Covid-19 – what are the implications for the bulk annuity market?

Estimated reading time: 6 minutes

At start of this year the bulk annuity market was setting itself for another busy year building on the record levels seen in 2019, with further strong demand from pension schemes looking to insure some or all of their pension liabilities. How has this market fared during the Covid-19 crisis? What does this mean for schemes and sponsoring employers? 

Pricing improved during March and April, relative to a gilts valuation measure compared to the start of 2020, with a number of schemes already in the market being able to take advantage of this opportunity. Well-hedged schemes may continue to see that insurer pricing looks relatively attractive for insuring liabilities, particularly for shorter duration liabilities (e.g. pensioners), compared to a gilts liability measure. 

The chart below illustrates the movement in pensioner pricing since the start of 2019. The dark green line shows the implied yield for a pensioner buy-in relative to a portfolio of gilts. Actual insurer pricing achievable may vary significantly depending on the commercial circumstances and specific transaction characteristics, as indicated by the green shaded area.

Chart - Bulk annuity pricing for pensioners

Covid-19 is likely to raise some challenging questions regarding longevity risks. Our longevity blog noted that the CMI has recently indicated that there may have been over 40,000 more deaths to the end of April in the UK than would have been expected without the coronavirus pandemic, based on ONS information.

Whilst 2020 has the makings of an exceptional year for mortality experience, it doesn’t necessarily mean that schemes’ future longevity expectations will be reduced. A watching brief is likely to be the name of game for trustees and sponsors in the short term, albeit with targeted analysis to aid understanding of their longevity risk exposures when considering transactions.

Pricing opportunities for the “right schemes”?

Insurer pricing is only one aspect in considering transaction opportunities. Focusing on partial transactions in the first instance, it is important to look holistically at the scheme and sponsor’s position, taking into account the wider funding and investment strategy. Our four point framework for identifying buy-in transaction opportunities can help here: 

Improved insurer pricing relative to gilt returns may help the first couple of these tests be met. The question of “flexibility” is arguably of increased relevance in the current environment. By taking stock of the scheme and sponsor’s circumstances, it is possible to explore whether the scheme may be better served by maintaining flexibility in their investment strategy and not investing in a buy-in policy, or possibly re-considering the size of any proposed transaction.

It could make sense to preserve flexibility, for example, where any transaction would overly constrain the potential investment strategy for the remaining scheme assets in the post-Covid-19 world. Further for schemes holding risky assets, investing in a pensioner buy-in at this time is likely to mean that a higher portion of their assets would be passed to the insurer to fund the transaction due to recent falls in equity and property markets, compared to a pre Covid-19 crisis buy-in. Schemes and sponsors should consider whether the buy-in is still attractive in these circumstances, even if insurer pricing relative to gilts looks reasonably attractive. 

Turning to full scheme transactions, for well-hedged schemes who have largely de-risked their assets, the solvency position may have improved due to the potential improvements in insurer pricing, particularly for the premium to insure pensioner liabilities. Insurers’ investment strategies for deferred liabilities are more nuanced given the variability and shape of those cashflows, in particular the duration of corporate bonds typically being too short to match these longer tail liabilities without significant reinvestment risks. As such, full buy-in pricing is more variable between insurers and heavily reliant on the individual insurer’s ability to source suitably matching assets. 

While credit spreads are slightly elevated, compared to the levels at the start of 2020, there is still significant potential for market volatility. This means that the stage is set for possible future pricing opportunities to arise. It is important to recognise that these can be short-lived, which can encourage insurers and schemes to move quickly to secure deals. As a result, well-hedged schemes may wish to review their solvency position and consider whether getting ready to pursue a transaction may have merit. Such preparations can support a rapid approach to market and speedy execution.

For schemes looking to insure liabilities in the short to medium term, these preparations will be required in any case, and so prioritising actions even if an opportunity isn’t immediately on the cards may be beneficial, in order to be in a position to take advantage of any opportunities as and when these arise.

As always, preparation is key in order to be in the right place at the right time.