-long approach to one big transaction.
70% 60% 50% 40% 30% 20% 10% 0%
27%
40%
62%
32%
37%
Buy-in (liberties partically insured)
Buyout (liberties completely insured)
While longevity swaps protect against one significant risk, buy-ins and buyouts can offer protection against many more. Investment, inflation and interest rate risks can all be taken care of alongside longevity risk, as well as potentially securing benefits and reducing the burden on sponsoring employers.
Chapter 03 Buy-In & Buyouts
Yes No - but we considered doing so No Don't know
29%
15%
Deals with PIC completed by The Co-operative Pension Scheme.
£400m & £1bn
Deals with Aviva completed by The Co-operative Pension Scheme.
£350m & £1bn
"
'Over the last decade or so, the market has developed so far that it's not just looking for buyouts at the end, it's looking for gradual risk transfer during the journey. Even some of the larger more sophisticated schemes don't seem to necessarily understand that until they're educated… If you’re going to eat an elephant, you need to eat it in small bites.'
Chris Martin, executive chairman, Independent Trustee Services
Chapter 04: Access to the Market
5
This is compounded by the recent dominance of mega-deals. There were five risk settlement transactions worth in excess of £3 billion completed in 2019, including the record-breaking £4.7 billion buyout of telent’s GEC 1972 scheme by Rothesay Life .
Source : ‘Aon says volatility has driven the widest range of pricing in the bulk annuity market for over 10 years’, Aon press release, 14 May 2020.
Access to providers
Schemes tend to believe that bigger mandates are a more efficient use of an insurer's time and money, ie, that it is more efficient for an insurance company to take on one £100 million scheme, than 10 schemes each with £10 million in assets. In practice, insurers are simply selective about where they deploy their resource and capital. Adequate preparation, and simplifying the process where possible, is essential to make the workload and resource investment attractive to insurers and ensure their engagement – especially for small and medium-sized schemes.
The same is true of longevity hedging; steps that schemes can take to streamline the process and standardise the terms available are vital for them to access the longevity swap market.
These recent high-profile mega-deals mask a far more dynamic insurance market. In reality, some brokers and insurers are now adapting their approach to cater for a growing demand among schemes of under £100 million and aiming to make these transactions as efficient and manageable as possible for all parties.
Behind the headlines, the reality of the market make-up is much more varied. In the first five months of 2020, Aon advised on bulk annuity transactions worth more than £3 billion, within which the smallest transaction was for a £10 million scheme. This demonstrates that even the smallest schemes can access the market – with sufficient advance preparation being even more crucial in periods of volatility . In many cases, Aon has seen smaller schemes achieve prices comparable to the largest transactions.
In recognition of an evolving market for smaller transactions, Aon has further developed its ‘Pathway’ proposition to help smaller schemes appeal to insurers and to help schemes obtain competitive pricing during auction processes. Pathway adopts a streamlined approach to bulk annuity broking, with a tried-and-tested approach to preparation, a quick and robust bidding process and a straightforward execution using pre-agreed contracts. This makes Pathway transactions more attractive to insurers, leading to the likelihood of more competition and better pricing and terms for smaller pension schemes.
In addition, insurers have invested significantly in technology to automate systems wherever possible, streamlining the risk transfer process and reducing both the time and resources required to complete a transaction.
Developments in other areas of the risk settlement market have opened up alternative options too. While it is early days for commercial consolidators, 6% of survey respondents currently consider consolidation an option for their scheme, and it is an area Aon is actively exploring with schemes.
Innovation
'Potential insurers put great store on not wasting time; they want to be certain that when they are asked to bid for a proposition that the trustees and the sponsoring employers are both at one on that. They appear to find it quite draining on their resources to run what they regard as sort of fishing trips to test the waters without any serious commitment.'
David Weeks, co-chair, Association of Member-Nominated Trustees
Many pension schemes – particularly smaller schemes – believe that an insurance-based endgame is not within their grasp. Despite the growth and innovation of the market alluded to earlier, buy-ins and buyouts are perceived as only being an option for the larger schemes.
