Over the last five years, I’ve keenly watched these solutions develop. They seemed to be gaining momentum at the same time that I was founding K3. In fact, my first industry event on founding K3 was Clara’s launch party. Fast forward five years, K3 have completed 65 insurance transactions, whilst the superfunds are only just leaving the starting blocks.
So now that these solutions are finally getting off the ground, is this a new dawn in pension scheme de-risking?
I’m more certain today than ever that these solutions have their place in this market.
The most basic example of why is probably that some sponsors of DB schemes will go bust. In this scenario, members will almost certainly end up receiving lower benefits than they were originally promised, either they will receive PPF compensation or a “PPF+” insurance buyout. That feels like an unnecessary (and frankly wrong) lottery that the UK population with DB benefits must take part in.
Although it is very good news that these alternative solutions seem to be up and running, let’s not forget that it’s taken too long for this solution to gain regulatory approval, and in that time many members who could have transferred to a superfund, or been part of a capital backed journey plan have had their benefits cut instead.
The vast changes in market conditions, primarily the higher interest rate and inflationary environment we now live in, have led to improved funding positions for a large number of schemes. At K3 Advisory we’ve really seen the impact of this, with record numbers of schemes, primarily smaller schemes, in a position to approach the insurance market. Our own research suggests that as many as 1,000 schemes may now be fully funded to buyout, and at least that number again may now be within cheque-writing distance of an insurance transaction. However, as was noted in a recent interview we saw by Simon True, Clara’s CEO, these changes in conditions were “devasting” for Clara as they found themselves talking to the wrong schemes, as many schemes in their pipeline could now afford insurance.
There are a number of areas where we see these solutions playing a part:
- The scenario outlined above where the sponsoring employer is weak or tending to weak and there is material uncertainty as to whether a scheme can reach buyout before an insolvency event of the sponsor.
- The insurance pipeline is vast, and there are certainly still question marks over the insurance markets capacity to provide all these schemes with insurance policies. As I sit writing today, K3 have never failed to secure interest from the insurance market and have had success in creating competitive processes for even the very smallest of pension schemes. Following M&G’s re-entry to the market earlier this year, we also expect multiple insurers to enter this market in 2024 and so capacity should be better than ever. However, there are definite signs that some insurers ability to provide quotations is slowing down, and a concern that there could be a danger that insurers are storing up problems for the post transaction stage – it feels inevitable at the moment that buy-in to buy-out periods will become longer – something we’re keen to avoid for our clients. These alternative solutions may well play a part in helping with capacity in the de-risking market.
- Lastly, there’s an interesting middle ground with schemes that aren’t able to afford buyout in the near term, and who don’t have an immediate concern with sponsor covenant. If their end game is an off-balance sheet solution, there is a question as to whether they target buyout with a plan B to bail to an alternative solution if covenant becomes an issue or start with the target of a superfund or capital backed journey solution.
This last option brings to the table a key unanswered question on the long-term sustainability of the superfund or capital backed journey plan, and that is how much lower is the entry price for these solutions compared to that for an insurance contract? The first few deals won’t answer this question. I was once a founding member of an insurance company, and it is standard to offer “special” pricing to get your first few deals completed. Clearly, I don’t know what was offered in these recent alternative solutions, but I’d be staggered if the providers didn’t push the boat out on their pricing. That means a lower expected return on equity for the backers, some of which are private equity companies. That won’t be sustainable in the longer term and pricing will have to normalise. When it does, it will be interesting to see if there is clear daylight between the pricing for these solutions and insurance – I think the jury is out on that for the moment!
Adam Davis – Managing Director, K3 Advisory
