The bulk annuity market in 2021 started off relatively slowly – while market volumes exceeded £30bn in 2020, fewer than £2bn of deals had been disclosed by mid-May 2021. However, activity increased dramatically over the second half of the year, with volumes estimated to have exceeded £30bn for 2021 as a whole.

In this blog I wanted to share thoughts on why so many trades are happening, the trends we have seen and to take out our crystal ball and suggest how we think 2022 will pan out.

Continued high transaction volumes are not surprising when we look at how pension scheme funding levels have changed. The recently published 2021 version of the PPF’s Purple Book shows that the aggregate buyout funding ratio increased by almost 18 percentage points between 31 March 2012 and 31 March 2021, with 2021 figure being the highest ratio since the PPF was established in 2005.

The recent increase in funding levels, which has broadly continued since 31 March 2021, has been driven in part by strong growth in asset returns (as at 31 December 2021, the FTSE 100 Total Return Index was up 18% over the previous 12 months – Source: Financial Times) and an environment of increasing interest rates (as at 31 December 2021, the FTSE 15 yield gilts yield index was up 61 basis points over the previous 12 months – Source: Financial Times).

This change in the economic environment is one reason why we believe there are many schemes which could also transact but are not aware of it. Smaller schemes, especially, might only be updated on their funding position infrequently, perhaps only every three years when a full actuarial valuation is undertaken. This is an area where the pensions industry needs to do better.

Buyout funding estimates also often do not allow for the dynamic nature of insurer pricing and become quickly outdated, meaning trustees may not recognise the gap to buyout could be smaller than they think.

Over the last few years, not only have market conditions become favourable, but membership activity has been high as many schemes have seen higher than normal levels of transfers out. This typically leads to improvements in buyout funding levels.

This effect is clear in our experience in 2021. Eight of the 13 scheme buyouts K3 led in 2021 were in surplus, with two of these schemes having a buyout funding level exceeding 125%! Each of these schemes overshot the mark and that can create a trapped surplus for sponsors.

Further it is notable that only three of K3’s transactions in 2021 were buy-ins, i.e. the vast majority of transactions were full scheme buyouts.

Our experience has also shown that schemes (especially sub-£10m schemes) are often led to believe that no insurers will quote for their scheme. However, insurers will quote for schemes if you can give them simplicity and certainty. Seven of K3’s transactions in 2021 were sub-£10m and three were sub-£5m. In some of those cases, multiple insurers provided quotations. So from where we are sitting the small scheme market looks alive and well.

It is clear from the PPF’s Purple Book that de-risking across the board continues and more schemes then ever have an asset strategy that at least to some extent protects them from market shocks, in particular in hedging interest rate and inflation risks. Schemes have reduced their allocations to equities on aggregate and more to “matching” investments, which all leads to more stability in buyout funding levels.

As a consequence, we expect demand for buyouts (and buy-ins) to remain strong in 2022, and less than ever susceptible to market shocks, and therefore for market volumes to remain in excess of £30bn, with potential for this to be much higher, depending on whether the market sees more £1bn plus, “jumbo” transactions in 2022.

Add to this that recently Clara Pensions has become the first commercial consolidator to have its assessment completed by The Pensions Regulator, we expect to see the first transactions in this new market early in 2022 and for this to further fuel the de-risking of schemes over the coming years.

Given the large change in funding levels seen and from our own experience of helping schemes, we would urge trustees and sponsors of schemes of any size to make sure they have a robust estimate of where their scheme stands relative to buyout and commercial consolidation options, so they can start to take the right steps to de-risk.

A successful bulk annuity transaction requires good planning and often there is significant work on data, benefits and assets that is needed before it can be achieved. Trustees really don’t want to have to start this work when they should be transacting, so they should take the first step now and get up to date on their funding position.