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The End Game? An analysis of the bulk buy-out market and other de-risking solutions

With a large number of players entering the UK pension bulk buy-out market in recent times, there has been considerable press speculation surrounding this market, with some commentators expecting to see rapid growth in this area. This report, by Richard Jones FIA, Martin Hunter and Oliver Herbert of Punter Southall Transaction Services, seeks to set out the current state of the annuity business, including the details of the environment in which it operates, the risks faced by insurers and a discussion of current pricing levels. It also discusses each of the current players in the market and describes the annuity purchase process, as well as looking at the buy-out decision from the perspective of the sponsoring employer. It then considers alternatives to buy-outs offered by the market, as well as other de-risking solutions available to pension schemes and their sponsoring employers.

Key Findings

• The buy-out market amounted to slightly under £3 billion in 2007 which is very small in relation to the £50+ billion capacity of the market and the growth of the £800 billion of UK private sector pension liabilities (estimated at £28 billion per annum). It is exceedingly unlikely that buy-outs will increase to such a level as to start to reduce the size of UK private sector pension liabilities.
• Nearly all the business in 2007 was written by just two insurers (Legal & General and Paternoster) despite the large number of new entrants in the market. Some high profile new entrants, such as Synesis Life, have yet to write any annuity business.
• People considering buy-out need to understand that a bulk buy-out does not provide a guarantee to the benefits, but reduces the risk of a shortfall. However, there remains a not insubstantial risk of members not getting full benefits due to the insolvency of the insurer.
• All life insurers are regulated by the FSA and subject to a restrictive regulatory regime. This regime, combined with insurers’ profit requirements, severely limits the price that insurers can charge. The new entrants do not have a “magic bullet” that allows them to change the pricing dynamic.
• Differences in mortality assumptions between company accounting and insurers’ pricing only account for around 25% of the additional cost of securing annuities – the majority of the difference is driven by insurers’ profit requirements.
• We, along with many market participants, believe that high levels of price competition are leading to insurers accepting very low returns on capital in order to ensure new business. This cannot continue forever and therefore prices are likely to rise in the future.
• The key consideration in selecting an insurer should be price, as the long term nature of the contracts makes extrapolating capital strength, strategy or service levels impossible. Pensioners are often perceived to be a “cheap” buy-out option, since the premium payable to insurers is lower than for deferred pensioners. However, this simply reflects the significantly lower level of risk presented by pensioners, and as such they are not genuinely cheap.
• Whilst all companies have a price at which they would willingly transfer their scheme to an insurer, the current pricing, even allowing for the discounts currently available, is uneconomic for the majority of sponsors.
• Other alternative solutions also exist, the most interesting of which is sponsor covenant insurance from BrightonRock.
• We think it is extremely unlikely that the current noise around buy-out solutions will lead to the rapid growth of the market predicted by some market participants.

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The Punter Southall Group was founded in 1988 and provides a unique range of financial Services that includes actuarial consulting, employee benefits consulting, independent financial advice and investment Services for pension funds, corporates and individuals. It is one of the few companies that can provide both corporate and private pension advice under one roof.