Chapter 04 Access to the Market
10%
39%
14%
6%
57%
25%
28%
20%
The innovative investment strategy adopted by telent's GEC 1972 scheme was key to the success of its £4.7 billion buyout with Rothesay Life.
high quality credit portfolios remain attractive to insurers.
“You need a dynamic strategy because otherwise you’re not really adapting to changed circumstances.
Many investment portfolios have been hit hard by the market impact of the COVID-19 pandemic
There were five risk settlement transactions worth in excess of £3billion completed in 2019...
...including the record-breaking £4.7 billion buyout of telent’s GEC 1972 scheme by Rothesay Life.
£4.7bn
In the first five months of 2020, Aon advised on bulk annuity transactions worth more than £3 billion.
In reality, some brokers and insurers are now adapting their approach to cater for a growing demand among schemes of under £100 million.
£100m
2020
2021
2022
2023
2024
Don't know
2025 or later
19%
Chapter 05: Preparatory Steps for Schemes
6
7
Source : ‘Rothesay Life agrees £4.7bn buyout of GEC scheme; Biggest ever deal smashes 2018 volumes’, Professional Pensions, 26 September 2019.
1 - Very difficult 2 3 4 5 -Very easy
But this volatility is double edged. While it can lead to attractive pricing opportunities for schemes, they can often be short-lived. This makes it even more important to be prepared to execute transactions when pricing allows.
Undertaking preparation work need not be an arduous or onerous task. Rather, there are several measures schemes can take now to get themselves in the best shape possible so that, should an opportunity to insure emerge, they can move quickly.
Insurers agree that the ability to stand out from the crowd continues to be a key component of capturing the best insurance pricing and terms. To do this, trustee boards need to be able to demonstrate exemplary governance arrangements combined with flexible and nimble project management.
Administration
Preparing for the insurance market
Administration is a core factor in the success of a risk settlement transaction. Do the trustees of the scheme know who their members are and how they can be contacted? Does the administrator have up-to-date records that are in a state to be shared with an insurer? Are the trustees clear on the structure of the benefits they plan to insure?
Accuracy of data: 'How would you rate the accuracy of your defined benefit scheme’s member data?'
The Pensions Regulator has been engaging with schemes to improve data standards and record-keeping . Regardless of how close a scheme may be to an insurance transaction, conducting regular data validation exercises is simply good practice.
In addition, schemes can sometimes find that an improvement in scheme data quality is enough to move them one step closer to a buy-in or buyout. Increased focus from The Pensions Regulator, including guidance released in 2019, means schemes are reviewing their data more frequently than in the past.
Source : ‘TPR begins crackdown on poor record-keeping’, Professional Pensions, 2 October 2019.
Data validation exercises
'When was the last time your defined benefit scheme conducted a data validation exercise?'
'When will your defined benefit scheme next conduct a data validation exercise?'
Investment portfolio
A scheme's investment portfolio can also have an influence on the price of an insurance transaction. In recent weeks, Aon’s analysis of deals and views from insurers has found that insurers' ability to source appropriate fixed income securities – predominantly corporate bonds – has affected their pricing . Having a bond portfolio that is already well matched to liabilities, and which is attractive to insurers, will help a scheme secure a deal.
Asset preparation was critical in a number of transactions over the past 12 months, and Aon continues to see it as a key area of differentiation for schemes coming to market. Aon's experience in 2019 showed that considering the impact of illiquid assets and engaging early with insurers could lead to significantly improved outcomes. The innovative investment strategy adopted by telent's GEC 1972 scheme was key to the success of its £4.7 billion buyout with Rothesay Life .
While it is likely that the current recessionary environment will have a negative impact on credit portfolios, high quality credit portfolios remain attractive to insurers.
Finally, as markets become more volatile, out of market risk during any transaction becomes even more important. Working closely with insurers and considering the use of a transition manager can help to minimise this risk which is often overlooked.
