For much of the past decade, the annuities market looked to be heading towards becoming a historical footnote as low interest rates made their guaranteed incomes look meagre, as investors sought out corporate bonds, equities, private crowd-funded lending – literally anything to generate the income on invested capital that annuities could not. Now that interest rates in the UK are marching upwards, the attraction of the guaranteed income that annuities offer has caught the eye of pension fund managers, with follow-on benefits for providers of bulk annuities in the life assurance industry and the companies looking to offload pension liabilities after years of having to support underfunded defined-benefit pension schemes.
At this point, shifting everything into a bulk annuity becomes feasible and, like the equivalent annuity for an individual investor, guarantees a stream of income so that the scheme can meet its obligations. This is clearly easier to do when interest rates are higher. The Prudential Regulation Authority (PRA) noted the rise of bulk annuities earlier this year in the context of risk management, with insurers writing larger volumes of business as pensions funds moved into surplus. "To be successful in both over the medium to long term, insurers’ senior managers need to exercise moderation in the short term," said Charlotte Gerken, the PRA's executive director for insurance supervision. "Their decisions today commit them and their successors to pay pensions for many decades to come."
BP (BP.) is the latest high-profile pension scheme to explore shifting its liabilities onto the bulk annuities market. Recent reports say that the company is in discussions over a buy-in for its mammoth £30bn pension scheme. If an agreement is reached and a buy-in takes place, it will be the biggest in the history of the annuities market.
Until recently, the single-biggest deal was the £6.5bn transaction between Pensions Insurance Corporation and RSA (RSAB).
A big year for annuities
Legal & General’s (LGEN) recent trading update said the pipeline for 2023 is “the largest we have seen and we are on track for one of our busiest years ever”. The insurer had already completed £5bn of annuity transactions by the end of the half. The sales of individual annuities are less dramatic in monetary terms than for whole pension schemes, but LGEN reported that total new business for individual annuities was still 27 per cent higher at £575mn.
Even a smaller player such as Just Group (JUST) wrote £3bn of new business last year in the £100mn to £1bn pension transfer bracket. Just’s management also points out that demographic changes for retiring pensioners will mean £1tn of defined contribution-schemes coming to maturity by 2030 and taking over from defined-benefit schemes as the main driver of annuity sales.
While it is easy to understand why companies would jump at the chance to get pension liabilities off the balance sheet, the attractions of annuities for individual investors are trickier to weigh up. The guarantee of a source of income until the autumn of one’s years has a certain attraction, but annuities can be both restrictive as to when they pay out and expensive in terms of annual fees, which can range anywhere from 0.25 to 1 per cent a year. And, unless death benefits have been agreed in some form, the money cannot be passed on to relatives.
From an investor’s point of view, the paradox in the current market is why the prospect of record-breaking high pension transfer fees has failed to translate into a price recovery for life insurers so far this year – share prices are either down or flat. While it is true that the liability-driven investment (LDI) debacle in the autumn has contributed to investor aversion, the wariness of the Bank of England over developments in the bulk annuities market might also be a contributory factor.
The improvement in interest rates is a boon for insurers, as with pension funds, with improved capital ratios generating excess capital that must be deployed in an expanding bulk annuities market, into which new entrants are starting to expand and make their mark.
The new business models are increasingly credit-focused. In other words, companies are more exposed to credit cycle risk that could cause several reinsurers/insurers to experience problems at the same time when a downturn hits. The bank’s other point to consider is whether new liabilities can be matched effectively with sufficient capital. The main problem here is the valuation of corporate bonds that have seen their yields rise as interest rates have risen, which can create “mark-to-market” pricing problems for insurers.
As the year progresses, investors will be able to better assess whether the risk of taking on someone else’s pension liabilities is worth the hassle for the life insurers, with the forthcoming results season offering more answers.
