The increasing popularity of insurance companies taking on UK pension funds' assets and insuring their liabilities via buyouts and buy-ins appears to have pushed longevity swaps to one side. Are UK pension fund trustees now looking at the option in a new light?

"Awareness of greater liability risk at DB schemes has been increasingly pushing sponsors towards drastic solutions like buyouts", says Charles Magoffin of legal firm Freshfields Bruckhaus Deringer. The experience of pension funds seeing other schemes successfully complete buyouts and downward price trends also appear to have helped make buyouts a more popular solution than longevity hedging, he adds.

The market is no longer 'mothballed', he says, with many schemes that were not in a financial position to complete a buyout in the wake of the financial crisis now back in surplus and thus able to purchase the solutions.

"There is also a feedback effect as buyouts become more of an accepted norm", adds Magoffin.

While longevity swaps are still a popular option for large schemes, Jay Shah of the Pension Insurance Corporation (PIC) has not seen a deal he sees as "sizeable" in that market over the last year or so. The insurer's co-head of business origination adds that "a longevity swap can leave you in a more difficult position, as despite removing that longevity risk it subsequently becomes quite difficult to do a buyout and you are then locked into that solution."

Increasingly attractive pricing, spurred on by competition between six major providers, is seen by both experts as a force that has opened up the possibility of buyouts and buy-ins towards the "top quartile", in Shah's words.

Although a new report from PensionsFirst says many large schemes now back in surplus are missing out on an ideal time to de-risk, Shah points to a series of "FTSE-100 equivalent" firms whose pension funds have completed buyouts with PIC in recent years. Cadburys, Boots, Honda and Panasonic all get a mention, as does the London Stock Exchange, whose £200m buy-in was announced just last week.

Innovating up the agenda

The London Stock Exchange buy-in is a "landmark transaction" for Shah that is illustrative of the increasing innovation on offer in the market. It takes the form of a partial buy-in with £158m paid to insure the payments for scheme members who have already retired and £45m pledged for the future to cover liabilities associated with members retiring within the next five years. This marks a "staged path to full buy-out", says Shah.

Innovation has also resulted in deferred premiums being offered in a buyout for the first time when the 700 members of the Arnold Laver Pension Scheme had their £43m combined liabilities insured by PIC in September 2010. Payments are to be spread out over five years as the scheme was in deficit at the time of the deal.

Shah explains that "we are increasingly seeing that schemes and sponsors want to lock down a deficit, so that it doesn't get worse, without having to fund it immediately."

Other pension schemes have thrashed out deals with insurers that look a couple of steps further into the future than has traditionally been the case. Magoffin recently advised on a buyout deal which saw a small pension scheme (Radius Systems) taking the rare move of closing to future accrual and enter into a buyout at the same time (with Rothesay Life). This indicates that pension funds are becoming keener to opt for the insurance-backed buyout guarantees as soon as possible, rather than try cheaper, less comprehensive de-risking solutions first.

Greater investor attention to pension liabilities has also forced some sponsors to proactively engage in buyouts when undergoing major structural changes – for instance the buyout of the Emap scheme in 2007 that allowed the publisher to be bought by Apax partners.

Both Shah and Magoffin stress that trustees are becoming more sceptical of sponsors' capabilities to insure schemes, with the latter saying that "trustees are much more conscious, in their role as major creditors as holders of corporate debt, of the materiality of the issues they are facing and the strain that the sponsor is placed under in managing the liability of a pension scheme".

Challenges

Shah is highly confident that the buyout and buy-in market will continue to develop apace, saying "trustees have got past the denial phase where they used to get a quote and say 'that's ridiculous, that doesn't represent our liabilities' but now the response is 'ok, we understand that's a fair benchmark, perhaps fairer than our funding assumptions. So let's do everything we can to bridge that gap.' "

Shah adds that despite better prices, completing a buyout at the right time is absolutely crucial, saying that "the key thing is how the price reacts to market conditions. All too often we have seen deals fall away because whilst looking to reduce the price by 0.5%, the scheme assets have fallen in value by a more significant amount."

He says: "While trustees are agonising about whether they have the best price or if their data is clean enough the big elephant in the room is the movement of external markets", that can make affordability vary as much as 20% within a six-month period, according to PIC research - in all likelihood a wider margin than between quotes from insurers. 

Magoffin feels that longevity swaps and buy-ins are still more attractive than buyouts for the very largest schemes "just because of the sheer scale of the liabilities and costs involved. One reason why we have seen the popularity of longevity swaps is that they allow for more flexibility in the assets that underlie the transaction, which can drive down costs and pave the way for more of these transactions to occur."

He points out that when a scheme gets up to around the £1bn pound mark it gets less defensible to complete a buyout unless something really radical happens to the company.

"I would though expect more buyouts in the medium section of the pensions market of schemes with several hundred millions pounds of liabilities."

First published: 18.05.11

dbillingham@wilmington.co.uk