De-risking plan
It is also important for schemes to have a dynamic strategy and de-risking plan in place, so they are less likely to be blown off course in the run up to the transaction. The first and second quarters of 2020 demonstrated this in dramatic fashion. Many investment portfolios have been hit hard by the market impact of the COVID-19 pandemic, while across the economy the shutdown has placed sponsor covenants under enormous pressure.
'You need a dynamic strategy because otherwise you’re not really adapting to changed circumstances. There is no point in saying that we want to get to this place in 10 years’ time if you are running behind and you need more money from the employer – or if you’re getting ahead of yourself and you want to adjust. It needs to be dynamic.'
Ian Pittaway, Senior Partner, Sackers
Member options
Other de-risking exercises can also help schemes improve the profile of their membership and optimise pricing ahead of an insurance transaction. These can include trivial commutation exercises, bulk transfer value or early retirement exercises, or offering a pension increase exchange.
Exploring these options – and communicating them clearly to members – ensures that beneficiaries can have access to the full range of choices for their pension savings and can take decisions appropriate to their individual circumstances. A well-run exercise can result in a significant price reduction on a risk settlement transaction and is often a key step in bringing forward timescales of schemes' journey plans. PA Consulting completed a buyout of its £850 million scheme with PIC, with pension increase exchange and enhanced transfer value exercises being run alongside the transaction to make the deal attractive for both parties .
Source : ‘Aon says volatility has driven the widest range of pricing in the bulk annuity market for over 10 years’, Aon press release, 14 May 2020. Source : ‘Daring to be different to make buyout a reality’, Professional Pensions, 23 April 2020.
Open to opportunities
Working through these steps can help ensure that schemes present a risk settlement provider with a well-run scheme that has up-to-date records and has fully prepared all areas of its operations – governance, investment and liabilities – for transfer. Regardless of whether an insurance transaction is on the horizon, schemes should be taking opportunities to get on top of the operational work.
60% 50% 40% 30% 20% 10% 0%
Before 2016
2016
2017
2018
2019
2%
55%
The recent market volatility has led to a much wider range of pricing for pension scheme buy-ins and buyouts; the spread is wider than has been seen for a decade .
Chapter 05 Preparatory Steps for Schemes
1 - Very Poor 2 3 4 5 - Outstanding
4%
66%
Don't Know
'Getting your house in order now is just a good investment.'
Chapter 06: What Next?
8
9
10
11
12
Source : 'PA Pension Scheme completes £850m buyout with PIC', Professional Pensions, 2 July 2018.
The development of the risk settlement market over recent years has presented schemes with an increasing array of options. Whether schemes want to explore hedging specific risks, such as longevity, or insuring tranches of members through a series of buy-ins, insurers have the capacity and flexibility to meet their needs.
Chapter 06 What Next?
Our research demonstrates that it is vital for schemes to ensure they are fully aware of all the de-risking options open to them. It is clear that many schemes are concerned about risks such as longevity, investment volatility and covenant strength and are uncertain about the best way to manage these to a satisfactory conclusion. Exploring the full array of risk management tools will help keep a trustee board on top of its position as the COVID-19 pandemic and its ramifications play out – and prepare them to face the next challenges.
The limitations of size that were barriers to the insurance market just a few years ago are no longer present. The market is open to schemes of all shapes and sizes.
While the 2020 risk settlement market is affected by the uncertainty arising from COVID-19, there may be opportunities to transact at attractive levels later this year, or early next year. It is therefore more important than ever that schemes are ready to seize the opportunities when they arise.
Get in Touch
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Karen Gainsford Principal consultant karen.gainsford@aon.com
David Thompson Principal consultant david.x.thompson@aon.com
Carly Bryan Senior consultant carly.bryan@aon.com
This article is intended for professional clients and is for informational purposes only and should not be construed as a specific recommendation. Aon Solutions UK Limited is authorised and regulated by the Financial Conduct Authority. Registered in England & Wales. Registered No - 04396810. Registered Office - The Aon Centre, The Leadenhall Building, 122 Leadenhall Street, London EC3V 4AN
