In these uncertain times, investment markets across almost all asset classes have become volatile. For most DB pension schemes this will be unwelcome news as both assets and funding are swinging wildly and likely not in the same way. However, for some schemes this type of market volatility creates de-risking opportunities that do not come around very often. Parallels can be drawn with the financial crisis in 2008, where similar market conditions rewarded schemes transacting at that time with record low pricing for buy-in deals. Those that benefited then often did so quite inadvertently and some of those that didn’t were kicking themselves for missing out on the opportunity.
Right now, corporate bond spreads have increased materially. For example, ‘A’ rated UK corporate bond spreads relative to LIBOR are up over a percent. Some of that is due to increases in credit and liquidity risk, and insurers are also passing extra yield through in pricing. Achieving Gilts + 50bps on smaller schemes is very real now and even better than that on larger schemes.
Ignoring mortality for now (more on that later), we are seeing 3% to 4% reductions in insurance pricing for pensioners in payment. This is roughly akin to insurers passing through 0.2% to 0.3% of extra return in their pricing.
Clearly for schemes sat will large exposures to growth assets the reduction in those assets will make the thought of purchasing insurance a non-starter. Schemes that are further along their de-risking journey, especially those who are well hedged and hold a large proportion of their investments in safer assets, the time to accelerate your de-risking journey might be now.
But is mortality a reasons to pause?
Sadly, people are dying, and listening to the media you would be forgiven for thinking it is all because of Covid-19, but how does the current situation compare with normal.
Firstly, over a 1,000 people a day die in England. As I write this the statistics (by the ONS) for the week ending 20 March have been released and there were 10,645 deaths in England and Wales. This compares to an average of 10,573 for the same week over the last 5 years, an increase of 0.7%.
And secondly we need to consider seasonal variations in mortality which can give us a different view on the current crisis, after all schemes do buy bulk annuities in the winter. Deaths are not uniform throughout the year and many more deaths in older people happen during the winter, for example, from catching the flu. The ONS publishes data on this and in the 2018 to 2019 winter period (December to March) there were an estimated 23,200 excess winter deaths (EWD) in England and Wales. This was substantially lower than the 49,410 EWD observed in the 2017 to 2018 winter and lower than all recent years since 2013 to 2014 when there were 17,280 EWD.
The fact is, whether looking at the flu or Covid-19, the number of deaths currently being seen are not likely to have a material impact on a pension scheme’s liabilities. Over half of the deaths from Covid-19 are happening in people aged 80 and over, which is not where most of a scheme’s liabilities are. And to offset the current 3% to 4% reduction in insurance pricing that we are seeing would require deaths to increase against what is expected by 9% to 12%, which is highly unlikely based on current experience.
So, mortality is not a reason to pause.
Time to trade
If the news is right, then as we stand in early April we are heading towards the peak or plateau of deaths. Trading a bulk annuity, even for the best prepared schemes, takes several months so now would be the time to get started. When we get over the peak and restrictions start to be lifted businesses will start to reopen and, in time, the expectation will be that the economic factors making insurance cheaper will normalise. All other things being equal, insurance prices will rise.
Although the experience of trading in the bulk annuity market back in 2008/9 is now a distant memory, I believe that both advisors and schemes are now better placed to assess the opportunity and, for the schemes who can, now is the right time to act.
Adam Davis, Managing Director of K3 Advisory
